Cost accounting basics

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:

  • 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.
  • 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.
  • 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.
  • 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.
  • 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.
  • 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.

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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Cost Accounting Fundamentals