In management accounting, the distinction between primary centers and auxiliary centers is fundamental for precise cost distribution and effective resource management.
Primary Centers, also known as Main Centers, are directly involved in the production of goods or services intended for sale. They are the main engine of operational activity and have a direct impact on the organization's profitability. In contrast, Auxiliary Centers, although not directly involved in production, play a crucial role by providing essential support services for the operation of Primary Centers.
In this article, we will explore these two types of centers, highlighting their roles, typical examples, and cost allocation methods that allow for fair and precise distribution of indirect costs within the organization.
If you want to know how to identify your Primary and Auxiliary Centers, we recommend consulting: Identifying your Primary and Auxiliary Centers from the Value Chain of your organization.
In management accounting, it is crucial to distinguish between primary centers, which are directly involved in the production of goods or services, and auxiliary centers, which provide essential support services.
Primary Centers, also known as Main Centers, are often departments or units directly involved in the production of goods or services intended for sale. They are at the heart of the organization's operational activity and directly generate revenue. The costs and performance of primary centers are often closely monitored as they have a direct impact on the organization's profitability.
Examples of Primary Centers: Production, Sales, Marketing, or Research and Development
Auxiliary Centers are also often departments or units within an organization that provide services or resources to other departments (primary centers and other auxiliary centers). Their role is to support the operations of primary centers by ensuring essential functions such as maintenance, cleaning, or accounting. Although they are not directly involved in the production of goods or services intended for sale, their contribution is indispensable for the smooth running of the organization.
Examples of Auxiliary Centers: Maintenance, Cleaning, IT Services, or Human Resources
By understanding the distinction between these two types of centers, we will better grasp the differences between allocation methods for distributing indirect costs within an organization.
Cost allocation methods for Primary and Auxiliary Centers channel expenses precisely and fairly within an organization. There are mainly three approaches: the direct method, the step-down method, and the reciprocal method. Each has its advantages and limitations in terms of complexity and precision in cost distribution.
The direct method consists of allocating the costs of Auxiliary Centers directly to Primary Centers without passing through other auxiliary centers. This method is simple to implement and understand. However, it does not take into account the services provided by Auxiliary Centers to each other.
Example
If the maintenance department (auxiliary center) and the cleaning department (auxiliary center) provide services to production and marketing (primary centers), the costs of maintenance and cleaning would be directly attributed to production and marketing without considering the services that maintenance can offer to cleaning and vice versa.
The step-down method (or sequential distribution method) allocates the costs of Auxiliary Centers following a specific sequence. In this method, the costs of Auxiliary Centers are first allocated among themselves, and then the remaining costs are distributed to Primary Centers.
Example
Suppose the cleaning department provides services to both the maintenance department and Primary Centers. First, the cleaning cost is distributed among maintenance and Primary Centers. Then, the maintenance costs, including those received from cleaning, are allocated to Primary Centers.
The reciprocal method is the most precise because it takes into account the services provided among all Auxiliary Centers. It uses simultaneous equations to allocate the costs of Auxiliary Centers reciprocally before distributing them to Primary Centers.
Example
If the maintenance department and the cleaning department provide mutual services, the costs are first balanced among them using simultaneous equations. Once the costs between the Auxiliary Centers are balanced, the total costs are then distributed among the Primary Centers.
Once indirect costs are allocated to Primary Centers, it is essential to distribute these costs among the various products and services they produce. This step gives us the Full Production Cost for each product or service, taking into account not only direct costs (such as raw materials and direct labor) but also indirect costs.
To allocate the costs of Primary Centers to products and services, it is crucial to identify the appropriate cost drivers, also called allocation bases or cost factors. These drivers reflect the relevant consumption of resources by each product or service.
Here are some commonly used drivers:
After imputing costs to products and services, it is crucial to allocate them to end customers, who are not internal clients, but those who actually purchase the products or services. This ultimate allocation sets a Full Cost for each customer based on the products and services rendered, which is essential for pricing, profitability analysis, and strategic decision-making.
Example :
If a product is sold to different customers, the costs associated with its production (direct and indirect) are imputed to reflect the actual use of resources by each customer. This includes production, distribution, and any other costs associated with serving the customer.
