Cost vs Profit Center: The Comparison, Benefits, and Examples


This article is a ready reckoner for all the students to learn the difference between a cost centre and a profit centre. And to calculate the cost of production of the respective cost centre, all the costs related to that particular activity would be accumulated separately. A centre for which cost is ascertained and used to control cost is Cost Center. Whereas a centre whose performance we can measure through its income earning capacity is Profit Center. Companies may decide it is not useful to have the expenses of a specific area segregated from other activities. The marketing and sales department has costs such as advertising, market research, and sales commissions.

Residual income is a better measure if a company wants to maximize profits. It is calculated by taking the net operating income and subtracting it from the product of average operating assets and the minimum required rate of return. This formula explains the amount of net operating income made over the required rate of return on operating assets. Often cost centers are service and support departments such as the accounting, legal, finance, and general administration. These departments don’t generate revenue by selling a good or service, but their objective is to support the organization. The manager of a cost center is held responsible only for costs incurred by the department and not any revenues generated.

We divide the organization into various sub-units for the purpose of costing. These sub-units are the smallest area of responsibility or segment of activity. On a related note, cost centers may also identify where current deficits exist and more resources need to be delivered. Companies can compare cost centers from different regions or teams to better understand the resources successful cost centers have and how they need to better support other areas. As opposed to the IT department above, a personal cost center would exclude physical materials. This type of cost center allows a company to isolate only the cost of headcount without being distorted by equipment, materials, or other goods.

  1. Allocating revenues and costs to all the profit centers helps identify the profitability of the various revenue-generating units.
  2. Hence, the subdivision of the factory into a number of departments becomes essential.
  3. This type of activity centre comprises persons or groups thereof in connection to which costs are ascertained.
  4. This concept was about the difference between a cost centre and a profit centre.
  5. Profit center are important to companies because they help managers track where revenues are being generated so that they can be maximized.

Running a cost center is a logistical burden that requires a company to perform potentially extra work to track, collect, and analyze information. Companies can opt to segment out cost centers however they choose, as the end goal of a cost center is to isolate information for better internal data collecting and reporting. Moreover, cost centers can be complex to set up and maintain, and may require specialized software or expertise. Profit Centers may be part and parcel of revenue generation, but Cost Centers are just as integral to the smooth running of the company. No business can run efficiently without proper coordination between profit- and cost-making units.

Key Differences Between Cost Centre and Profit Centre

The head of a regional division might have sway not only over managing the organization’s expenses and profits, but also investing its funds most wisely to generate more revenue. By contrast, profit centers are any business units that directly generate profit. These include the sales departments and subsidiaries, which are responsible for managing both their own costs and profits. A standalone product line could qualify as a profit center, as could a regional division of the larger company. Profit centers work under the supervision of managers who balance costs and revenues to drive profit. They’re responsible for all actions related to production and the sale of goods.

Project Cost Center

Even when a team does not generate revenue directly, they may still be perceived as a profit center by leadership. For example, sales organizations are typically seen as profit centers, even when they cost much more to operate than the revenue they bring in. A profit center is a reporting unit of a business that is responsible for profits generated. An example of a profit center is a subsidiary, which is responsible for the amount of sales generated, as well as all costs incurred. Similarly, a country division is also treated as a profit center, as may a product line.

A company may choose to have as many cost centers it feels necessary to best understand how the supporting, non-revenue areas of the company support the revenue-generating areas. Companies must also be mindful that having too many cost centers creates an administrative burden on tracking expenses and may dilute the usefulness of information. A service cost center groups individuals based on their function and may more closely refine the costs within a department. For instance, a company may feel an IT department is too large of a cost center and may want to break out employees by more dedicated services.

For this reason, cost-center accounting falls under managerial accounting instead of financial or tax accounting. Firstly, both types of units are responsible for generating revenue and controlling costs. Departments are generally classified on the basis of their
functions and their contribution to the business. Identification of departments
is essential for multiple reasons including cost allocation and budgeting,
staff management, profitability and efficiency analysis etc. In it, Cloudflare’s CEO highlights products like the Zero Trust solution, Workers, DDoS protection services, Magic Transit, Magic Firewall, Cloudflare for Offices, and others. It’s clear all these are profit centers that drive more revenue, and all of them are engineering-heavy products.

What Is a Cost Center?

Like a profit center, an investment center incurs costs and earns revenue, but it also controls the amount and type of investments it makes in order to earn profits. Managers can decide which assets or items of value owned by the business that it needs to purchase to generate additional revenues and earn profits. A profit center incurs costs and earns revenue by selling its goods and services to customers. Managers are evaluated on their success in controlling costs and how well they generate revenue and profits.

The state was replacing legacy hardware and had decided to move to a cloud-based solution when they began talking to us. If you work at a publicly traded company, reading the quarterly reports is an underrated way payintuit to understand which areas the business cares about – and to discover things never mentioned at work. Kia can identify the highly profitable car models by making a comparison of the profit made by each model.

The principal object of a profit centre is to generate and maximise the profit by minimising the cost incurred and increasing sales. The major issue that profit centres encounter is the ascertainment of the transfer price. The use of transfer price is that for the centre whose goods are being transferred, it is a source of revenue. In this way, it has a great impact on the revenue, cost and profits of the centre. Transfer price is nothing but the value placed on the exchange of goods and services between two profit centres. And the way in which we determine this profit, will decide the profitability of the supplying (selling) and receiving (buying) profit centre.

Performance reports for cost centres typically focus on differences between budgeted and actual costs using variance analysis. The manager of a cost centre should be evaluated on how well he or she controls costs in the respective segment. Cost centre managers are expected to minimise cost for certain level of output or maximise output for a certain level of cost.

Similarly, a Supermarket chain like Big Bazaar or Walmart can identify their highly profitable stores by making a comparison of the profit made by each centre. It represents such machines or persons which undertake the same operations. The aim is to determine the cost of each operation regardless of the location within the unit. Meet Assam, a final-year chartered accountant student who’s always hungry for knowledge.

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