Cost Centre

A cost centre is a centre or a section of the business, to which cost can be charged. It is a
segment of business activities or area of responsibility for which costs are ascertained and are
used for cost control. It is also known as 'Responsibilities centre'.

According to CIMA, London, Cost Centre refers to "a location, person, or item of equipment
(or group of these) for which costs may be ascertained and used for the purpose of control."
Thus, a cost centre refers to a section of the business to which costs can be charged.

Analysis of above definition reveals that a cost centre may consists of:
 A location like department, a section or a division.
 A person like sales manager, marketing manager, customer and operator etc.
 An equipment like machine, delivery van, truck etc.
 A group of these like 2 machines run one by one operator in the production department.

Types of Cost Centre:

Cost centre may be classified into following categories:

1. Location or Area Cost Centre:

A location or area cost centre is one which consists of a department or a section or a division
of the business organization.
Example:
Production department, sales department, accountant section, repairing section, marketing
division, computer division etc.

2. Personal Cost Centre:

A cost centre which consists of a person or a group of a person is called personal cost centre.
Example:
A customer, an operator, a clerk, an accountant, a manager etc.

3. Machine Cost Centre:

A cost centre which consists of equipment or machine or a group of these, is called machine
cost centre.
Example:
Truck, delivery van, crane, building, machine etc.

4. Process Cost Centre:

A cost centre which consists of a process or operation or a service of a continuous process, is
called process cost centre.
Example:
Process A, process B, Process C, process D.

5. Service Cost Centre:

A cost centre which consists of a service and not any product, is called a service cost centre.
Example:
Hotel service, transport service, communication service etc.
6. Production Cost Centre:
A cost centre which consists of a production of a factory, is called a production cost centre.
Example:
Melting shop, welding shop, finished shop etc.

7. Mixed Cost Centre:

A combination of production and service cost centre is called mixed cost centre.
Example:
Repairing section may sometimes be asked to produce equipment besides rendering repairing
service.

Cost Unit
A cost unit is a unit of measurement of cost. It is the basic of measuring the cost of a product
or service. It refers to a quantity or a unit of product, unit of service, unit of time or a
combination of these with relation to which costs are ascertained and expressed. One of the
objectives of cost accounting is to find out the total cost and the unit cost of a product or service.
In order to find out the cost per unit of a product or service, it is necessary to express them
through physical measurements like numbers, weight, liter, time, area, meter etc. This physical
measurement through which the unit cost of a product or service is expressed is called as cost
unit.

According to CIMA, London, ' A cost unit is an unit of product, service or time in relation to
which costs are ascertained or expressed.'

Hence a cost unit may include:

 A unit of service like; cost per bed, cost per shift.
 A unit of product like; cost per car, cost per cycle etc.
 A unit of time like; cost per hours, cost per day etc.
 A unit of weight like; cost per kg, cost per liter, cost per ton etc.

Types of Cost Unit:

There are 2 units of cost units viz. single cost unit and multiple or compound cost unit.

1. Single Cost Unit:

When only one unit measurement of cost is used to express the cost, it is called single cost unit.
Example:
Cost per kg, cost per liter, cot per hour etc.

2. Multiple or Compound Cost Unit:

When two or more unit measurements of costs are used to express the cost, then it is called
multiple cost unit.
Example: Cost per passenger-mile, tone-km, kilowatt-hours etc.
Some Important Cost Units:
Industry/ Product Cost Unit
Automobiles (motor car) Per car
Television Per TV set
Cement Per bag/ tone
Telephone Per call
Bricks Per 1000 bricks
Canteen Per meal
Paper Per kg
Coal, iron, minerals etc. Per tone
Chemical Per liter/ Per kg
Hospital Per bed
Hotel Per bed/ room/ day
Transport Per km
Electricity Per kilowatt, per Hours
Pencil Per dozen
Petrol Per liter/gallon

Difference between Cost Unit and Cost Centre:

Cost Unit Cost Centre
Cost unit is the unit of product, service or Cost centre is a location, person or item of
time in relation to which costs are equipment for which costs may be
ascertained. ascertained and controlled.
Cost unit is a part of the output produced or Cost centre is a part of the whole
service rendered. organization.
A single product has only one cost unit. An organization producing a single product
may have more than one cost centre.
It is used after cost are allocated to cost It is used before the use of cost unit.
centre
It is used for computing cost in smaller parts. It is used for allocation and apportionment of
example: kg per liter etc. cost.
 Element of Total Cost:
The total amount of expenditure incurred to produce or to render a service, is called its 'total
cost'. The constituent part of the total cost based on some common factors, is called the
elements of total cost. In fact, the total cost can be divided into certain categories on the basis
of some common factors. Each such category is called its elements.

The elements of total cost can be expressed in the form of the following chart.

Total Cost

Material Cost Labour Cost Service Cost

(Other Expenses)

Direct Indirect Direct Indirect

Material Cost Material Labour Labour cost
Direct Indirect
Expenses Expenses

Indirect Cost
Direct Cost Or
or Overhead Cost
Prime Cost

1. Material Cost:
The substance, from which the product is produced, is called 'material'. The cost incurred in
buying and holding the materials, is called 'material cost'.

According to CIMA, London, ' material cost is the cost of commodities supplied to an
undertaking.' Material can be classified into 2 categories viz. direct materials and indirect
materials.

(a) Direct Materials:

The materials which directly enter into the production and which form a part of the finished
product, are called 'direct material'. Such materials can be easily identified with the finished
product. The cost incurred for buying and holding the direct materials, is called 'direct material
cost'.
Example:
Wood for a table, sugarcane for sugar, leather for shoe or leather goods, cotton for garments,
Lime for chalk, Primary packing materials like wrapper, pouches, cardboard, boxes. Any other
materials specifically purchased for any job, process or contract like glue for book binding.

(b) Indirect materials:

The materials which don't form a part of the finished product and are consumed indirectly in
the course of production are called 'indirect material'. In other words, materials other than direct
materials are called 'indirect material'. Such materials don't form or are not identified with the
finished product even if they do; they are ignored because of their less significance. The cost
incurred for indirect materials, is called 'indirect material cost'.

Example:
 Items of comparatively small value which formed a part of the finished product like
bottoms, pins, nuts, bolts etc.
 Items which don't form a part of the finished product like coal, glue, fuel, lubricating
oil, soap paper, cleaning materials etc.
 Secondary packing material
 Small tools and equipment used in production
 Sundry store items used in a factory

2. Labour Cost:
The physical or mental effort of the human being put him to produce a product or to render a
service, is called 'labour'. The human beings, who put these efforts, are called 'labourer' or
'workers'. The reward or benefit given to the labourers for their labour is called 'labour cost'. It
is the cost of remuneration (i.e., wages or salaries, bonus, commission etc.) given to the workers
at a work place. There are 2 types of labour viz. direct labour & indirect labour.

I. Direct Labour:
The labour expended in attraction of raw materials into finished product, is called 'direct
labour'. The workers who help in changing the composition, configuration, construction and
condition or shape of the raw materials are called 'direct labourers or direct workers' The reward
or benefit given to the direct workers is called 'direct labour cost' or direct wages'.

Example:
 Carpenters in a carpentry shop.
 Tailors in tailoring shop.
 Weavers in a textile shop.
 Printers in a printing shop.
 Bakers in a bakery.
 Welders, painters, shapers in an engineering shop.
 Drivers & conductors, loaders in a transporting business.
 Factory or plant workers doing productive work.
II. Indirect Labour:
The labour other than direct labour is called 'indirect labour'. In other words, the labour
expended in rendering ancillary service, are called 'indirect labour'. The workers who don't
produce anything but render service indirectly to production, are called indirect labourers or
'indirect workers'. The reward or benefit given to the indirect workers, is called 'indirect labour
cost' or 'indirect wages'.

Example:
 Time keeper
 Store keepers
 Security personnel or watchman
 Administrative or office staff like clerk, manager etc.
 Peon, foreman, supervisor, inspectors, cleaners etc.

Note:
I. Sometimes indirect labour cost may be treated as direct labour cost.

Example:
If a foreman or supervisor or inspector is in charge of a number of jobs, then it is called indirect
labour cost. But if the foreman or supervisor or inspector is in charge of a specific job, then it
is treated as direct labour cost.

II. It is also possible to treat direct wages as indirect wages.

Example:
Overtime wages, extra shift allowance, idle time wages of the direct workers are treated as
indirect wages.
Hence, there is no clear line of distinction between direct and indirect labour.

(c) Service Cost (Other Expenses):

The expenses incurred other than material cost and labour cost, are called service cost or other
expenses. It is defined as, ' The cost of service provided to an undertaking and the notional cost
of the use of owned assets. So, the cost of services provided to an undertaking within or outside
the business, is called 'service cost' or 'other expenses'. Other expenses are of 2 types viz. direct
& indirect expenses.

(a) Direct Expenses:

The expenses which are specifically incurred for any job, process or operation, are called direct
expenses. Such expenses can be directly charged to production and hence, are also known as
'chargeable expenses'. It is defined as 'the expenses which can be identified with and allocated
to cost centers or cost units'.

Example:
 Royalty on production (the periodical payment made by the users of the property to the
owner of the property is called royalty)
 Hiring charges of special plants and equipment used in production.
  Cost of special designs, drawings, patterns and layouts.
 Cost of patent and copyrights.
 Carriage inward for specific materials.
 Travelling expenses paid for obtaining special contracts.

(b) Indirect Expenses:

The expenses which can't be directly charged to production and are incurred in common for
almost all the sections of the whole organization, are called 'indirect expenses'. It is defined as
'the expenses which can't be identified with the particular job or process and are common to
cost centers and cost units'.

Example:
a) Rent, rates & taxes
b) Insurance
c) Power & fuel
d) Lighting & heating
e) Printing & stationery
f) Depreciation
g) Repair & maintenance
h) Canteen expenses
i) Welfare expenses
j) Dispensary or medical expenses
k) Timekeeping expenses
l) Selling & distribution expenses
m) Many others

COMPONENTS OF TOTAL COST:

There are 2 types of components of total cost viz. prime cost (direct cost) & overhead cost
(indirect cost).

1. PRIME COST:
The direct portion of the total costs is called prime cost or direct cost. It is the aggregate of a
direct material, direct labour and direct expenses. So,

Prime Cost = Direct Material Cost + Direct Labour Cost + Direct Expenses

Symbolically,

PC= DM + DL + DE

2. OVERHEAD COST:
The indirect portion of total cost is called 'indirect cost' or 'overhead cost' or 'overheads'. The
aggregate of all indirect materials, indirect labour and indirect expenses is called overhead.

Overhead Cost = Indirect Material Cost + Indirect Labour Cost + Indirect Expenses
 OH = IM + IL + IE

The cost incurred overhead and drive the prime cost is called overhead cost or overheads.

Prime cost + overhead cost=Total cost

Prime cost = Total cost – overhead cost

Overhead cost = Total cost – Prime cost

Overhead can be classified into following 5 categories

i) Works/ Factory Overhead
ii) Office / Administrative Overhead
iii) Selling Overhead
iv) Distribution Overhead
v) Research & Development Overhead

(i) Factory / Works Overhead:

The overhead incurred in running and operating the works division or factory of an
undertaking, is called works or factory overheads. These are also known as production
overheads or manufacturing overheads. These include factory indirect materials, factory
indirect labour and factory indirect expenses.
a) Indirect Materials like lubricants, cotton wastes, consumable stores, small equipment,
pins etc.
b) Indirect Labour like salaries of foreman, supervisors, inspectors, works manager, room
operators, staff of drawing & designing office, factory store keeper, factory clerks etc.
c) Indirect Expenses like factory rent, rates & taxes, factory insurance, factory lighting &
heating, factory power & fuel, depreciation of factory building, depreciation of plant &
machine, repairs & maintenance of machine, manufacturing expenses etc.

(ii) Administrative / Office expenses:

The overheads incurred in connection with the general administration of the business, are called
'administration/office overheads'. These are also known as 'general overheads'. These include
office indirect material, office indirect labour and office indirect expenses.
a) Office indirect materials like printing & stationery, stamps, computers etc.
b) Office indirect labour like salaries of office clerk, office manager, managing director,
office peon, counting house staff and office staffs etc.
c) Office indirect expenses like office rent, rates & taxes, office insurance, office lighting
& heating, postage & telegram, audit fees, legal charges, general charges, depreciation
of office building, depreciation of office furniture & fixture, time keeping expenses, any
official expenses.

(iii) Selling Overhead:

The overheads incurred for promoting sales by stimulating demand in the market, are called
selling overheads. These include:
a) Indirect materials like free samples, gifts, printing & stationery for sales etc.
 b) Indirect labour like salaries of sales manager, commission to sales agents, salary or
commission of salesman, salary to sales department staff.
c) Indirect expenses like sales depot expenses, advertisement, sales promotion expenses,
expenses relating to fairs & melas, exhibitions, depreciation of sales department
building, rent, rates & taxes and insurance of sales department building, bad debt,
discount to customers etc.

(iv) Distribution Overhead:

The overheads incurred for warehousing sold products and distributing them to different places,
are called 'distribution overhead'. These include:
a) Indirect material like secondary packing materials, spare parts of delivery vans,
printing & stationery required for distribution etc.
b) Indirect labour like wages of driver of delivery vans, loaders of materials, packing
staff, dispatch clerk etc.
c) Indirect expenses like carriage outward, packing expenses, up-keep (maintenance) of
delivery vans, depreciation of delivery vans, repairs of delivery vans, warehousing
expenses, go down rent, showroom expenses etc.
Note:
From practical point of view selling & distribution overhead are taken under the block/one
head, even though they differ from each other.

(v) Research & Development Overheads:

Research cost is the cost of searching for new and improved product, new applications of
materials or products and new applications of improved methods.

Development cost is the cost of the process which begins with the implementation of the
decision to produce a new or improves method and hence with the commencement of formal
production of that product or by that method.

The overheads incurred in connection with research & development activities of an

undertaking, are called 'research & development overheads'.