Basic Cost Accounting Information starts with cost: a financial measure within your accounting management system defined as resources consumed or acquired in accomplishing a specified purpose such as performing a service, providing a product, or carrying out a project or program regardless of when the resources were ordered, received, or paid. Cost can be defined in a variety of ways depending on the objectives or information desired.
Cost accounting provides essential information to management to control operations, make future plans, and facilitate the decision-making process.
First, let’s define a few terms. There are two fundamental methodologies of accounting, each with assumptions, constraints and theories, which guide all financial recording, reporting, and measurement activities: Cash and Accrual.
Most companies require the use of the accrual basis of accounting for financial transactions unless otherwise stated in your accounting manuals.
Cost accounting is defined as a technique or method for determining the cost of a project, process, or thing. This cost is determined by direct measurement, specific assignment, or systematic and rational allocation. Central to cost accounting is the process for tracing various input costs to the product or services of the company. Cost classifications are based on such characteristics as time incurred, reaction to changes in activity levels, and influence on decision making.
The Controller should accumulate, distribute, monitor, and evaluate cost information during each accounting period, when appropriate. Accounting Management will use cost information for purposes such as:
Cost accounting is not applicable to all activities; however, for those activities that do use cost accounting, the principles are designed to assure that:
The Controller is responsible for ensuring that any cost information maintained to meet customer service requirements is minimized and that cost recovery information is maximized.
Some aspects of cost accounting may be measured in relationship to the time the cost is incurred. In many cases, the measurement time period for a cost is specified in the authorizing documents or contracts for a program. In other cases, the Controller is responsible for determining which costs will be used for specific purposes, and for assuring that similar activities are treated consistently within the company.
The three most common measurements are historical costs, current market costs, and budgeted costs.
In any period, cost may or may not change in relationship to changes in levels of activity. Based on the relationship to changes in levels of activity, costs are classified as variable, fixed, or mixed costs. Activity measures can include production or service levels, machine hours, or sales in units or dollars. The way a cost reacts to changes in activity is determined by how the total cost for the period, rather than the cost of a single unit of activity, changes when activity levels change.
The Controller is responsible for developing cost projections and budgets that identify costs by variable, fixed, or mixed categories. All managers are responsible for minimizing variable and mixed costs and ensuring that fixed costs are minimized, and are fairly spread over all projects, whether or not those projects incorporate cost accounting.
The Controller is responsible for classifying costs as either direct or indirect and ensuring that costs are consistently classified as either direct or indirect in similar situations.
Direct costs are all costs that can be specifically or readily identified with producing a specific product or providing a specific service. These direct costs include direct labor, equipment purchased for use on a program, and other direct costs. The portion of base wages and salaries, direct labor, be identified with and charged to a particular activity.
Indirect costs are those costs, which cannot be specifically identified with producing a specific product, or providing a specific service but which can be shown to bear some relationship to, result from, or be in support of, the product or service.
Indirect costs should be accumulated in indirect cost pools. The Controller is responsible for clearly defining identifiable cost pools. Indirect costs may include the following examples, if the item is not directly attributable to a specific activity:
The indirect cost pool will generally include costs that benefit both cost recoverable and non-cost recoverable work like Sarbanes-Oxley compliance costs. Although indirect costs are not required to be allocated to non-cost recoverable work, an allocation basis must be used that would, if applied to all projects or activities, fairly distribute the cost pool over the benefited activities. Make sure your cost recovery projects are not unduly burdened with indirect costs.
Cost accounting provides important costing information to management to improve operational effectiveness, evaluate programs, and enhance profitability (or reduce costs). The CFO or Controller are responsible for developing and documenting the allocation method, using a generally acceptable and consistently applied overhead rate based on direct costs, identifiable cost pools, and the cost elements that are charges to those pools.
Our Internal Control Procedures product is available to download. See how easy it is to edit MS Word Templates to build your own cost accounting policies and procedure management system.