COST ACCOUNTING • CORE VOCABULARY
Part of the cost accounting series: basics • financial vs cost • costing methods • and now the words that power them all
Cost Unit, Cost Centre, Cost Object and Cost Driver: Give Every Rupee an Address.
Crisp definitions, six types of cost centre, a 5-point and a 9-point difference, and one factory that ties it all together.
0COST CENTRE TYPES
0UNIT VS CENTRE POINTS
0CENTRE VS PROFIT CENTRE
0PRACTICE ITEMS
The HookCost UnitCost Centre6 TypesCost ObjectCost DriverUnit vs CentreCentre vs Profit CentreClassify ItSelf-TestRevisionThe Last Word
Rs. 11,00,000 Spent. Who Spent It? On What? Why?
Kalinga Steelcraft spent Rs. 11,00,000 last month. The owner asks four simple questions, and a pile of bills cannot answer a single one.
QUESTION 1
Where was the money spent, and who answers for it?
Answer: the cost centre.
QUESTION 2
Cost per what? Per almirah? Per tonne? Per kilometre?
Answer: the cost unit.
QUESTION 3
What exactly do we want a separate cost figure for?
Answer: the cost object.
QUESTION 4
Why did the cost go up this month?
Answer: the cost driver.
ExpenseRs. 11,00,000
Cost centreWHERE and WHO
Cost unitPER WHAT
Cost driver sits behind every arrow: it is the reason the amount moved, such as more machine set-ups or more material requisitions.
Cost accounting is, at heart, the art of giving every rupee an address (cost centre), a destination (cost unit or cost object) and a reason (cost driver). Get this vocabulary right and the rest of costing, from overhead absorption to ABC, becomes straightforward. Get it muddled and exam answers collapse. Let us fix that, one term at a time.
COST UNIT
The yardstick
The unit of product or service against which cost is measured.
COST CENTRE
The collection point
A location, person or machine where cost is gathered and controlled.
COST OBJECT
The thing we want costed
Any item or activity for which a separate cost figure is wanted.
COST DRIVER
The reason it moved
The factor that causes the cost of an activity to rise or fall.
1. Cost Unit
MEANING AND DEFINITION
A cost unit is a unit of product, service or time in relation to which cost is measured and expressed. It answers the question: cost per what? Put another way, the cost unit is the denominator of every cost sheet.
IN SIMPLE WORDS
A total such as Rs. 11,00,000 tells you very little on its own. To make it useful you divide it by something countable, and that countable thing is the cost unit. A furniture factory counts almirahs, a cement plant counts tonnes, a bus company counts passenger-kilometres. The cost unit is simply the "per" in "cost per almirah", "cost per tonne" or "cost per passenger-km".THINK OF IT AS
The unit on a price tag: price per kilo, per litre, per metre. Cost accounting puts the same idea on cost, so that costs of different periods, products and firms can be compared fairly.REMEMBER
A cost unit is a measure, not a place and not a person. It should be the unit that best reflects what the business actually makes or sells. Do not confuse it with a cost centre, which is the place where cost is collected.Exam-safe wording follows the common CIMA-style definition, "a unit of product or service in relation to which costs are ascertained". Use the text of your own prescribed book.
Features
QuantitativeIt is a measure such as a piece, tonne or kilometre, not a place or a person.
Chosen to suit the industryCement counts in tonnes; a hotel counts room-nights.
The end point of costingAll collected cost is finally charged to cost units.
Basis of pricingSelling price is built from cost per unit plus margin.
Simple and Composite Cost Units
A simple (single) unit uses one measure, such as a tonne or a piece. A composite unit combines two measures, such as tonne-km (weight and distance) or patient-day (patients and days).
| Industry | Cost unit | Kind |
|---|---|---|
| Steel almirahs | One almirah | Simple |
| Cement, coal | Tonne | Simple |
| Bricks | 1,000 bricks | Simple |
| Sugar | Quintal | Simple |
| Printing, repair work | One job | Job |
| Goods transport | Tonne-km | Composite |
| Passenger transport | Passenger-km | Composite |
| Hospital | Patient-day (bed-day) | Composite |
| Hotel | Room-night | Composite |
Four Tests of a Good Cost Unit
MeasurableEasy to count without dispute
MeaningfulMatches what the customer buys
ConsistentSame unit every period
ComparableUnderstood across the industry
EXAMPLE BOX
Same company, two cost units
Kalinga's factory uses one almirah as its cost unit: Rs. 11,00,000 / 500 = Rs. 2,200 per almirah. Its delivery truck uses a composite unit: a trip costing Rs. 4,200 over 840 tonne-km gives Rs. 5 per tonne-km. Different businesses, different yardsticks, one idea.
2. Cost Centre
MEANING AND DEFINITION
A cost centre is a location, function, person or item of equipment for which costs are collected so that they can be controlled and later attributed to cost units. It answers: where was it spent, and who answers for it? It may be a physical place, a function, a machine or even a person.
IN SIMPLE WORDS
Imagine the business as a building with many rooms. Every rupee is spent in some room, by someone. A cost centre is that room: a department, a section, a machine or a person against whom spending is recorded, so that it can be watched and controlled. Without cost centres, all expenses sit in one big lump, nobody can be questioned, and a rise in cost cannot be traced to its source.THINK OF IT AS
A household budget with separate envelopes for groceries, travel and rent. Each envelope is a cost centre, so at month-end you can see exactly which one overspent and ask why.REMEMBER
A cost centre does not have to make anything. Stores, maintenance and HR are cost centres too. Its job is to collect and control cost; the cost collected there is later charged to cost units.Based on the common CIMA-style definition of a production or service location, function, activity or item of equipment whose costs may be attributed to cost units.
Why Businesses Create Cost Centres
Collect costEvery expense gets an address instead of floating in one big total.
Fix responsibilityEach centre has a person who answers for its spending.
Control and compareActual cost is compared with budget, month after month.
Absorb into unitsCentre cost is divided over the units that passed through it.
Four Tests of a Good Cost Centre
Clear ownerOne person is accountable
Similar workActivities inside are alike
MeasurableCost can be traced to it
Right sizeNot too many, not too few
EXAMPLE BOX
Kalinga's five cost centres
The factory overhead of Rs. 1,50,000 is first collected in the five places where it was actually incurred:
| Cost centre | Answerable person | Overhead (Rs.) |
|---|---|---|
| Cutting shop | Cutting supervisor | 30,000 |
| Welding shop | Welding supervisor | 45,000 |
| Painting shop | Painting supervisor | 40,000 |
| Packing section | Packing in-charge | 15,000 |
| Stores | Store-keeper | 20,000 |
| Total factory overhead | 1,50,000 | |
Types of Cost Centre
Cost centres are classified in three ways: by function (what they do), by nature (what they are) and by activity (how they work). That gives six types, each with a clear example.
BY FUNCTION
1Production Cost Centre
Directly engaged in making the product. The product physically passes through it, and its cost is charged to the product.
Example: Cutting, Welding and Painting shops at Kalinga.
BY FUNCTION
2Service Cost Centre
Supports production but does not produce. Its cost is reapportioned to the production centres that use its service.
Example: Stores, maintenance, canteen, power house, boiler house.
BY NATURE
3Personal Cost Centre
A person or a group of persons. Cost is collected against that person so performance can be judged individually.
Example: The sales manager, or the team of quality inspectors.
BY NATURE
4Impersonal Cost Centre
A location, department or item of equipment, or a combination of these. The cost belongs to the place or machine, not to a named individual.
Example: The painting booth, a hydraulic press, the Stores room.
BY ACTIVITY
5Operation Cost Centre
A set of machines or persons carrying out the same operation. Cost is collected for that operation across all of them.
Example: The drilling machine group, or five spot-welding machines.
BY ACTIVITY
6Process Cost Centre
A distinct stage of a continuous production process. Cost is collected process by process and carried forward to the next.
Example: Process 1 (rolling) and Process 2 (galvanising) in a steel mill.
EXAM TIP
One centre, several labels
These are three different ways of sorting the same centres, so a single centre can carry several labels. Kalinga's Welding shop is a production centre (by function), an impersonal centre (by nature) and an operation centre (by activity). Always say which basis you are using.
EXAMPLE BOX
A service centre hands its cost to production centres
The Stores cost of Rs. 20,000 is shared on the number of material requisitions: Cutting 100, Welding 60, Painting 40 (200 in all), a rate of Rs. 100 per requisition.
| Production centre | Own overhead | Stores share | Total |
|---|---|---|---|
| Cutting | 30,000 | 10,000 | 40,000 |
| Welding | 45,000 | 6,000 | 51,000 |
| Painting | 40,000 | 4,000 | 44,000 |
| Packing | 15,000 | 0 | 15,000 |
| All production centres | 1,30,000 | 20,000 | 1,50,000 |
3. Cost Object
MEANING AND DEFINITION
A cost object is any item or activity for which a separate measurement of cost is wanted. It answers: what exactly do we want a cost figure for? Whatever the manager chooses to cost becomes the cost object.
IN SIMPLE WORDS
Whenever a manager says "I want to know what this costs", the "this" is the cost object. It can be a product, a job, a department, a customer, a project or even a single activity such as a machine set-up. It is the widest term in this post, because anything you decide to measure the cost of becomes a cost object.THINK OF IT AS
The subject of the question "What does X cost?" Change X and you change the cost object, and with it the figures you will report.REMEMBER
Cost units and cost centres can both be cost objects. That is why the same expense can be a direct cost for one cost object and an indirect cost for another.Based on the standard definition of an item or activity for which a separate measurement of costs is desired.
The cost object is the widest of our four terms. A cost unit is one kind of cost object, and so is a cost centre, a job, a customer or a project. The manager decides what to cost; the cost object is that decision.
| Cost object | Question it answers | Kalinga figure |
|---|---|---|
| A product (one almirah) | What does one almirah cost? | Rs. 2,200 |
| A job (hotel order, Job 207) | What did this order cost? | Rs. 41,250 |
| A cost centre (Welding shop) | What does this department cost? | Rs. 51,000 |
| A contract (warehouse) | What has this project cost so far? | Rs. 30,00,000 |
| An activity (machine set-up) | What does one set-up cost? | Rs. 2,000 |
| A customer (a dealer) | Is this dealer profitable after discounts and delivery? | Depends on orders |
THE INSIGHT STUDENTS MISS
Direct or indirect depends on the cost object
The Welding supervisor's salary of Rs. 30,000 is a direct cost of the Welding shop, because it can be traced there exactly. But it is an indirect cost of any single almirah: it has to be spread, for instance at Rs. 30,000 / 500 = Rs. 60 per almirah if every almirah passes through welding. Same rupee, two answers, because the cost object changed.
4. Cost Driver
MEANING AND DEFINITION
A cost driver is the factor that causes the cost of an activity to change. It answers: why did this cost go up or down? It is the cause behind the cost.
IN SIMPLE WORDS
A driver is the cause behind a cost. More machine set-ups cause more set-up cost, more inspections cause more inspection cost, more kilometres cause more fuel cost. Finding the true driver tells you what to change if you want the cost to fall, and it gives a fairer basis for charging that cost to products.THINK OF IT AS
The accelerator pedal of a car: the cost is the speed on the dial, and the driver is what your foot is pressing. Manage the pedal and you manage the speed.REMEMBER
A cost driver explains a cost. It is not a place to collect cost (that is the cost centre) and not a thing to be costed (that is the cost object). Production volume is one possible driver, but many costs are driven by activities, not by volume.Based on the standard definition of a factor that causes a change in the cost of an activity.
Cost drivers are the engine of Activity-Based Costing. Instead of spreading overhead on one blanket basis, we find what really makes each activity expensive and charge cost in proportion to it. The cost driver rate is simply the activity's cost divided by the total quantity of its driver.
| Activity | Cost driver | Kalinga rate |
|---|---|---|
| Machine set-up | Number of set-ups | Rs. 60,000 / 30 = Rs. 2,000 each |
| Quality inspection | Number of inspections | Rs. 40,000 / 200 = Rs. 200 each |
| Material handling (Stores) | Number of requisitions | Rs. 20,000 / 200 = Rs. 100 each |
| Machine power | Machine hours | Cost / total machine hours |
| Delivery | Kilometres driven | Cost / total kilometres |
| Order processing | Number of orders | Cost / total orders |
EXAMPLE BOX
Why the driver matters
Kalinga's premium almirah needs 20 set-ups; the standard model needs only 10. At Rs. 2,000 per set-up, the premium model is charged Rs. 40,000 and the standard one Rs. 20,000 for set-ups alone, however many units each makes. Spreading set-up cost per unit would have hidden that and made the standard model subsidise the premium one.
PUTTING THE FOUR TERMS TOGETHER
One chain for every cost
Driver (why it moves) → activity → cost centre (where it is collected) → cost object or cost unit (what it is finally charged to). Remember the chain and every exam definition falls into place.
Cost Unit vs Cost Centre: 5 Points of Difference
Students confuse these two more than any other pair. The cleanest way to separate them: a cost centre is a place where cost sits; a cost unit is a measure that cost is divided by.
1
Meaning
COST UNIT
A unit of product, service or time in relation to which cost is measured and expressed. It is a yardstick.COST CENTRE
A location, person or equipment for which cost is collected and controlled. It is a collection point.Kalinga: one almirah is a cost unit; the Welding shop is a cost centre.
2
Question answered and purpose
COST UNIT
Answers "what does one unit cost?" Its purpose is cost ascertainment: building cost sheets, fixing selling prices and measuring profit per unit.COST CENTRE
Answers "where was the money spent and who is answerable?" Its purpose is cost control: comparing actual spending with budget for each place.Kalinga: Rs. 2,200 per almirah sets the price; Rs. 51,000 in Welding is checked against its budget.
3
Nature
COST UNIT
A unit of measurement, a quantity such as a piece, tonne, litre or tonne-km. It has no physical location; it is a way of counting output.COST CENTRE
A real entity in the organisation: a department, a section, a machine or a person. You can point to it on the factory floor or the organisation chart.Kalinga: you cannot walk into "one almirah" as a place, but you can walk into the Painting shop.
4
Flow of cost
COST UNIT
The final destination. Cost collected in the centres is ultimately absorbed into cost units, by dividing centre cost by the units produced.COST CENTRE
The first stop. Expenses are collected here first, then apportioned between centres and reapportioned from service to production centres.Kalinga: Rs. 1,50,000 of overhead lands in the centres first, then Rs. 1,50,000 / 500 = Rs. 300 is absorbed into each almirah.
5
Responsibility and control
COST UNIT
No person is answerable for a unit. Control comes from comparing unit cost with a standard, and tracing any difference back to a cost centre.COST CENTRE
Has a responsible person, such as a supervisor or manager, who is held to a budget and must explain variances.Kalinga: if cost per almirah rises, nobody owns "the almirah"; the report points to the Welding supervisor whose centre overspent.
ONE-LINE MEMORY
Centre is where. Unit is per what.
Cost is collected in centres and measured in units.
Cost Centre vs Profit Centre: 9 Points of Difference
Both are responsibility centres: segments of the business headed by a manager who is judged on results. The difference is what the manager is judged on, and what the manager is allowed to control.
1
Meaning
COST CENTRE
A segment where costs are incurred and collected, but whose revenue is not measured.PROFIT CENTRE
A segment whose costs and revenues are both measured, so that its profit can be worked out.2
What the manager answers for
COST CENTRE
Only for cost: keeping spending within budget for the output and quality required.PROFIT CENTRE
For profitability: both the revenue earned and the cost incurred to earn it.3
Revenue
COST CENTRE
Earns no revenue of its own. It consumes resources and supports the business.PROFIT CENTRE
Earns revenue, either from outside customers or from internal sales to other units at a transfer price.4
Performance yardstick
COST CENTRE
Judged by cost variances, cost per unit and efficiency: actual cost against budget or standard.PROFIT CENTRE
Judged by profit, profit margin and contribution: actual profit against budgeted profit.5
Decision authority
COST CENTRE
Limited to using inputs efficiently. The manager cannot set selling prices or choose markets.PROFIT CENTRE
Wider authority over pricing, product mix, markets and often some purchasing, because these shape revenue.6
Level in the organisation
COST CENTRE
Usually lower: a shop, a section, a machine or a support function such as Stores or HR.PROFIT CENTRE
Usually higher: a division, branch, product line or retail outlet that behaves like a business of its own.7
Transfer pricing
COST CENTRE
Not needed. Its cost is simply apportioned or charged out to the users of its service.PROFIT CENTRE
Needed whenever it supplies or buys from another unit inside the firm, so that each side's profit is measured fairly.8
Complexity of measurement
COST CENTRE
Simple: only expenses are tracked and compared with a budget.PROFIT CENTRE
Harder: needs reliable revenue recognition, fair sharing of common costs and, often, agreed transfer prices.9
Objective and examples
COST CENTRE
Objective: minimise cost for the required output and quality. Examples: Stores, HR, maintenance, the Welding shop.PROFIT CENTRE
Objective: maximise profit. Examples: a showroom, a regional branch, a product division, a hotel unit in a chain.EXAMPLE BOX
Same group, two kinds of centre
Cost centre: the Welding shop spent Rs. 51,000 against a budget of Rs. 48,000, an adverse variance of Rs. 3,000. Nothing is said about profit, because the shop sells nothing.
| Kalinga Retail Showroom (profit centre) | Rs. |
|---|---|
| Sales to customers | 6,00,000 |
| Less almirahs bought from the factory at transfer price | 4,50,000 |
| Less showroom expenses | 60,000 |
| Showroom profit | 90,000 |
ONE STEP FURTHER
The responsibility ladder
Responsibility accounting has three rungs: cost centre (judged on cost), profit centre (judged on profit) and investment centre (judged on profit against capital used). If the showroom employs Rs. 9,00,000 of capital, its return on investment is 90,000 / 9,00,000 = 10%.
Classify It: 8 Quick Items
Tap an item and see which term it is, and why. Try to answer before you tap.
Tap any item above. The correct term and the reason will appear here.
Quick Self-Test
Answer in your head first, then tap to reveal.
Q1.Which of these is a composite cost unit: a tonne, a piece, or a patient-day?
Patient-day. It combines two measures, patients and days. A tonne and a piece are simple units.
Q2.What type of cost centre is Stores, and what driver could share its cost?
A service cost centre. Its Rs. 20,000 can be shared on the number of material requisitions, at Rs. 100 per requisition.
Q3.Can the same cost be both direct and indirect?
Yes, it depends on the cost object. The Welding supervisor's Rs. 30,000 salary is direct for the Welding shop but indirect for any single almirah.
Q4.Why is it unfair to judge a cost centre manager on profit?
Because the manager does not control revenue. A cost centre earns none and cannot set prices or choose markets, so cost against budget is the right yardstick.
Q5.Is cost collected first in the cost unit or the cost centre?
The cost centre. Expenses are collected in centres first, then absorbed into cost units, such as Rs. 1,50,000 / 500 = Rs. 300 per almirah.
Last-Minute Revision
Cost unit: unit of product or service for which cost is measured. Simple (tonne, piece) or composite (tonne-km, patient-day).
Cost centre: location, person or equipment where cost is collected and controlled.
6 types: production, service (function) • personal, impersonal (nature) • operation, process (activity).
Cost object: anything we want a separate cost for; a cost unit is one kind of cost object.
Cost driver: the factor that makes an activity's cost change. Driver rate = activity cost / total driver quantity.
Unit vs centre (5): meaning, purpose, nature, flow of cost, responsibility.
Centre vs profit centre (9): meaning, accountability, revenue, yardstick, decision authority, level, transfer pricing, complexity, objective and examples.
One line: centre is where, unit is per what, object is what for, driver is why.
The Last Word
A bill is not information. A bill with an address is.
Rs. 11,00,000 is just a number. It becomes knowledge only when it is given an address in a cost centre, a destination in a cost unit or cost object, and a reason in a cost driver. Every report a manager reads, every price a firm quotes and every variance a professor sets in an exam rests on those four ideas.
And the final distinction is the most human one. A cost centre manager is asked, "Did you spend wisely?" A profit centre manager is asked, "Did you earn wisely?" One question is about thrift, the other about judgement, and a firm that confuses them will punish the wrong people for the wrong things.
So next time you see a cost figure, do not ask only "how much?" Ask: where, per what, for what, and why.
Taxloom Academy • Finance, taxation, capital markets and CA/CMA/CS exam preparation. The Kalinga Steelcraft factory, its retail showroom and all figures are fictional and used for teaching only.