One of the first questions I ask our Warehouse Management students is, “Do you know your operating costs?”, and our Production Planning Management students, “Do you know the cost to produce one of your items?” After five years of training, I can count on one hand how many students were able to answer these questions, which immediately tells me their company does not utilize cost accounting.
The reason students are unable to answer the question is their company only has what is called management and financial accounting in place. Management accounting focuses on historical and estimated data management needs to conduct ongoing operations and do long-range planning. The purpose of management accounting is to accumulate financial information for use in making economic decisions.
Financial accounting focuses on gathering historical financial information to be used in preparing financial statements that meet the needs of investors, creditors, and other external users of financial information. The statements include a balance sheet, income statement, retained earnings statement, and statement of cash flows. Although these financial statements are useful to management as well as to external users, additional reports, schedules, and analyses are required for management’s use in planning and controlling operations.
Management and financial accounting focus on the company’s operations as a whole and cannot provide the detail necessary to accurately determine product costs and pricing. At best all they can do is provide averages. In addition, cost accounting provides the detailed cost information management needs to control current operations and plan for the future. Management uses this information to decide how to allocate resources to the most efficient and profitable areas of the business.
Cost accounting enables management to properly allocate costs such as raw materials, labor, and other factory resources to the products actually using then instead averaging them over all products. Without cost accounting, expenses such as major investments in physical assets, developing the workforce, depreciation, taxes, insurance, utilities, machine maintenance and repair, materials handling, production setup, production scheduling selling and administrative expenses are usually lumped together to create an overhead rate which is added to a product as an overhead markup. The true cost of a product is never determined which means the company is charging too much for some products and not enough for others.
Principles of cost accounting have been developed to enable manufacturers to process the many different costs associated with manufacturing and to provide built-in control features. The information produced by a cost accounting system provides a basis for determining accurate product costs and selling prices, and it helps management to plan and control operations.
Determining Product Costs and Pricing
Cost accounting procedures provide the means to determine product costs that enable the preparation of meaningful financial statements and other reports needed to manage a business. The cost accounting information system must be designed to permit the determination of unit costs as well as total product costs. Unit cost information is also useful in making important marketing decisions such as determining the selling price of a product, meeting competition, bidding on contracts, and analyzing profitability.
Planning and Control
One of the most important aspects of cost accounting is the preparation of reports that management can use to plan and control operations. Planning is the process of establishing objectives or goals for the firm and determining the means by which they will be met. Effective planning is facilitated by clearly defined objectives of the manufacturing operation and a production plan that will assist and guide the company in reaching its objectives.
Cost accounting information enhances the planning process by providing historical costs that serve as a basis for future projections. Management can analyze the data to estimate future costs and operating results and to make decisions regarding the acquisition of additional facilities, any changes in marketing strategies, and the availability of capital.
Effective control is achieved by assigning responsibility for each detail of the production plan through the establishment of cost centers. All managers should know precisely what their responsibilities are in terms of efficiency, operations, production, and costs. The key to proper control involves the use of responsibility accounting and cost centers by periodically measuring and comparing results and taking necessary corrective action.