Cost accounting is based on the concept or framework of cost centers, i.e. all the costs incurred during the production process have to be identified and accumulated around certain points of the production process, referred to as cost centers.
A cost center may be defined as ‘any point at which costs are gathered in order to control cost, fix responsibility and enable costs to be recharged on an equitable basis. We will use a cost flow diagram to illustrate the principles of a cost center framework
Each rectangular box represents a cost center. Each cost will be the responsibility of one management member and will have costs charged to it and also costs recharged from it if such costs are incurred for purposes of offering a service to other cost centers.
Summary of features of an effective cost center framework
In establishing cost centers, an organization should consider the following points:
- Clear definition of the cost center boundaries. This should ensure that there’s no overlapping of the boundaries defined in two or more centers and no gaps where some aspect of the business which incurs cost is not contained in a cost center.
- A clear link with the manager responsible so as to hold someone responsible for the costs incurred in a cost centre.
- Costs should be analyzed into clearly defined categories in order to ensure that planned and actual expenditure may be analyzed in the same way.
- The cost centres should enable the effective and efficient planning, directing and control of the organization’s activities, thereby enabling it achieve its objectives.