Cost unit is a unit of output (product or service) to which costs can be related.
Cost center is any part of an organization where costs are incurred and is only responsible for the costs that it incurs. Cost centers are not responsible for revenues, profits, or making capital investment decisions.
Example (cost unit vs. cost center)
Let’s look at an example of a factory making footballs for the English Premier League, and cricket balls for International Cricket Council tournaments.
Simple way to differentiate between the two terms is:
- Where costs are incurred to make a product or deliver a service is called cost center.
- The product produced or service delivered is called cost unit.
In our example, to manufacture footballs and cricket balls, an organization would need a factory, some machines and staff. It is the business’ discretion how it wants to ascertain and control the costs. In the above example, costs are incurred at the following levels:
- Employees (Production Manager and staff)
- Factory as a whole.
A business can choose any of the above to be its cost centers. So, a cost center is any part of a business where costs are incurred and which is responsible for the costs it incurs.
The output of the business, i.e., a footballs and cricket balls are the cost units of this business.
Purpose of cost units and cost centers
Costs incurred in different cost centers are collected at the cost center level. These costs are then absorbed into the cost of products or services so that an organization can analyse its costs and profits of its products or services.
The managers of each cost center will be responsible for keeping the costs within the expected levels. Hence, organization is controlling its costs by keeping track of costs at the cost center level.
A broader picture is seen by viewing the costs and profits at the cost unit level. This helps the organization in controlling costs, as well as in making decisions such as what should be the price of a product, whether a product or service should be discontinued as it is loss making etc.