fundamentals of cost accounting pdf

fundamentals of cost accounting pdf

Exploring the Fundamentals of Cost Accounting: A Comprehensive Guide

1. Introduction to Cost Accounting

Through the information provided by a cost accounting system, management can make the key determinations with respect to an enterprise’s products and services. In addition, cost accounting can determine how well the valuation attributed to an enterprise’s products and services match the pricing structure that was established by the enterprise’s marketplace. The mechanism for accomplishing this objective, particularly the control function, will require that relevant data be provided that compares the original decision-making framework to the subsequent operating process. Once the relevant data is received by management, a performance measurement and evaluation process can be performed in order to determine the extent to which the actual conditions coincided with the planned output. Finally, the program of actions can be put into place in the decision-making framework to guarantee that future activities will be as expected. Such an interactive feedback mechanism provides the devices for intelligent management control and will result in the increased efficiency of the planning and decision-making process.

Cost accounting is a facet of management accounting that incorporates the detailed description, as well as the measurements pertaining to the production of goods and services within an economic entity. A cost accounting system, which involves the utilization of formalized accounting informational procedures and methods, may generate information that is of value to managers. This accounting system could be used to accomplish any of the four basic steps of management accounting, which include the planning phase, the controlling phase, the decision-making phase, and the higher management-approved phase of profitability and program evaluation. However, the major built-in capabilities can be primarily attributed to the first three steps. The successful use of cost accounting is predicated upon the application of underlying concepts and principles, the application of cost accumulation processes and procedures, as well as the application of the techniques and methodologies.

2. Basic Principles and Concepts of Cost Accounting

There might not be a paint-by-numbers set of rules for calculating these costs, but smart people with a little bit of training can quickly put a system together. If cost accounting is not a part of my job responsibilities, why should I bother with its theory? The person is free to set up any kind of system he wants to come up with an appropriate answer to the problem. If you own a business, you should have a system as good as it can get. How do you know if you have a good answer if you don’t understand the underlying theory of cost accounting? Would you rather depend on the word of an “expert” who makes unjustified assumptions about the accuracy and reliability of his calculations, or would you rather be able to make your critical judgments about his answers?

In this module, you will deepen your understanding of cost accounting basics by familiarizing yourself with cost accounting principles, concepts, and classifications. All organizations have to know what their costs are in order to operate. In large multi-segmented companies, there exists a department specializing in this function. It is called the “cost accounting department” and it is a part of the finance department or such other appropriate department or person. Even a small company needs cost accounting. It might not be housed in the finance department. It might not even be acknowledged. But must have cost information, or it would soon be out of business, in the long run if not in the short run.

3. Cost Classification and Behavior

Costs are incurred to maintain each of these related accounts. In the merchandising firm, inventories are usually classified as purchases. The cost of goods purchased and available for sale is a good example of cost accumulation and cost flow. Service businesses may require inventories of supplies or contract work in process. Real estate and insurance businesses have customized product design features that make matching procedures necessary. Retail businesses receiving internal concession services operate part of their business as service units. These companies incur costs for their same services. They also classify commissions separately from service income. Under Generally Accepted Accounting Principles (GAAP), certain types of costs are usually classified as expenses in order to match revenues recognized with the costs of goods sold or services performed. Revenues resulting from cost-accounted sales increase the sales revenue account balance. Period expenses decrease the net income account balance. Net expenses are reported on the income statement format to calculate cash flow from operating activities. The relationship between costs recognized as expense and revenues recognized is the cost matching concept. In the contribution margin concept, which is used for the variable cost analysis, only the variable cost element is used. Total fixed expenses are usually deducted from the contribution margin. Gross profit, contribution margin, direct costs, and direct expenses may be reported at alternative levels of performance measurement. Dividing cash costs by the number of activity units provides an average cost estimate. Variable-rate and unit-level approaches are used to analyze specific levels and alternatives of costs. Variable costs usually change proportionally with activity changes. Such economists initially refer to fixed costs as period costs. Total average fixed costs remain constant at different levels of activity. The average cost per cost dimension decreases as volume increases. Certain internal organization processes require a zero base assessment of process activities. Time-driven, activity-based performance measurement is still based on cost drivers: process calibration expenditures are traced to ready-to-serve facilities and process steps under activity-based cost control. Information about cost drivers is used in benchmarking studies and industry comparisons. If an industry has relatively high expense levels, performance comparisons may not create an appropriate competitive standard. Control benchmarking estimates compare similar cost performance characteristics. Characteristics of products and customers should also be compared when detailed benchmarks are used. Cost control through process performance measurement may assist companies in attaining market leadership positions. Product-cost distributions are assigned to each product distribution category. The products are tracked until they are completed. The costs are then transferred to a department that has an exclusive relationship with completion. A brief recap of cost allocation for service companies is presented. Finally, variable and absorption cost comparisons summarize cost behavior differences in managerial decision-making.

Managers rely on cost classifications for analyzing and controlling costs. Cost accounting systems should be designed to provide information relating to the classification of costs and the behavior of costs. Furthermore, the Financial Accounting Standards Board (FASB) requires the special study of management accounting to emphasize the critical importance of classifying costs for control purposes and product-line decisions. This chapter examines the basic classification and behavior of costs. Manufacturing companies account for different types of costs. Manufacturing businesses have inventories of raw materials, work-in-process, and finished goods.

4. Costing Methods and Techniques

So, the fundamental purpose of costing is to ascertain the cost of distributed products. For instance, in the services industry, the cost of organizing an event, consultancy/problem-solving costs, creative costs, replenishing costs, and maintenance costs are calculated to provide a bill. Similarly, in the production industry, the cost of packaging products, distribution costs, beauty products cost, or brand ad costs are calculated to provide an invoice. Costing is carried out on cost centers and cost units. The advent of computer technology and increased levels of accuracy as a result of enhanced costing packages has made cost accounting procedures even more dependable and effective than before. The costs will need to be calculated in practically all walks of life, whether an undertaking is in the service, production, or trading industry.

In cost accounting, costing (sometimes called cost allotting) is the technique and process of identifying the various components of costs involved in carrying out some project or facility, taking into account a number of physical and managerial factors. Because different elements of costs are borne by cost centres or cost units, the techniques or methods needed for cost finding vary. So, every type of cost is assigned to a separate unit of product used for costing that type of cost. Once all the necessary costs are assigned, the units make up the total product, and their individual costs can be added to get the cost of the total product or the entire manufacturing process. Consequently, the elements of costs, the product or process unit in which they are fully identified, and the method employed in identifying them will form an important aspect of this discussion. The objective is to match/determine the total unit cost against the total output of the product or process.

5. Cost Analysis and Decision Making

The relevance criterion states that if information makes any difference in a choice, it may also be relevant to decision makers. This relevance concerns the future and it stresses the concept of ‘future benefit’ as the crucial factor in decision making. Consequently, the past costs are of no importance in decision making. Differences in estimates of the effect of decisions are called relevant costs and are normally outside the domain of traditional cost analysis, for traditional accounting costs are based on the full cost concept and refer to average costs. Only if a cost behaves in the future as it does in current cost studies is it a relevant cost. Only such costs are useful for short-run decision making.

Costing systems are important tools as they provide managers with the information they need for planning, controlling operations, and evaluating the performance of each organization. The information must be reliable and accurate in order to be relevant for decision making. In making decisions, management must first find out the relevant information that is appropriate to the decision criteria used. For short-run decisions, it is almost always necessary to estimate the effect of making a decision rather than setting up a comprehensive accounting study of the effects.