Explaining the Purpose of Cost Center Accounting

In this lesson, you will learn about the reason for using a cost center as an assignment object to collect overhead costs and get to know the role of a cost center hierarchy.

Your company consists of different departments like Accounting, Manufacturing, Marketing, and so on. All of these departments are accountable for the costs that are incurred in their area of responsibility. The manager of the marketing department, for example, must make sure that all the expenses which are caused by his department – like consuming office supplies, electricity, or IT support – are tracked accordingly.

From a management accounting perspective, the departments are represented by cost centers. Each cost center is assigned to the person responsible – the manager. This person is accountable for all costs incurred in their area of responsibility.

Costs can also be planned so that you can compare the actual expenses with the planned values for each cost center. This enables you to analyze where your cost center has caused less (or more) costs than expected.

By charging the cost center with costs and monitoring them closely, you can clarify the following questions:

• If costs have been incurred in the organization, which departments are responsible for them? For example, all departments use the internal IT support on a regular basis. The incurring costs for this support are charged monthly to the causing cost centers. As a result, you can track the IT costs and you are able to find out which cost center is responsible for causing which amount of IT costs. 
• What are the variances between planned and actual costs on each cost center? For example, in the current period the marketing department spent more expenses on producing marketing videos than expected because the rental fee for video equipment has risen. This led to more costs which were charged to the cost center. Otherwise, the department caused less heating expenses than planned due to a warm winter period. 

Tracking costs using Cost Center Accounting helps to identify cost drivers in the company and to understand why costs are developing in a certain way.

Cost centers are not only cost objects but also used to represent the whole company from a management accounting perspective. In SAP S/4HANA, the organization chart is constructed through the cost center standard hierarchy.

Let’s have a look at how this hierarchy comes into play. Imagine the following scenario:

• The bike company is starting a new venture to produce electric scooters.
• It is creating new departments to support this new venture, so the organizational chart must be extended. 
• From a management accounting perspective, the new departments are represented by cost centers which are added in the cost center standard hierarchy where each cost center is assigned to a node.
• The new venture will be represented as a new node in the hierarchy under which the associated cost centers are grouped (Marketing, Finance etc.).
• It is mandatory to maintain a cost center hierarchy in your controlling area and to add all cost centers here.

In the hierarchy, the top node is always connected with the controlling area. Apart from that, you are free to build up the structure depending on your organizational chart. In this example, there are further nodes created for each company code, department, and sub-department. All cost centers are assigned on the lowest node within a branch of the hierarchy.

Now, you can explain that a cost center tracks the cost and revenue assignment for areas of responsibility and you understand that a cost center is part of a standard hierarchy that represents the overall enterprise organization.