My First Lessons in Cost Accounting

Like any other subject, the first few discussions are always focused on basic concepts and principles. Here we discuss the basic cost concepts and terminologies used in cost accounting. You may begin by getting a cup coffee and grabbing the nearest sandwich...

Definition of terms:

Cost – Anything that is sacrificed to obtain a benefit. It could be monetary or non monetary. In cost accounting, we only focus on monetary cost. Though some  non monetary cost may be relevant in decision making, we can only account for monetary cost because of its measurability. 

Cost accounting is a branch in accounting focused on the identification, measurement, analysis, accumulation,preparation, interpretation, and communication of costs resulting from operation. Its main objective is to provide consistent cost information for financial reporting and decision making  

According to the Chartered Institute of Management Accountants, London, cost accounting is the process of accounting for costs from the point at which its expenditure is incurred or committed to the establishment of the ultimate relationship with cost units. In its widest sense, it embraces the preparation of statistical data, the application of cost control methods and the ascertainment of the profitability of the activities carried out or planned.

Classifications of Cost:

Things to remember:

-Costs can be classified in a number of ways

      --depending on the purpose of the classification.( external Vs internal)

      --classifications of costs are not mutually exclusive.

GAAP Costs are costs used for financial reporting, they are normally recorded in the books and are found in our financial statements. These are your manufacturing and non manufacturing costs (functional costs such as rent, salaries,operating expenses, etc). Any cost classification that cannot be classified as GAAP Costs are Non GAAP cost ( Variable cost, opportunity cost, etc)

GAAP COSTS

1. Manufacturing Cost – production cost, incurred in the production area or factory...thats it!

a.    Direct materials-traceable cost of raw materials that become an integral part of a finished product. (Lumber in a wooden furniture)

b.    Direct Labor.- labor cost that can be easily traced to a product. Also known as "touch labor"

c.    Manufacturing Overhead. ANY manufacturing cost that cannot be classified as Direct materials or direct labor belongs to this category. ( salary of the supervisor, hardware nails, paint, depreciation on factory equipment, government contibutions)

d.    Prime versus Conversion Costs. Prime costs consist of direct materials and direct labor, the absence of one will not allow production. Conversion costs consist of direct labor and manufacturing overhead, used to convert the raw materials to salable goods.

2. Non-manufacturing costs. If its not a manufacturing cost, then it falls on this category...nuff said...Typically classified as selling (marketing) costs and administrative costs. 

            As to Accounting Periods

1.    Capital Expenditure – outlays classified as an asset (benefit more than one year)

2.    Revenue Expenditures – outlays classified as an expense(benefit less than a year)

3.    Product Costs. also known as inventoriable costs . Initially treated as asset cost (part of inventory), then EXPENSED when the inventories are sold.

4.    Period Costs-charged against the period when incurred 

NON-GAAP COSTS

           As to behavior

1.    Variable Cost – dependent on the level of activity, varies in total but fixed on a per unit basis.

2.    Fixed Cost – constant in total within the relevant range

3.    Semi-variable/semi fixed Cost (Mixed Cost or total) – has both fixed and variable components

4.    Step-fixed Cost (Semi-Fixed Cost) – Fixed in nature but only up to a certain range.

5.    Non linear Cost –  (YOU GOT THIS) it may increase at a decreasing/increasing rate

As to activity

1.    Direct Costs – specifically identified with a particular cost object (product, segment, activity, etc) normally traceable .

2.    Indirect Costs – non directly attributed with a particular cost object. Usually allocated.

3.    Common Costs – costs to benefit more than one activity or department. cannot be eliminated or reduced by removing one department.

4.    Joint Costs – incurred when multiple outputs are derived from one source

As to Managerial Influence

1.    Controllable Cost – cost that is subject to influence by a particular manager 

2.    Non-controllable cost – just the opposite, obviously.

Cost Classification according to a time frame perspective

1.    Committed cost – cannot be easily changed or avoided by a management decision. It is  consequence of a previous commitment or decision. (ex: depreciation)

2.    Programmed or Discretionary or Managed Costs – Can be easily avoided or reduced by coming up with a decision. 

VII.         Cost for Planning and Control

1.    Budgeted Costs  - future costs usually expressed in totals

2.    Historical Costs  - past costs

3.    Standard Cost – costs pegged at a predetermined rate usually expressed on a per unit basis

VIII.       Cost for Analytical Process

1.    Relevant Costs – future differential costs. Are those costs which change by managerial decision.

2.    Irrelevant costs – costs that will not affect decision making. Are those costs which do not get affected by the decision.

3.    Differential costs – difference in cost between two alternatives. Are the difference in total cost between two alternatives.

4.    Incremental Costs – decision results in an increased cost

5.    Decremental Costs – decision results in a decreased cost

6.    Marginal Cost – additional costs on a per unit basis.

7.    Avoidable Cost – Avoidable costs are those which will be eliminated if a segment of a business (e.g., a product or department) with which they are directly related is discontinued. Costs that can be eliminated by virtue of an alternative

8.    Unavoidable Cost – costs that remain regardless of the decision. Are those which will not be eliminated with the segment. Such costs are merely reallocated if the segment is discontinued. For example, in case a product is discontinued, the salary of a factory manager or factory rent cannot be eliminated. It will simply mean that certain other products will have to absorb a large amount of such overheads.

9.    Out of Pocket Cost – costs that require current or future cash outltay. It means that the present or future cash expenditure regarding a certain decision that will vary depending upon the nature of the decision made.

10.  Imputed Cost – These are the costs which do not involve cash outlay. They are not included in cost accounts but are important for taking into consideration while making management decisions. For example, interest on capital is ignored in cost accounts though it is considered in financial accounts. In case two projects require unequal outlays of cash, the management should take into consideration the capital to judge the relative profitability of the projects.

11.  Opportunity Cost – cost of benefits foregone as the result of the acceptance of an alternative. It is measured as the benefits that would result from the next best alternative use of the same resources that were rejected in favor of the one accepted. It refers to an advantage in measurable terms that have foregone on account of not using the facilities in the manner originally planned.

12.  Sunk Cost – cost which are already incurred and therefore irrelevant in decision making process

QUALITY COSTS- These are costs incurred to maintain the quality of the company's outputs. there are four categories:

Prevention Costs- These are incurred to prevent possible events or factors in affective the quality of the product.

Appraisal Costs-Incurred to check and maintain the quality during the process

Internal Failure Costs-result of producing a defective product and the product is not yet delivered

External Failure Costs-incurred when defective products were already delivered

If you are still reading this, catch my HIGH FIVE!

IX.          Methods of Costing

These are the different ways on how you can accumulate and present costs

1.    Job Costing

You use this if your products are heterogeneous (customized boots). Different process for different products. ( different strokes for different folks!)

2.    Contract Costing

Similar to job order costing but the outputs are on a larger scale (perhaps a subdivision)

3.    Cost Plus Costing

(i just saw this somewhere but hey... its more of a pricing method. We will get back to this...)

4.    Batch Costing-still another form of job order costing but cost accumulation is done in batches.

5.    Process Costing/Operation costing

When products are homogeneous. Think of conveyor belts and repetitive process...you get the same results! (When a company produces one kind of product...say, WD40, or Nintendo Switch) 

TRUST ME, as of this point, you just want to understand the difference between Job Order Costing and Process Costing....

Wait for concepts relating to Normal costing systems, Standard costing systems, and the Standard costing system...

Now finish your coffee, and don't forget to drink your water!