Cost accounting can be seen as the whole process of recording costs in order to support management decision. To maximise its effects, companies use individually designed cost accounting concepts. In this post, I will present a short theoretical overview before showing two examples of such concepts. If you are interested in reading more about how management accounting aids decision makers you should head to the relevant article.
Cost accounting concepts in theory
Classical theory teaches us that cost can be differentiated, among others, by its type. On the one hand, there are variable costs. This type increases when the number of products produced rises. A good example is a material used to manufacture a product. On the other hand, fixed costs are present. These costs do not vary when the level of production changes, e.g. rent of an office.
This view can now be broken down from the whole company to its products. Costs and revenues can be allocated to single products and this then allows to produce profitability reports for single products. Below is a graphical example showing the two types of cost, the sum of it (total costs) and the revenue generated. In this example, 500 sold units will make up for the total cost. This point is also called break-even.
Example of cost accounting concepts
I would like to show two completely different approaches to cost accounting concepts I have seen so far in practice.
The first example is drawn from a classical industry business. A final product was not only technically but also on the paper broken down in single pieces which all had price tags. The necessary amount of labour to manufacture all these pieces together was also defined and its cost was added. All prices to manufacture a product were collected like this. Having the price of a good (variable costs), we simply added a margin for overheads and profit on top to reach the desired sales price and the minimum sales price (variable costs covered + a little uplift).
The second example is related to e-business. The approach is completely different to the first one where the pricing was product based. The market situation, customer demands, and the current competition is analysed to determine possible products and a market price. The products and prices are adjusted when market movements require it. The cost structure of this company is fundamentally different from the industry business in the first example because all costs (or at least nearly all) are fixed costs.
In theory, a company’s strategic focus can be divided between product orientation and market orientation. This also requires a different approach to cost accounting concepts. The two examples highlighted exactly that.
As a management accountant you should be familiar with the different parts of cost accounting concepts (variable costs, marginal cost, etc). For your work you also need to understand whether your company is rather product or market orientated. In a product orientated company you will spend more time calculating supposed and actual production costs. Whereas in a market orientated company you will rather focus on how your position on the market is and whether this allows providing the required return.
If you are interested to learn more about cost accounting, Investopedia provides a nice and detailed description.
Fancy sharing your own experience? I would gladly appreciate your comment.