Cost Accounting
| Author | John Alvis |
| Pages | 144-148 |
Page 144
Cost accounting, often referred to as managerial or management accounting, is the branch of accounting that provides economic and financial information to decision makers within a company. The idea of providing information for use within the company (to aid management to plan, direct, and control operations) differentiates cost accounting from other segments of the accountancy profession. For example, financial accounting serves the public by providing financial reporting via financial statements, financial press releases and such. This public information is prepared and presented based on generally accepted accounting principles (GAAP), the broad rules that assure the user of the underlying framework supporting the information.
On the other hand, cost accounting is limited predominantly to use within the company to aid management in the process of making choices that will benefit the stockholders by maximizing company profits that translate into maximizing stockholder wealth. Since the information is used internally, the information may be presented on any logical basis just so long as it will aid the manager to reach an appropriate, informed decision.
A few concepts in cost accounting, however, form the bridge between financial and managerial accounting topics. One such concept is that of product costing for a manufacturing company. Not only is this information used internally in decision making (e.g., does a company make or buy a component?), product costing is also used to determine the historical basis to account for the cost of products sold during a period and the cost of the unsold inventory that remains as an asset on the statement of financial position at the end of the period.
Numerous cost accounting concepts can benefit management in decision-making, both for manufacturing and service companies. While many of the concepts discussed below are applicable to both types of companies, the basis for ease of discussion will be that of a manufacturing company. Therefore, some of the concepts to be discussed include understanding the distinction between manufacturing and non-manufacturing costs (and how these are disclosed in the financial statements), computing the cost of manufacturing a product (or providing a service), identifying cost behavior in order to utilize cost-volume-profit relationships, setting prices, budgeting and budgetary controls, and capital budgeting. These topics will be briefly discussed below.
Manufacturing costs are those costs incurred by a producer of goods that are needed to transform raw materials into finished products, ready to sell. These costs consist of the cost of basic materials and components, plus the costs of labor and factory overhead needed to convert the materials into finished products.
Materials and labor can be classified as either direct or indirect in relation to the final product. Direct materials are those major components that can be easily traced to the finished good and are accounted for carefully due to their significance to the product. In the case of manufacturing a lawn mower, for example, these types of materials would include the engine, housing, wheels, and handle. Indirect materials would include those minor items that are essential but which cannot be easily traced to the finished product. Examples of these would be screws, nuts, bolts, washers, and lubricants. One might say that the cost of keeping an account of each of these indirect items exceeds the benefit derived from having the information. Consequently, the costs of these items are accumulated as part of factory overhead and prorated to products on some appropriate basis.
Direct labor refers to the efforts of factory workers that can be directly associated with transforming the materials into the finished product, such as laborers who assemble the product. Indirect laborers are those whose efforts cannot be traced directly or practically to the finished product. The indirect laborers would include maintenance personnel and supervisors.
Factory overhead includes all factory costs that can only be indirectly associated with the finished inventory, that is, all factory costs incurred in making a product other than the costs of direct materials and direct labor. In terms of cost behavior, some of these costs do not change in total even if the number of products manufactured increases or decreases from period to period; the behavior of these costs is said to be a fixed cost. For example, the amount of the monthly factory rent would not fluctuate based on the number of units produced during a particular month.
Page 145
Other factory overhead costs that change in total in direct proportion to changes in the number of products manufactured are known as variable costs. For example, the number of nuts and bolts needed to assemble lawn mowers would increase and decrease exactly in proportion to the number of mowers produced and are therefore considered to be a variable cost. In summarizing this brief discussion of factory overhead costs, these costs include such things as depreciation of factory buildings and machinery, factory utilities, factory insurance, indirect materials, and indirect labor; some of these costs are variable while others are fixed in total for a specific time period.
All material, labor, and factory overhead costs are summarized into totals that represent the cost of the goods manufactured during a period of time. The cost of products that have been completed and sold during a time period are deducted from the related sales revenue total in order to determine the gross profit for the period. Thus it is logical that these manufacturing costs are referred to as product costs. The cost of unsold completed units at period's end is shown as finished goods on the balance sheet. Any costs of...
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