Cost accounting formulas

In the field of cost accounting, several formulas should be monitored on a regular basis. By doing so and comparing the results to those of prior periods, one can spot spikes or drops in the performance of an organization, which can then be investigated to see if remedial action should be taken.

Here are some of the most important cost accounting formulas:

  • Net sales percentage. Divide net sales by gross sales. The result should be close to 1. If not, the company is losing an inordinate percentage of its sales to sales discounts, returns, and allowances.
  • Gross margin. Subtract the cost of goods and services from net sales. The result as a percentage of net sales should be quite consistent from period to period. If not, the mix of products has changed, the sales department has altered prices, or the cost of materials or labor has changed.
  • Breakeven point. Divide total fixed expenses by the contribution margin. This calculation shows the sales level that must be attained in order to earn profits of zero. Management must then determine the organization's ability to meet that minimum sales level on a regular basis; otherwise, the company will lose money.
  • Net profit percentage. Divide net profits by net sales. Compare the result to what was generated in each month for the past few years. A steady downward trend is cause for action, since it implies that expenses have increased or sales margins have declined.
  • Selling price variance. Subtract the budgeted price from the actual price, and multiply by the actual unit sales. If the variance is unfavorable, it means the actual selling price was lower than the standard selling price. This may indicate an excessive usage of sales discounts or other promotions.
  • Purchase price variance. Subtract the budgeted purchase price from the actual purchase price, and multiply by the actual quantity. If the variance is unfavorable, it can indicate that the company is buying materials at a higher cost than anticipated.
  • Material yield variance. Subtract the standard unit usage from actual unit usage, and multiply by the standard cost per unit. If the variance is unfavorable, there may be an excessive amount of scrap in the production process, or spoilage in the warehouse, or a lower quality of materials being acquired.
  • Labor rate variance. Subtract the standard labor rate from the actual labor rate, and multiply by the actual hours worked. If the variance is unfavorable, the company is paying more than expected for its direct labor, perhaps because higher-grade people are being used, or because a labor contract has increased the labor rate.
  • Labor efficiency variance. Subtract the standard hours from actual hours incurred, and multiply by the standard labor rate. If the variance is unfavorable, employees are being less efficient than expected. This could be due to poor training, hiring less experienced personnel, or baulky production equipment.