cost accounting

cost accounting

The Importance of Cost Accounting

1. Introduction to Cost Accounting

The real risks are increases in backlog and delays, trapped provisions of finished goods, and a decreasing level of customer satisfaction and customer loyalty.

Eventually, traditional cost values and product costs become religious numbers with “sent down from columns” character and are used as the basis for many and far-reaching decisions. At the same time, managers reduce inventories to reduce costs because costs are now inflated in the traditional system. Customer responsiveness and flexibility of internal processes decline, however. You should expect that managers confront the loss of effectiveness and efficiencies of downstream processes, but traditional accounting fosters more short-term optimizing reactions.

A powerful cost accounting system is the database for the estimation of real resource consumption and the identification of bottlenecks in a lean production system. This is a significant extension of the production and planning principle regarding resource allocation of production factors to products and services. In traditional accounting, this allocation is based on assumption or on narrowly defined cost drivers that usually are not relevant in depth and degree. Results are misleading cost values in traditional accounting, and traditional cost values are used as input for decisions that additionally aggravate the distortions.

In this context, cost accounting accumulates costs and assigns them to multiple individual cost objects and tasks. However, it can be much more than that because the collection and allocation to specific cost objects is a necessary effect of estimating the real consumption of resources by products and services. Cost accounting systems also can be used to estimate the real consumption of resources per cost object by dividing the total actual resource costs of departments or cost categories by direct labor hours.

Cost accounting is an essential management accounting tool. It is a powerful computer-based system to model, manage, control, and profit from value and low costs. A major potential of cost accounting is its ability to increase corporate income by reducing product or service costs. However, companies usually use cost accounting for official financial statements and rectangle reports, instead. This far underestimates the value of comprehensive and integrative systems that capture and provide user-friendly feedback on waste costs and value creation opportunities.

2. Methods and Techniques in Cost Accounting

Method Qualifications Cost accounting is a fact-finding (score-keeping) activity. Its object is to inform the management of business changes and results. This is to be accomplished as economically as possible. These are the advantages of being very specific with the resulting information. For only practices with a major effect are worthwhile. It is noted that the defenses of the specific identification (item number and total price) are (1) the most specific, (2) best suited for the busy demographic embrace of entry-level managers, and (3) realistically maintainable without steep learning curves. Their primary weakness is that they lack the persuasiveness peculiar to having associated norms. This is to say, unless years of data support the “result”, its merits are unknown. Conversely, these special norms (and their structures) implicitly elevate the status (appearance) of their possessed data. It is notable that inventory data attributes outside of category identification are also of great benefit to management. Specifically, parameters relevant to their contents, for example, the number of batches, work in process (WIP) or the date of last activity, are useful data to collect and have automatically included.

The following is an examination of the methods and techniques used in cost accounting by the various business entities introduced in the previous post. The objective is to describe, in general measure, the available methods and techniques by entity. For service providers, the first section highlights the generally accepted cost accounting methods; for merchandisers, the second examines the choices made by the better informed; and for manufacturers, the third places these methods in the context of established best practices.

3. Cost Analysis and Decision Making

Cost accounting cuts at the various major problems at the manager’s stable in a significant manner. Cost accounting facilitates many essential managerial functions such as budgeting and standard costing control, cost volume profit analysis, break-even analysis, pricing decisions, make or buy decisions, product mix, special sales decisions, capital investment and replacement decisions, design of efficient cost systems. In respect of fixed and variable costs, they affect the manager’s decision on how to increase profit. For such a purpose, cost accounting provides them important information such as break-even points and other management useful analytical data. The break-even point decision is one where the firm under consideration is deciding the possible volume of production activity necessary to definitely cover the unavoidable committed costs. If a manager in profit gets should increase his break-even point by liberties with fixed cost commitments, then the manager definitely increases his risks of settling up in the blood-red sea of loss.

At the very outset, cost accounting is not merely a device for product costing but also useful as an important technique for cost analysis and for making various managerial decisions. Cost accounting is an internal aspect of financial accounting. The former supplies cost data and financial data at the end results. If there is no cost accounting blueprint, there is no logic in the finalization by financial accounting. Again, it is cost accounting which budgets, standardizes, and controls costs efficiency levels. But in this area, in their particular set of affairs, they are based on financial accounts only, difficult esoteric ideas from the outside. So, cost accounting should be technically considered for the benefit of being interlocked with general financial accounts. The accounting database can be used to provide information to management. Generally accepted accounting principles define official measures to perform financial reports.

4. Cost Control and Budgeting

Accountants have been advancing ideas to assist management in its planning and control functions since the early 1900s. In the second decade of this century, cost accounting developed so rapidly that its applications to industrial efficiency and operations on national industrial questions were generally recognized by the operating executives. At a meeting of the Pittsburgh Chamber of Commerce, addressing himself to the importance of costs, Mr. Charles A. Ormsby stated: “We are face to face with the fact that this development of what we call the art of cost-keeping, which, indeed, has disturbed not a few of us because it seemed at first to make such heavy exactions upon the activities and time of the entire executive staff, has at last come to be able to yield a very substantial measure of practical returns, not later than at the end of the first three or four years of its service.”

All too often, financial analysis and budgeting consist of comparing budgeted dollar and unit costs with actual costs and ignoring the reasons why the actual costs differed from the budgeted costs. Conversely, in an ideal cost accounting system, any significant variance between actual and budgeted costs would induce immediate research to determine (1) why the variance occurred, i.e., what combination of prices, volumes or production methods was different from what was anticipated or planned by management; (2) when the variance originated, i.e., what phase of the cost process was divergent from plan; and (3) what management options were available for further comparison of the degree of divergence with a flexible plan. A rigid plan could be based upon anticipated costs or revenues rather than upon the interest of the organization in organizational improvement and combined management, labor relations, research and development, and controlled costs.

5. Emerging Trends in Cost Accounting

Outsourcing has become the trend to allow companies to concentrate on something they do well and outsource the manufacturing and assembly of products to other firms. Although exports and imports have traditionally been large, world prices have previously been rather weak, but as ingredients, supplies are imported into countries with low currency values, the price of local products increases. This positions local products in the foreign market, and global pricing performance improvements have also resulted in company exporting, thus leading to intense global competition. In order for U.S. companies to participate in global manufacturing and distribution competition, the focus must have changed from simple product cost accounting to strategic cost management and decision-making anchored in the method of strategic planning, design, manufacturing, and marketing.

In today’s highly competitive economies, increasing attention has been focused on the design, reorganization, and management of cost accounting systems to allow for capability enhancement and superior performance through continuously updated strategies, consistent evaluation, reflection, and decision-making monitoring in organizations. The emerging trends in cost accounting tend to revolve around cost management and internal control activities that are integrated and conditional to the overall organizational strategic management and decision-making activities. Currently, many variables motivate the trend councils: advances in manufacturing technology, including manufacturing rather than labor focus of corporate assets, market globalization, advances in IT, trends in the workforce, product market, and U.S. regulatory initiatives. The performance of an organization and the viability to change the financial statements’ resource and process using laser-driven decisions in this ambitious, change-focused atmosphere depends largely on the level of data quality offered by the cost accounting device and depends on the role played by the users for managing and managing the cost information generated.