Question

What is the difference between a cost center and a profit center? Give a complete answer that demonstrates what critical element distinguishes the profit center from the cost center.

Answer 1

Solution:-

An activity center or responsibility center is the unit of business organization which is accounted for a specific task or activity. Cost Center and Profit Center are the two major types of the activity centers. A center for which cost is ascertained and used for the purpose of cost control is known as Cost Center, whereas a center whose performance measurement can be done only through its income earning capacity is known as Profit Center.

The ascertainment of the cost center is helpful in making a regular comparison of cost and its control. On the other hand, a profit center includes both the cost it incurs and profit it reaps. These are created with an aim of assigning responsibility to individuals and assessing their performance. In this handout, we’ve compiled the fundamental differences between cost center and profit center

Comparison Chart

Definition of Cost Center

A cost center is a unit of a business organisation to which various types of costs are allocated, segregated and eliminated. It can be any person or location or the combination of both, for which the cost is determined. Cost centers are mainly established in big organisations to reduce and control the cost. Its performance can be monitored by comparing the standard costs with the actual costs incurred. The following are the types of Cost Center in an organisation.

• Production Cost Center
• Service Cost Center
• Personal Cost Center
• Impersonal Cost Center
• Operation Cost Center
• Process Cost Center

Definition of Profit Center

Profit Center is a department of an organisation which works for the ascertainment of profit. There are several profit centers in a business organisation which are operated by the managers, which recognise profits on the basis of revenues and costs. It is responsible for all activities associated with the production and sales of goods.

The ultimate aim of the profit center is the generation and maximisation of profit, by increasing sales and decreasing the cost incurred, that will give a boost to the profit earning capacity of the company. The performance of a profit center is evaluated in terms of the increased profits, during a particular period.

Key Differences Between Cost Center and Profit Center

1. Cost Center is a department of an organisation for which the costs are ascertained while Profit Center is a department of an organisation which ascertains the profit.
2. There are many cost centers in a single profit center.
3. The role of a profit center is very thought-provoking as compared to a cost center, as the profit center has to maximise profit along with the reduction in direct and indirect costs, but the cost center has to work only for the minimization of costs.
4. The cost center is responsible only for costs while the profit center is responsible for both the costs and revenue.
5. The performance of a cost center is evaluated by reducing the actual cost of the standard cost. Conversely, the performance of profit center is analysed by deducting the actual cost from the budgeted cost.

Conclusion

Cost Center is a segment of a business organisation. Examples of a Cost Center is a Production, Administration, Research and Development, and Service Department of the organisation which is responsible for the costs of that particular department.

On the other hand, profit center is a specific division of the entity, which is responsible for its revenue, that results in profit. Examples of a profit center can be a Sales organisation or a Store, etc. All the cost centers in an organisational unit are profit centers, but all the profit centers are not the cost centers.