Cost accounting basics
/What are the Basics of Cost Accounting?
Cost accounting is the art of translating the costs incurred by a business into actionable analyses that can improve operations and profits. Here are several basic ways in which to use cost accounting:
Activity-based costing. This is a methodology for more precisely allocating overhead costs to products and services. This approach is more accurate than the traditional, less-targeted methods for allocating overhead costs. Activity-based costing is useful for gaining a greater understanding of which activities and cost objects within a business absorb the most (and least) overhead. With this information, a management team can engage in the targeted reduction of overhead costs. ABC works best in complex environments, where there are many machines and products, and tangled processes that are not easy to sort out.
Constraint analysis. There is typically a bottleneck somewhere in the company that limits the amount of profit that the business can generate. If so, the relevant cost accounting is to constantly monitor the utilization of this constraint, the costs incurred to run it, and the throughput (sales minus all variable expenses) generated by it.
Contract costs. All costs assignable to a specific customer contract are compiled, documented, and justified. This information is used to compile billings to customers.
Cost reduction analysis. There is a decline in business, so management is looking for ways to prudently cut costs while retaining the basic functionality of the organization. The related cost accounting is to determine which costs are discretionary, and so can be eliminated or deferred without lasting damage to the business.
Customer costs. The variable costs of products sold to specific customers are combined with the other costs that are directly traceable to those customers, to determine the profitability of each one. The result can be a selective reduction in the number of customers with which the company chooses to do business.
Employee costs. Determine all aspects of the compensation, benefit, and travel and entertainment costs of employees, and aggregate this information by employee. This information can be compared to employee output to see which employees are the most cost-effective for the organization. It can also be used to determine the savings to be achieved from an employee layoff.
Product costs. Determine just the variable costs associated with a product and aggregate this information by product. This is typically done using a bill of materials, which is maintained by the engineering department. With this information, you can decide whether the prices being set for products are too low. Any price set below the sum of the variable costs of a product will lose money on every unit sold.
Product line costs. Combine the variable costs of all products in a product line with all of the overhead costs specifically associated with that product line. These additional costs may include the costs associated with the production equipment, factory overhead, marketing, and distribution costs. This information is used to decide whether it is profitable to expand the sales of the product line, or (conversely) to shut down the entire product line.
Sales channel costs. The variable costs of products sold through a particular sales channel can be combined with the overhead costs specific to that channel, to determine its profitability.
Variance analysis. Compare actual results to standard or budgeted amounts to derive variances relating to such areas as efficiency and revenues generated per unit. Then drill down into each of these variances, looking for actionable items that can be recommended to management for resolution.
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Each of the tasks just noted can be employed to gain a better understanding of how a business generates profits. These cost accounting basics form the fundamental tasks of the cost accountant in supporting the decision making of the management team.
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