Manufacturing cost accounting definition
/What is Manufacturing Cost Accounting?
Manufacturing cost accounting encompasses areas that impact production operations and the valuation of inventory. These activities can significantly boost the profits of a business, as well as bring it into compliance with the applicable accounting standards. The cost accountant is primarily responsible for manufacturing accounting activities. The following are all elements of manufacturing cost accounting. The most critical is constraint analysis, since proper management of a company’s constraint is the most important driver of its profitability.
Inventory Valuation
Inventory valuation is the fully loaded cost of inventory at the end of an accounting period, which is required under various accounting standards to place a correct valuation on inventory. It is of little use in the day-to-day operations of the manufacturing area. Nonetheless, cost accountants spend a significant amount of time in this area, since a company’s external auditors can be expected to spend a large amount of time reviewing inventory cost records. There are a number of ways to assign a valuation to inventory, such as the standard costing, FIFO, and LIFO methods. The essentials of these valuation methods are as follows:
Standard costing. Under this valuation method, a standard cost is assigned to each inventory item, rather than an actual cost. The standard cost is derived from actual cost records, and so should be quite close to the actual cost. Any differences between actual and standard costs are accounted for as variances.
First in, first out. Under the FIFO method, the inventory items charged to expense are assumed to be the ones that were in the inventory records first. In an inflationary environment, this usually means that the lowest-cost items are charged to expense first, which tends to result in higher profits.
Last in, first out. Under the LIFO method, the inventory items charged to expense are assumed to be the ones that were added to the inventory records last. In an inflationary environment, this usually means that the highest-cost items are charged to expense first, which tends to result in lower profits.
Cost of Goods Sold Valuation
Cost of goods sold valuation is closely related to inventory valuation. It is possible to track the cost of specific production jobs (job costing), or in general for all units produced (process costing). This cost tracking can be at the level of just those costs that vary with changes in revenue (direct costing), or it can include a full allocation of factory overhead costs (absorption costing).
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Constraint Analysis
Constraint analysis involves finding the bottleneck in the manufacturing process (if any) and advising the production department regarding the impact on throughput of changes to the flow of work through that bottleneck. The analysis can include an examination of the inventory buffer in front of the constraint and the existence of any upstream sprint capacity. This can be among the most important functions of manufacturing cost accounting.
Margin Analysis
Margin analysis involves the compilation of all costs associated with a product and subtracting them from product revenues to arrive at the margin of each product. Margin analysis can also be applied to distribution channels, business units, customers, and product lines. This is a traditional cost accounting role that is gradually giving way to constraint analysis, since many businesses now realize that incorporating allocated costs into margin analysis can lead to incorrect decisions to sell more or less of a product. Instead, it is better to consider that all products usually have some amount of throughput associated with them, so the real issue is to find the most profitable mix of products to produce (including the option to outsource production).
Variance Analysis
Variance analysis is the comparison of actual costs incurred to standard or budgeted costs, and exploring the reasons for any variances. This aspect of manufacturing cost accounting may not be necessary, since the baseline budget or standard cost may be faulty. Thus, a favorable variance may simply mean that a standard was set to be so easy to attain that all variances from it are bound to be favorable.
Budgeting
The information derived from the preceding analyses can be used as the basis for the annual budget for the production area, though this work is ultimately the responsibility of the production manager, not the cost accountant. The cost accountant will likely act as an advisor to the production manager in formulating the production budget.
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