Cost Accounting: Introduction of Cost Centres
In the second part of our blog series on clean cost accounting, we look at cost centres. Cost centres define where costs are incurred in the company and thus allow deep analysis possibilities to continuously optimise your company. However, many smaller companies and start-ups wait far too long before introducing cost centres. In the following article we will explain why it makes sense to introduce cost centres for companies with 15 to 20 employees, what possibilities cost centres offer and how you can introduce them. 
What are cost centres? Why do they exist?
A cost centre is the place where costs are incurred in a company. Depending on the company, these cost centres can be different, for example production, development or sales. Each company can decide for itself how a cost centre is structured. Services are charged to a cost centre in order to allocate them internally. The individual cost centres are usually formed according to areas of responsibility as well as spatial or functional aspects.
Regardless of the size of the company, cost accounting is one of the most important instruments of corporate management. With cost accounting it is possible to determine exactly which areas of a company cause which costs. This is essential in order to manage a company strategically and to measure its success. Only if you know where which costs are incurred can you react accordingly and make sound decisions. For example, the question of which part of the business needs the most IT support can be answered by evaluating the cost centre by type of cost. To answer this question, IT must charge its expenses to the respective cost centres. In this way, it can be seen, for example, that a particular department is incurring extremely high IT costs, and the company can react accordingly.
Without cost centres, the individual costs, e.g. for personnel or rent, would simply “float around” without a fixed allocation. So at the latest when a company consists of several departments and a few dozen employees, systematic cost centre accounting becomes mandatory. Without cost centre accounting, one would not be able to assign in which area of the company the respective costs were caused. Ultimately, only a figure for total costs could be determined and not a detailed breakdown. Without such details, it is impossible to adjust the company’s financial strategy in an economically sensible way. With cost centres, on the other hand, one knows exactly which department, location or product generates which costs.
The breakdown by cost centre is therefore necessary. This helps to maintain an overview and to make decisions according to purely logical points of view. Moreover, business partners, investors or banks also want to know exactly which task in the company causes how many costs.
Cost types vs. cost centre vs. profit centre
Before we delve deeper into cost centres, we should make a clear distinction between cost types, cost centres and profit centres. Cost types answer what the money was spent on – e.g. for personnel or rent. More information on cost types can be found here. The place where the costs are incurred is the cost centre and here the originator pays – so the central question is: Where do the costs arise? In addition to the cost centre, there is also the profit centre. Here the question is: What are the costs for? Specifically, profit centres are the sales activities or internal services of a company that generate turnover and to which the costs are allocated. For example, the various products that a company produces and sells are the profit centres. The costs incurred in different cost centres are allocated to them.
Through cost accounting and controlling, the company receives precise information about which costs have been incurred and how. By adding profit centres, it is also possible to determine which output results from them. In this way it is possible to see whether the costs have produced a real equivalent value.
Cost types, cost centres and profit centres thus serve to answer a multitude of questions for the company. Cost accounting can provide information on these questions:
- How does profit change if production is increased by 10%?
- Which department incurs the lowest costs?
- Why are costs much higher than originally planned? Where did they arise?
- Is it better to produce a product element yourself or to buy it in?
How are cost centres classified?
A cost centre is a separate area of a company for which costs are calculated separately. On the one hand, costs are monitored in this way, and on the other hand, costs can be allocated to the originator. This originator-pays principle primarily serves to control costs so that overhead costs are allocated to those who caused them and motivate them to save. The classification of cost centres is always based on spatial, organisational, functional and accounting criteria. This then results in the following basic distinction
- Main cost centres: Here the costs flow in directly, for example for the materials used or for the wages paid in the respective area. The costs incurred here can be allocated to the individual cost units with the help of costing overheads.
- Auxiliary cost centres: This is where the costs flow in that cannot be directly allocated to an individual area. This is, for example, electricity or janitorial services. In this case we speak of auxiliary cost centres. The costs incurred here are allocated to the main cost centres – this is internal activity allocation. In practice, there is a distribution key for this, which is determined on the basis of historical data.
Best practice for cost centres
To ensure effective cost control, it is important that the cost centre always remains an independent area of responsibility. Finally, the person responsible for the cost centre must be able to control the costs themselves. Furthermore, it should always be a spatial unit so that there is no overlapping of responsibilities. In addition, a measure of cost causation that is as accurate as possible must be found for each cost centre, because otherwise there is a risk that the cost control and calculation is/will be faulty.
Based on these things, an optimisation problem of controlling can be recognised in the cost centre allocation. The more precise the cost centre allocation is, the more likely it is to find exact benchmarks for cost causation and the more precise the cost control as well as the calculation and the corresponding costs can be. On the other hand, the fine-tuning of cost centres also means higher accounting costs within cost centre accounting. This is because the account assignment of the documents is significantly more time-consuming. Here, pre-accounting tools that enable a simple distribution of the vouchers to the cost centres directly when the costs are incurred can be very helpful.
Exemplary cost centre structures
The cost centre structure is always individual to each company and can vary greatly depending on the industry and business model. For example, a traditional manufacturing company might divide its costs according to the following structure:
Material
- Procurement
- Disposition
- Warehousing
Production
- Production / Assembly
- Quality assurance
- Work preparation
- Research and development
Administration
- Management
- Accounting / Finance / Controlling
- Human Resources
Sales and Marketing
- Marketing
- Distribution
- Invoicing
- Order management
Distribution and Logisics
- Trade
- Factory sales/direct sales
- Sales agent
In contrast, the cost centre structure for a software-as-a-service company would probably look quite different:
Development
- Software Development
- Product Management
- Design
- Dev Ops
Customer and technical support
- Telephone, chat and web support for customer queries, issues and bugs.
- Customer support
- Customer success (can also be considered a profit centre!).
Sales and Distribution
- Sales
- Marketing incl. content marketing
Administration (operations)
- Management
- Accounting / Finance / Controlling
- Human Resources
In practice, cost centres are identified in accounting by a multi-digit number combination specific to each cost centre. This is added to each entry so that each expense is attributed to a cost centre.
You want to introduce cost centres?
After you have set up your cost types and cost centres properly, you naturally want to be able to draw insights from your accounting data quickly and easily. In practice, this is often more difficult than expected. Normally, such analyses are done in Excel, but setting up an Excel model correctly for these analyses is not easy, time-consuming and very error-prone. In addition, there is the hassle of manually transferring the latest available data from the accounting system to the Excel model. This is where Pectus Finance can help! Pectus connects directly to your accounting system (e.g. Datev), so you always have access to your latest data. You can also create reports, calculate KPIs and run analyses in no time, and share them with your colleagues.
If you don’t have cost centres yet, but are still interested in the analysis possibilities of Pectus and would like to introduce cost centres, we will help you in the onboarding process and together we will find the best, individual cost centre structure for your company. In addition, Pectus offers you the possibility of correcting any incorrectly posted transactions as part of your monthly controlling process in order to ensure ongoing data integrity.