what is cost accounting with example

what is cost accounting with example

Understanding Cost Accounting: Theory and Practice

1. Introduction to Cost Accounting

c. Period costs: These costs are unrelated to productive facilities and apply to any major expense incurred in the non-profit area. They include selling costs, distribution costs, and general administration costs.

b. Overhead costs: These costs are identifiable and controllable in specific cost centers and are often known costs. They are set out to be controllable by appropriate members of management, who are empowered to take budgeted costs and take management action on the actual costs that become apparent at a later stage. The difference between standard costs and actual costs can have a major effect on the final cost of products being manufactured.

a. Product costs: These costs are created by the actual manufacturing activities and include the cost of materials, labor, use of plant and building, etc. Costs of a similar type are often referred to as “stock costs,” particularly in companies engaged in mass manufacture of complex products.

The second major class of accounting reports is now generally referred to as “management accounting” and is considered the main area of focus for most accountants. However, there is an area of accounting that is rapidly increasing in economic importance and is concerned with cost and how it is captured from the initial transformation of materials into a finished product. This practice of cost accounting is designed to assist with accounting decisions for both internal and external users and is often referred to as meeting the requirements of individuals concerned with the purpose of such cost accounting. The practice of cost accounting can be broken down into three categories of costs that are generally faced by most businesses. These are:

The role of the accountant has been gradually changing due to economic conditions, but especially in recent years, due to advances in technology, particularly computerization. The traditional roles of the accountant and the types of accounting they engage in are usually categorized into three classes. The first class is now often referred to as “financial accounting” and is primarily concerned with the preparation of financial accounts for use by external constituencies such as company shareholders, creditors, and others who have invested in the company.

1.1 What is Cost Accounting?

2. Key Concepts and Principles of Cost Accounting

Cost accounting is concerned with the ascertainment of costs, the accurate analysis of ascertainments, and control of costs. It includes the presentation of information for the necessary ingredients of cost control and determination of selling prices. This is mainly used for external reports, but company management has found the information management in this report to be helpful in the decisions as well.

Cost accounting is “accounting for costs” and it measures the performance of a company’s operations according to specifications in the company’s operations budget. It represents actual financial transactions and their implications for the company’s operations or other functions. The primary purpose of cost accounting is to provide a detailed break-up of the cost of goods or services concocted by a company or its particular operations without regard to the type and quality of procedures applied to it, to determine or demonstrate factors which bring out variations in profit, or inefficiencies or wasteful aspects of such operations. Managing costs rather than their direct measurements is the key objective of cost accounting. It becomes a management accounting function when the primary objective is to earmark a resource or explain important variations via control of costs.

3. Methods and Techniques in Cost Accounting

This chapter outlines and develops the methods and techniques employed in cost accounting for classifying costs, accumulating costs, and dealing with production problems such as spoilage and rejections and the determination of equivalent units in a process cost flow. The basic concepts underlying the cost accumulation techniques of job order and process cost accounting are introduced and proposed. The various costing methods are presented in terms of both their theoretical bases and the mechanics of application. Examples are presented to illustrate the application of each method.

If the cost accountant is to fulfill his function as an aide to management, he must have not only a rather high degree of general technical competence augmented by an intimate understanding of both the organization itself and its particular conditions and problems, but he must also know how to assign costs in terms of cost theory. To perform the latter well, that can hardly be any exception taken to that unless one is adequately familiar with both the method of assignment and the basic techniques of analysis, he cannot operate efficiently unless the data in the cost analysis request are specific or specialized such that a specific cost for a particular analysis can be generated. Yet, the direction for cost analysis can properly come only from cost theory. Hence, for cost accounting to be meaningful, it must depend heavily on a clear and essentially simple development of the principle theory of cost that is grounded in economics and management.

4. Application of Cost Accounting in Business Decision Making

When one-of-a-kind production of a product involves a high level of material and production complexity as well as experienced workers, these workers can design certain levels of product performance (called levels of product functionality). These item-by-item relations between price and product and price and functionality suggest the need for cost accounting for one-of-a-kind production. Sophisticated products provide many functions for buyers. Engineering designers each develop products with their own criteria for evaluation. Product feature functions, feature standards, product system functions, and system functions provide points of reference for setting production standards. These points of reference are also useful for carrying out cost performance comparisons. Cost relations analysis is employed to calculate the hours that are spent on expensive products. The engineering cost function is typically price, but there are exceptions such as relative cost performance. Product design is one of the most powerful tools for cost performance conversion. Its techniques are so powerful that they are used for the materials cost decisions inquiry. Design information search supports pairing of production and production rates. Measure of engineering design information is useful for determining design cost drivers and for selecting and allocating engineering resources. Engineering resources are typically allocated based on examination of the trade-offs between engineering costs, product performance, and production performance. Visualized engineering work instruction grouping is applied to engineering supermarkets as well as applying measurable design differences. This provides a means by which the amount of design work being performed as well as the type of engineering work being performed can be determined. This knowledge facilitates studying the trade-off between product design, production plan adjustments, target costing, and various types of labor that are involved in the one-of-a-kind production environment. Engineering cost functions help evaluate engineering reports and empirical cost data. Analysis of the one-of-a-kind production business suggests that the most important relationship in the cost management and performance evaluation process for this business is the price/production/functionality relationship. In one-of-a-kind production facilities, in a process where a significant amount of experience is involved, traceability and cost estimation are the core concepts of cost accounting. These concepts are used to reduce the costs of providing a process for accumulating costs. They also are used to compare the accumulated costs to cost standards. They are fundamental for achieving successful business results.

Under normal business conditions, customers’ requirements change from time to time. New designs of goods which satisfy customers are necessary to create situations conducive to business competition. This is the motivating factor behind most engineering activities. An engineer must design products so as to contribute to company objectives. In this respect, then, an engineer can be considered as a type of businessperson. However, in some cases engineers become specialized in using equipment and estimating the cost of goods. Traceability of costs and cost estimation are concepts which are useful when carrying out studies related to process performance improvement. Such activity introduces an “accounting viewpoint” into technology-related activities. This type of accounting is known as cost accounting.

5. Case Studies and Examples in Cost Accounting

The assessment and discussion of case studies has long been an important component in many professional examinations and has played a key role in accounting education. Despite this, there is some evidence to suggest that the use of case study material within the accounting undergraduate curriculum in the United Kingdom has possibly declined in recent years. Case materials are widely used on MBA programs, but it is clear that not only is case study writing a very time-consuming exercise, but whereby the instructor uses a case to deliver a lecture by proxy, it is probably of little value to the students in providing the opportunity to develop the practical evaluation skills they will need in their future working lives. Some of the underlying reasons for the decline of the case study are examined in order to provide an explanation for this possibly surprising change in the way educators choose to teach by reference to the findings of a survey of accounting and finance program managers. With this background, the final section of Chapter Two makes a plea for a reinvestment in case-based teaching for students following a variety of levels and types of accounting courses.

This chapter reports on a study of a random sample of articles drawn from a group of leading cost and management accounting journals in an attempt to ascertain the current state of the use of case studies in accounting research. The findings suggest that while accounting research is often quasi-experimental in nature, a significant proportion of accounting publications uses the case study method. However, only in a minority of cases did such studies take the form of a detailed exploration of the case, and there was no evidence of the issues of case study research design receiving serious attention. These are important findings because such literature plays a significant role in guiding the education of the next generation of accounting professionals, and publication output has a direct impact on an academic’s standing within the accounting community. The findings are therefore likely to generate interest and concern amongst educationalists and professional researchers alike, and are developed and discussed in the final section of the chapter.