cost accounting basics

cost accounting basics

Foundations of Cost Accounting: Understanding the Basics

1. Introduction to Cost Accounting

This chapter helps you to understand the basics of how traditional cost accounting and modern management accounting fit into your field and the subject of business, as well as the worldwide community and your culture in promoting thought about the future and job creation. Cost accounting is a facet of management accounting that turns data into useful information by studying the full cost. The data are linked to policies, initiatives, decisions, and outcomes and anticipate consequences of actions in the future to ensure overall success. Cost accounting sets up monitoring systems and modifies the systems as necessary. It provides the basis on which management accountants create, control, and judge performance and value so that business ideas can be communicated and shared. It transforms students of business into business leaders of today and potential leaders of tomorrow. Significant portions of cost accounting have moved toward decision support and away from inventory costing, except for the accumulation of history for purposes of monitoring accountable outcomes. The United States and the nation’s defense agencies provide guidance for the cost accounting subset called contract costs, or contract and cost negotiation objectives with defense contractors and certain organizations and farming families that manage farms are subject to audit by oversight bodies.

Cost accounting might seem like a surprise course for a business student to take. But think of it this way: you’re seeking a degree in business, and most of you are business students. You also know that cost accounting is an important aspect of the subject we call accounting. And we all know that accounting is fundamental to any business. It’s far too important to be left solely to the accounting majors! Cost accounting combines both of your major courses. It focuses on business rather than on the business itself. Cost accounting is very important to any business, and certified public accounting firms look for a knowledge of cost accounting in young CPAs. You may not want to pass up a month spending time in a large firm earning an income for that month of more than some people earn in a whole year!

2. Key Concepts and Terminology

In this section, we will discuss several basic cost management definitions, cost objects, direct and indirect costs, common cost behavior patterns, various supporting cost management documents, and the differences in presentation of financial accounting versus managerial cost information in the reports provided by these two accounting systems.

Cost accounting provides the detailed cost information that management needs to perform three broad functions: 1) cost control; 2) product and service costing; and 3) strategic decision making. To understand cost accounting, you need to understand key cost accounting concepts and some of the common terminology used in cost accounting. Cost management refers to the overall process relating to the conservation of an organization’s resources, which is what cost accounting is all about!

3. Cost Classification and Behavior

Although managers use cost classification extensively, the terms used are often not precise. The Generally Accepted Accounting Principles don’t define these costs, only provide guidance regarding inventory costing for external reporting. Therefore, each organization uses their own classification system. Knowing the different names and definitions is far less important than understanding the logic behind cost classification. This logic is based on the behavior that an individual cost has in relationship to specific cost objects such as products, services, and customers. These relationships are important when analyzing performance, pricing, and evaluating process improvement, or introducing management theories into accounting data. According to current practice and professional view, cost behavior is a more important attribute of costs than cost classification. Although cost classification can identify the relative size of costs, some costs, such as sales or lease, can be both fixed and variable. Since most activities in organizations are driven by production and sales and since we often change behavior if we can define it, understanding the behavior of costs becomes a primary goal.

Cost classification allows for the accumulation, assignment, and understanding of costs, and is an essential skill for managerial accountants. Costs can take several forms, including direct, indirect, variable, fixed, and mixed. Some of these concepts relate specifically to the cost objects to which costs are assigned. Managers need this information in order to make decisions regarding product pricing, product emphasis, cost reduction, and demand analysis. They use this information to evaluate the performance of responsibility centers, to reduce costs in the value chain, to assist in measuring and reporting sustainable business practices, and to understand and apply various management theories to their own organizations. Future interwoven chapters will provide further understanding for the accumulation and assignment of these costs to cost objects and how they apply to external financial reports.

4. Costing Methods and Techniques

Job costing: This technique attributes costs to individual or groups of products. It has traditionally been used in the construction industry, for print and design, and products that, whilst being similar, might require different input cost profiles. In the modern manufacturing environment, job costing would generally be used in conjunction with other methods, such as process or standard costing.

N.B. Activity-based costing, although a distinct method, can be used in combination with any of the other costing methods (job, process, marginal, etc.). It would, however, normally be seen as a more advanced method used by organizations with sophisticated cost systems.

Costing methods that can be used for financial management and control purposes include job, process, standard, direct and absorption costing, and activity-based costing. Below, we examine the role played by each of these methods and the differing costing techniques within them. All of the methods identify costs for cost-centre managers and the responsibility for costs established by the appropriate placement of managers within the organizational hierarchy.

5. Applications and Benefits in Business

Almost every organization focuses some attention on providing products and services that are of high quality to consumers, customers, and clients. One generic approach to quality starts with the belief that everyone in the organization does want to deliver customer satisfaction and to meet stakeholders’ expectations for business results. And, given a competitive and changing business environment, this may be viewed as a precondition for survival. In this chapter, we focus on the topic of activity-based management (ABM), which is an organization-wide approach that is designed to assure the achievement of strategic goals. ABM addresses not only the production function but also all the other business processes of the organization. The theory behind ABM is not complicated. In most organizations, the way in which people conduct their business processes was established a generation or more ago. There have been numerous changes in the production and business environment since that time. Why should any company today complete a process simply because it is an activity described on a piece of paper written decades ago, especially if that activity serves no value-added purpose?