meaning of cost center

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sriram

sriram (Querist)
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05 December 2008 Hi

what is the meaning of cost center and profit center. please explain with an example

Sudharshan

Sudharshan (Expert)
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05 December 2008 Profit Center
A profit center is an area of your business that you operate with the goal of earning a profit. A profit center also has a well defined output. For instance, "corn" is typically a profit center. If you raise corn you do so with the goal of earning a profit, and the output is easily defined as bushels of corn.

Now, you could identify "crops" as a profit center. That would be OK, but wouldn't provide very detailed management information, partly because the output of "crops" can't be easily defined except in terms of dollars--there's no single common unit of measure across all crops.

Often you may need to break a single "chain" of production down into two or more profit centers to gather figures on which parts of your operation are profitable.

For instance, suppose you raise your own beef calves and market them after a backgrounding period. To know whether you're efficient at producing weaned calves and at backgrounding cattle, you really need to set up two profit centers. You might call the first Beef Cow/Calf and the second Cattle Backgrounding.

After weaning calves you would "sell" production from the Beef Cow/Calf enterprise to the Cattle Backgrounding enterprise, at a fair market price. (Transferring income and expenses between Classes will be discussed in another article.) This credits the Beef Cow/Calf enterprise with income, and charges the Backgrounding enterprise with expense. If you've kept a good record of other income and expenses for the two enterprises, at year's end you'll be able to determine whether both are profitable parts of the farm business.

Cost Center
A cost center is an area of your business that you primarily operate to service the needs of one or more profit centers. A typical example of a cost center may be a combine. Unless you do a lot of custom harvesting you don't operate a combine to earn a profit; but rather, to supply harvesting services to corn, soybeans, wheat, or other profit centers.

The main reason for identifying cost centers in your operation is to figure out how much those services are costing. In the case of a combine, this information can help you make decisions about repair or replacement..."How much did I spend on combine repairs last year?"...or whether you should be hiring custom harvesting instead of owning the machinery yourself.

sriram

sriram (Querist)
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05 December 2008 Hi

Thanks for your advice

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