lanen fundamentals of cost accounting

lanen fundamentals of cost accounting

Foundations of Cost Accounting: An Essential Guide for Students and Professionals

1. Introduction to Cost Accounting

Thus, the concept of cost is closely related to most decisions that a manager must make. In today’s fast-changing economic environment, every manager needs to constantly reevaluate how he or she is using the resources available. Several methods may be used to help the manager in this decision-making process. The methods vary considerably in scope, complexity, and cost, as well as in their suitability in helping to solve specific decision-making problems. These methods must be based on accurate information suitable to management’s needs, provided in a timely and cost-efficient manner. The selection of the most appropriate method for any one particular problem will be determined by the size and nature of the decision to be made, reluctances in the feasibility of various methods. The necessary input to any of these decision-making methods usually comes from the information systems of the business entity.

Foundations of Cost Accounting: An essential guide for students and professionals. Cost accounting derives considerable importance from its nature and its usefulness to management for decision-making. The objective of cost accounting is to provide financial information about the costs of operations performed by a firm. This will help those who are concerned with operations to take action based upon this information. For example, the production manager may want to use the cost accounting output of production costs to understand whether the company’s operations are running efficiently. Similarly, cost accounting provides important information about costs of a product/service, which is very useful in fixing up the selling price.

2. Key Concepts and Terminology in Cost Accounting

Two points need to be brought out at this stage. First, it is important to point out that it is not enough merely to assign actual costs to various products and services. We also need to have a standard cost against which the actual cost in the cycle can be benchmarked. This standard cost represents the best estimate of the costs that can be expected. Second, one should also understand that only those differences between actual and standard costs that affect the costs of products, customers, or services are relevant to the cost of the product. Other factors contributing to cost differences but not affecting the costs of other products are likely to be of interest, for example, to process improvement teams.

Cost accounting is the process by which two key components of cost – namely the actual cost and the standard cost – are calculated and compared with planned cost. Carrying out this exercise is essential to administering the classic cost-accounting cycle, which encompasses planning, scheduling, and control. Actual costs associated with the use of various resources are recorded during the cost accounting cycle, known as the execution phase. Variance costs arising from this phase are then typically analyzed at the conclusion of the planning cycle. Finally, action points for each variance are planned so that performance can be improved upon in the next cost accounting cycle.

3. Costing Methods and Techniques

The cost of service departments presents problems similar to those of production departments, insofar as service departments also render services to other departments. Cost data serve as a criterion for eligible allocation of service budgets to various departments requiring service on a basis that is equitable and reflects the services provided. Any variation in services received by users of the service department should be reflected in the final cost data. Furthermore, the number of production units (or service units) is often a fair or a reasonable basis for allocation of service department costs. It should be noted that when both fixed and variable costs exist, each should be considered when evaluating the fairness of the service department cost allocation basis. When fixed costs exist, a department should pay a fair share of the service cost, whether that department utilized the service or not.

The production and marketing of goods and services are the central concerns of cost accounting, and the policies of a manufacturing or service organization are greatly influenced by the costing methods used. It is important to note that all costing methods should be flexible enough to accommodate variations in the physical nature of the elements being costed. For example, direct labor should be capable of being costed not only by time-clock or other hard data, but also through other sound bases including time ticket, standard hour, or “on the spot” observation of individual performance by a responsible supervisor, including an allowance for relaxation and fatigue.

4. Cost Behavior and Analysis

We refer mainly to business organizations or companies, for they represent the most frequent and complex manifestation of cost behavior and cause line managers and colleagues on the controllership staff the most tears and glory. However, the effect on not-for-profit organizations and governments is the same, and similar cost behavior and analysis principles apply. Municipals want to know how police pension costs behave; hospitals want to monitor the cost behavior of health insurance paid by employees and retirees. Cut services, increase fees, or hire more personnel to improve response time or patient care; all entities need to understand their chosen service cost structures. Similarly, already cost-conscious educational organizations increasingly worry about recent and future cost behavior for curriculum, for attracting new students or members, or for responding to technological advances, to mention only a few concerns of managers in these segments.

This chapter conceptualizes the fundamental relationships between costs and the level of activity, a crucial step in the application of cost accounting tools to business problems. Costs behave differently as the level of activity changes under both fixed and variable cost behavior patterns. Cost analysts use these concepts to explain cost behavior and predict cost in the presence of change. Costs concern every section in a planted or business and drive not only the income statement but also the form and content of the balance sheet and the cash flow calculations. Understanding cost behavior and its predictability is a vital skill and a great place to start a conversation with a colleague or manager, be they in marketing, HR, finance, or accounting, or, increasingly with the advent of corporate-wide cost management these days, in any other section of any business.

5. Strategic Cost Management

The terms Porter uses include “cost leadership,” “differentiation,” and “focus.” Cost leadership typically implies that the firm will have low costs and that products will be standardized. Differentiation implies that products will be unique or specialized. This may require a higher level of investment and cost than a focus strategy. A focus strategy requires that a firm concentrate on a market segment and form a tight fit between the segments and the configurations. According to Porter, the worst position a firm can take is being stuck in the middle. Being stuck in the middle means that a business tries to be all things to all people and has neither a simple, clear business model nor a value proposition. Needed cost accounting systems will flow from these strategies.

It is clear from earlier chapters that cost accounting is an important tool for strategic cost management. It provides the cost information that is needed for making operational and strategic decisions. The development of cost accounting systems provides opportunities for improved operational efficiency and development of new products and long-run competitive advantages. The principles of strategy developed by Porter have immediate implications for cost accounting.