lanen fundamentals of cost accounting pdf

lanen fundamentals of cost accounting pdf

Foundations of Cost Accounting: A Comprehensive Guide

1. Introduction to Cost Accounting

This bibliographical study located cost reports currently being used in business accounting circles to plan, motivate, and control costs. Our findings in the practical world of management showed that operation measurement reports were more fluent, adaptable, granular, and more responsive to changes than the truth as stated by accounted costs. Because of inherent limitations, measurement and valuation reports lagged the structuring of new operations and were fraught with systematic and random errors. Most cost information actually being used in business was being created to answer particular and specific questions that needed answering. Their purpose was to satisfy the requirements for financial administration in a spatial context (value chain governance). Standard and customized operation measurement reports played various theoretically driven and contextually inspired roles in justifying Catholic cost allocation decisions. They were also integral and material inputs for all the interventions needed to appear successful in the eyes of the Bible belt cost efficiency manager. The management accountant manipulates costs in space to add value. How else are academics able to say cost accounting was rooted in actual practice if their current approach relied mainly on prompts, classification, and one-size-fits-all theory? Our proposal is based on the premise that practical cost accounting activities, operation measurement, and cost allocation, were capable of being systematized scientifically. Operation measure reports need to mirror the production and support operations of businesses in sufficient detail to be of use to people in organizations.

This book seeks to address the current gap in support material for the teaching of cost accounting as a practical discipline in South Africa. It was written in response to the university accounting academics who expressed the sentiment that cost accounting, as a discipline, was increasingly tending towards becoming overly theoretical and less rooted in actual practice. Furthermore, the ±70% revision barriers for cost accounting at major South African universities were a reliable testament that current teaching materials were not serving the needs of the students being taught. The discrepancy between the learning outcomes prescribed and the material actually delivered was clearly observed. Financial reports being used at graduate levels of learning were not adequately serving management accounting practice in South Africa. Orientation was towards satisfying external users’ information needs rather than internal users.

2. Key Concepts and Terminology in Cost Accounting

Whenever costs relate to a specific segment of the company or are caused by a particular activity, they are treated as a direct cost. The cost relationship, or cost behavior, is measured in physical rather than financial terms and is easily and economically determined from an analysis of the production or sales processes. The majority of costs depend on the contribution of other activities rather than on physical factors. For example, if total costs increase because of a manager’s decision to produce more shirts, data processing and warehousing costs rise because the number of units shipped increases. It is important to relate costs to the purposes for which they are used. Positions and their responsibilities should be clarified when cost data are assigned or controlled. For example, designing a payment incentive may be more important than assigning the cost of the detail-design department to each job worked on. Designing an incentive plan involves several less costly options than assigning costs, even if employees do not need to know about the incentive as part of their job. Normally, activities differing in both kind and amount influence the cost of a product. This is a key aspect of cost accounting.

Cost accounting is a simple subject based on cost analysis and control. Answers to general questions such as “Where did we make a profit in the past,” “Where are we making a profit today,” “Where can we make a profit in the future,” “Where did we lose in the past,” “Where are we losing now,” and “Where can we lose in the future” can only be answered through cost accounting. The profit and loss statement of a company is prepared by grouping and analyzing its general ledger accounts, and is based on the same economic decisions that arise in business practices. Many major problems in assessing profits and progress can be solved by isolating the profit and loss characteristics of each service or product offered by a company. The company will be able to ignore services or products that do not measure up to desired standards. Thus, one of the aims of cost accounting is to pick the winners as well as the losers among the services and products of a company.

3. Cost Classification and Behavior

Every organization needs to allocate costs as a means of effective management control. One unique aspect of successful cost allocation in a product or segment-flow environment is the behavior of specific costs. This is because these costs or revenues are affected by departmental choices when a range is recognized by management. Recognition of the relevant range is important to decision-making as it provides the parameter that allows management to make choices with the options available for standard behavior prior to affecting that behavior. Combining good cost classification with an understanding of cost behavior allows management to set markers that help control significant departmental and company costs. Management policies must be cognizant of these three characteristic costs, given that they vary in both behavior and relevant range. After examining four aspects of cost behavior, practical considerations that are important to management are addressed.

Once costs are accumulated for an item, they need to be classified in such a manner that pertinent costs can be allocated in a meaningful way. The process of classifying costs generally is concerned with an understanding of the cost accounting system used to capture costs. Proper classification allows costs to be assigned to specific jobs, machines, departments, products, or functions. Classifications based on the benefit received by the organization include both product and period costs, whereas necessary function and behavior considerations are based on their cost behavior. Recall that costs can expire in one of two ways: they can expire on the income statement by being reported as a period cost, or they can expire on the balance sheet by appearing as an asset and then being expensed at a future point in time as benefits are achieved from cost outlays.

4. Cost-Volume-Profit Analysis

Cost-volume-profit analysis uses fixed costs, variable costs, the selling price per unit, and the sales mix of a company’s products to give you data so you can make more informed business decisions. A detailed knowledge of cost behavior is needed to comprehend the effects of changes in sales volume on the cost patterns of a company. With cost-volume-profit analysis, a business can measure this impact not only in terms of profits but also in terms of the break-even point and the margin of safety-income.

When you are trying to find the impact on the profits of a business from changes in output, sales volume, prices, or costs, you need to use cost-volume-profit analysis. This technique helps you to answer the following questions: What must my sales be in order to break even? How will a price cut affect my profits? What will happen if costs increase? How much will I make on a contract job or a special order? What volume is needed to generate a desired profit? So before forming any marketing plans, making price changes or accepting special orders, you should conduct cost-volume-profit analysis to check the potential effects of changes on your company’s profitability.

5. Costing Methods and Techniques

This is a good time to identify that absorption costs should include the appropriate allocation of indirect manufacturing costs. In the traditional versus direct costing debate, the indirect manufacturing costs are allocated to the goods – whether for inventory or cost of goods sold. After that, the accounting focuses on the treatment of the expenditures. Stated another way: which expenditures are related to this allocation? Recognizing the type of cost is a determining factor in the nature of the allocation. The decision as to the product-to-manufacturing cost relationship is of concern to the evaluation-and-decision process. Differences in that determination may lead to massive changes in costs and profitability comparisons.

Employee productivity is the most important management concern in most industries. The productivity of employees and machines determines cost efficiency. Cost accounting is the first tool used by the manager to measure productivity. The traditional emphasis of cost accounting is on valuing and controlling direct material, direct labor, and some types of conversion costs. Cost accounting corrects the distortions in standard accounting – which uses only cash payments as a basis for reporting business operations – and it provides the proper basis for improved management decisions. Purchases of goods and services not yet in use must be expensed when used. Allocations over time of indirect costs to segments of the business can be done only in cost accounting. It signals management dilemmas and improves managers’ decision-making process.