fundamentals of cost accounting lanen pdf

fundamentals of cost accounting lanen pdf

Fundamentals of Cost Accounting: A Comprehensive Guide

1. Introduction to Cost Accounting

Cost accounting involves a variety of management approaches. It accumulates and documents costs using books. It is an internal function that is oriented towards the managers of the organization. It may be generally concerned with the determination of product costs, but it is more concerned with strategic decision-making and other specific applications like activity-based management, strategic cost analysis, and cost management system design. Cost accounting has a dedicated internal management and control purpose and supplies cost information. The management actions based on the efficiency criteria available for the organization can be tracked.

Cost accounting is the analysis, interpretation, and presentation of cost information to management. It is used by managers to understand the true cost of resources used in an organization’s products or services. It is also the method of aggregating, classifying, allocating, and reporting costs of a fairly uniform nature. Cost accounting involves the analysis, scrutiny, and reporting of costs in one or more divisions. It is the method of assessing, calculating, reducing, and eventually reporting the commitment of an accrued activity as a planning activity followed by analysis of the operation of the activity in a controlled manner.

2. Cost Concepts and Terminology

Cost accounting is a separate aspect of accounting grown out of the necessity for timely and precise cost details about sales, production, labor, and properties for the expanded recognition and interpretation of costs. Its primary objective is the constant allocation of costs to a given base of operation and the arrangement and interpretation of the resulting information. The use of specialized records and the routine collection of primary accounting details are equaled by cost methods and correspondingly specialized cost accounting records to result in accounting that is highly significant to management.

It provides the manager of the business with the accounting data essential for his purposes and gives him methodical reports that help to discharge his checks and control, coordination, and business objectives. An efficient system of cost accounting is built up with the use of the same elementary bookkeeping techniques and accounting faculty utilized in monetary accounting. The subsequent distinction is largely in the objectives to be fulfilled by the costs.

The successful management of any firm calls for the establishment and use of an advanced system of costing as an integral part of the business procedure. Cost accounting is an original and proven approach to guarantee control and to assist in the preparation of the operations of both manufacturing and other business concerns of all kinds.

3. Cost Classification and Behavior

In addition to providing cost information related to cost classification, traditional cost accounting systems are also designed to describe how costs behave in a manufacturing environment. To examine cost behavior, a variety of mathematical and graphic cost functions can be used. Such cost functions reveal that the manner in which a particular cost changes as a function of changes in a cost driver (nonprofit organization) or a production activity or transaction (business) stimulus, determines the cost’s contribution to different costs and product prices. By understanding the behavior of costs, businesses are able to employ such costs to their strategic advantage and create cost-effective measurement, information, analysis, and control systems. The four different types of cost functions used to describe the behavior of costs are: fixed costs; variable costs; step costs; and mixed costs. These four types are introduced below to understand how they relate to a specific cost and cost function model.

Cost Behavior

Organizations typically use their budgets to estimate the total quantities of commodities and/or services, called cost drivers or cost drivers, needed to provide each service and to calculate the total dollar amount of the indirect costs associated with each service. Businesses use cost drivers to assign the calculated indirect costs to a product’s direct cost. The indirect costs assigned to a product as direct costs in one of three ways. The most frequently employed method assigns indirect manufacturing costs to products through a single (machine hours) in relation to manufacturing labor, machine, cost driver (such as production supervision dollars) for the entire manufacturing shop. Although the single cost driver method has the advantage of simplicity, it is often rejected because it fails to recognize that the use of services varies among producing different types or sizes of products.

Indirect costs are costs that are not directly traceable to a cost object in an economically feasible way. Indirect costs are often referred to as overhead or burden costs. Examples of indirect costs for a product include the factory-related expenses of maintaining the facility in which the product is produced and the salaries of the specifically, the department manager of the manufacturing labor, engineers responsible for production supervision, and maintenance workers. Similarly, indirect costs for a service organization include organizational resources used to support services such as utility expenses charged to service areas and the salaries of the nonprofit organization’s administrators. In each case, essentially, direct costs are traced directly, while indirect costs represent estimated costs for which the service areas receive partial allocations of organizational resources. For nonprofit organizations, indirect costs also include organization-wide expenses.

Direct costs are costs that can be traced to a cost object in an economically feasible way. In the context of manufacturing firms, direct costs are those costs that can be traced to the product being produced. Examples of direct costs for a manufactured product include the direct materials and direct labor used to produce the product. Direct costs of a service organization are those costs that can be traced to individual services such as the costs of travel to and from service locations to perform a service (e.g., travel and travel-related costs for private museum tours).

Because cost data are used for a variety of purposes in organizations, there is a variety of ways to classify costs. Costs can be classified very generally according to their relationship with the product or service: as direct, indirect, or overhead costs. In this section, we introduce these general categories as well as several subcategories of each type.

4. Cost-Volume-Profit Analysis

In business or industry, the same principle applies. Managers are aware that costs are fixed and are also variable with the extent of production. CVP provides valuable information to help managers manage these changing costs better. What is essential for managers to know is this: At a time when the business experienced financial difficulties, was the operating loss the result of producing too few units or making too few sales? If additional sales would have made a difference, could the sales price have been lowered without increasing the loss? Could, for that matter, prices be raised? Could additional units be produced without increasing the loss, whether more were sold or not? What if the sale price were increased? Should the new price be high enough to drive away business slowly, just enough so that the company could break even or resort to the loss?

In many high school activities, a student pays a participation fee. This fee, in effect, says that the school district incurs costs that are fixed and variable with the number of students who participate in the activity. For example, the district incurs costs to pay the activity director. Although the activity director receives the same wages whether 20 or 200 students participate, the district incurs costs that fluctuate with the number of students, such as for printing programs or umpires for a controversy-prone basketball game.

5. Costing Methods and Techniques

5.1 Specific Order Costs: This method applies to those concerns which produce according to customers’ order. The industries like machine tools manufacturing, ship-building, foundries, aeronautical and other engineering manufacture. The output is called a batch, lot or a contract, which is specific according to customers’ order detailed specification. The production period is generally long running. Each batch has its own unique characteristics. Either a separate account or cost card or sub-account will be prepared for each job. As each batch is separate from the others, the bulk of the production orders will be different in terms of materials, time, method, and other costs. The costing will have to be exclusively undertaken. All such relevant costs are recorded in the cost card, which will and record materials, the direct labor and the indirect expenditure costs and if required, draws, returns and other costs on the material.

Management, having realized the importance of cost, requires accurate information about cost. Different techniques and methods for determining the cost have been developed and are being applied in practice. Cost accounting has to put in place a proper cost system and select the method or technique most suited to the type of operations. Given here are the major methods and techniques. The fundamental of cost accounting will understand the nature and objectives of methods of costs.