ACCOUNTING

Cost Accounting

Cost Accounting

Introduction

Costing is important to ensure that all an organisation's costs are recognised in the cost of its outputs, to ensure that prices can be set at a level that covers these costs and returns a profit. In any situation more complex than a single-product firm, it is necessary to find a basis for sharing indirect or “overhead” costs across the range of a firm's outputs.

Discussion

Managers need to know what outputs cost to produce or deliver (and what profit is earned by each main category of output) (Shim & Siegel 2000). For financial accounting purposes, this is important because it is necessary to split production-related costs between cost of sales (which are expensed in the period to match the related sales) and closing stock (which is carried forward as an asset into future periods and expensed against future sales). For decision-making, this knowledge is also important because of the need to

allocate resources and marketing efforts between product lines;

review product ranges and decide which new products to introduce, and which existing products to retain or to abandon;

choose between manufacturing in-house and outsourcing products or components; and

compare an organisation's costs against those of its competitors for benchmarking and cost reduction purposes.

Direct costs are costs that can be traced directly to a product. They may be product-specific (e.g. unique materials and components, or the wages of dedicated production staff who work on only one product). They may also be traced by a process of attribution (e.g. wood used to make chairs, tables and desks can be traced to the three products based on quantities used; wages of production staff who work on all three products can be traced to the products based on records of hours worked).

In the case of a supplier which produces only one type of product or service - in other words, all its outputs are identical - full costing is straightforward. All the costs of a period are totalled and divided by the outputs for that same period, with suitable adjustments made in the accounting between

period costs, which are expenses of the period, and

product costs relating to unsold or part-completed products/services which need to be carried forward.

There is no strict need in such circumstances to distinguish direct and indirect costs, at least for profit recognition purposes, although most managers would obviously like to be able to analyse costs in more detail for control ...