A cost centre is a department, function, location or activity within a business to which costs can be identified and allocated. Cost centres do not directly generate revenue; instead, they are used in management accounting to track where money is being spent, control budgets and hold managers accountable for the costs under their control.
Every UK business above a certain size uses cost centres in some form. Even sole traders may informally separate costs by activity. For limited companies, formal cost centre structures underpin internal reporting, budgeting and performance management.
How Cost Centres Work
Each cost centre is assigned a unique code in the accounting system. When an expense is recorded, it is tagged to the relevant cost centre. This allows the business to produce reports showing the total cost of running each department or function.
Example Structure
| Cost centre code | Description | Manager |
|---|---|---|
| CC100 | Sales department | Sales director |
| CC200 | Marketing | Marketing manager |
| CC300 | Finance and accounting | Finance director |
| CC400 | Human resources | HR manager |
| CC500 | IT and systems | IT manager |
| CC600 | Warehouse and logistics | Operations manager |
| CC700 | Customer service | Customer service lead |
Types of Cost Centre
Production Cost Centres
These are directly involved in manufacturing or delivering the product or service. In a manufacturing business, each production line or workshop may be a separate cost centre.
Service Cost Centres
These support the business but do not produce output directly. Examples include finance, HR, IT and facilities management. The costs of service cost centres are typically reallocated to production cost centres for full cost analysis.
Personal Cost Centres
Some businesses create cost centres around individual managers or teams, particularly in professional services firms where each partner or team leader controls a distinct budget.
Location-Based Cost Centres
Businesses with multiple sites may create cost centres for each physical location, enabling comparison of operating costs across branches, offices or warehouses.
Costs Allocated to Cost Centres
Direct Costs
These are costs that can be traced directly to a specific cost centre without any allocation:
| Cost type | Example |
|---|---|
| Staff salaries | Employees working exclusively in one department |
| Direct materials | Supplies used by a specific team |
| Department-specific subscriptions | Software licences used only by one team |
| Travel costs | Travel expenses of a specific department’s staff |
Indirect Costs (Overheads)
Overheads shared across multiple cost centres must be apportioned using a fair basis:
| Overhead | Typical apportionment basis |
|---|---|
| Rent and rates | Floor area occupied |
| Electricity and heating | Floor area or metered usage |
| Building insurance | Floor area |
| Depreciation of shared equipment | Usage hours or headcount |
| IT infrastructure costs | Number of users or devices |
| Cleaning and maintenance | Floor area |
| Canteen costs | Number of employees |
Cost Centre Reporting
Monthly Cost Centre Report
A typical monthly report compares actual costs against the budget for each cost centre:
| Expense line | Budget (£) | Actual (£) | Variance (£) | Variance (%) |
|---|---|---|---|---|
| Staff costs | 45,000 | 46,200 | (1,200) | -2.7% |
| Office supplies | 2,000 | 1,850 | 150 | 7.5% |
| Travel | 3,500 | 4,100 | (600) | -17.1% |
| Software licences | 1,200 | 1,200 | 0 | 0% |
| Training | 1,500 | 800 | 700 | 46.7% |
| Total | 53,200 | 54,150 | (950) | -1.8% |
Negative variances (shown in brackets) indicate overspending. The cost centre manager is expected to explain material variances and take corrective action where needed.
Variance Analysis
Effective cost centre management requires investigating variances rather than simply noting them:
- Volume variances: Did the department handle more work than planned?
- Price variances: Did input costs rise unexpectedly?
- Efficiency variances: Was the department less productive than expected?
- One-off items: Was there a non-recurring cost that distorts the comparison?
Reallocation of Service Cost Centre Costs
For businesses that need to understand the full cost of production, service cost centre costs are reallocated to production cost centres. Common methods include:
| Method | How it works |
|---|---|
| Direct allocation | Each service cost centre’s costs are shared among production cost centres based on a single allocation base |
| Step-down method | Service cost centres are allocated sequentially, with each allocation including costs received from previously allocated service centres |
| Reciprocal method | Recognises that service cost centres serve each other (e.g., IT supports HR, and HR recruits for IT) using simultaneous equations |
Step-Down Example
| Service cost centre | Total cost (£) | Allocation basis | Allocated to |
|---|---|---|---|
| Facilities | 60,000 | Floor area | All departments |
| IT | 80,000 | Number of users | All departments except Facilities |
| HR | 40,000 | Headcount | Production departments only |
Cost Centres vs Profit Centres
| Feature | Cost centre | Profit centre |
|---|---|---|
| Revenue tracked | No | Yes |
| Costs tracked | Yes | Yes |
| Manager accountable for | Costs only | Both revenue and costs |
| Performance measure | Budget adherence | Profit or contribution |
| Examples | Finance, HR, IT | Sales region, product line, branch |
A profit centre is responsible for both revenue and costs, making its manager accountable for the contribution or profit generated. Cost centres focus solely on cost control.
Cost Centres in the Accounting System
Most UK accounting software packages support cost centre tracking through:
- Tracking categories (Xero)
- Classes or departments (QuickBooks)
- Dimensions (Sage and other mid-market packages)
- Cost centre fields in enterprise ERP systems
Transactions are tagged at the point of entry, and reports can be filtered or grouped by cost centre at any time.
Setting Up Cost Centres
When designing a cost centre structure, consider:
- Granularity: Too many cost centres create administrative overhead; too few reduce the value of the reporting
- Controllability: Each cost centre should contain only costs that the responsible manager can influence
- Consistency: The structure should remain stable over time to allow meaningful period-on-period comparison
- Alignment: Cost centres should reflect the organisational structure and reporting lines
A well-designed cost centre structure gives management visibility into where money is being spent and provides the foundation for meaningful budgeting, forecasting and performance management.