Accounting involves the gathering and consolidation of data for various decision makers such as managers, investors, regulators, lenders, and the public. Accounting systems impact behavior and management and have implications that extend across departments, organizations, and even nations. This paper aims to provide the reader with an insight into cost accounting.
Discussing the importance of cost accounting for a firm’s success and exploring the different methods of cost accounting, as well as their application. Examining the role of an operating budget in disciplining management and outlining its elements and construction. Explaining variance analysis and its utilization. Cost accounting involves accumulating, measuring, analyzing, interpreting, and reporting cost information that is valuable and pertinent to internal and external stakeholders of a business entity.
Cost accounting has numerous advantages. It converts data into valuable information, knowledge, and wisdom about a business entity’s operations. This information is beneficial for various purposes such as measuring performance, managing costs, setting fees or prices, and making decisions regarding programs or activities. Additionally, cost information can be utilized to estimate future costs when creating and reviewing budget requests. Ultimately, cost information also provides valuable feedback on performance once budgets are approved and executed.
Moreover, costs can be compared to known or assumed benefits to determine value-added and non-value added activities. According to Devilliers (2007), having reliable information on the cost of programs and activities is essential for effectively managing a business entity’s operations. Cost accounting plays a crucial role in assessing operational performance and striving for continuous improvement in delivering outputs and outcomes to stakeholders. This objective can be achieved by providing program managers and others with timely and relevant cost-based performance information.
Cost accounting is vital for firms as it enhances managerial decision-making. Each industry adopts different methods of cost accounting to determine the cost of their products based on their production nature and output type (http://rajubrotherhood. com/). The various methods of cost accounting and their uses include job costing, which focuses on determining the cost of each job or work order.
Under the job costing system, a job cost sheet is necessary to determine the profitability or losses of each job or work order. This kind of costing is commonly applied in construction and hospitals.
Batch costing involves treating a batch of similar products as a distinct unit to calculate costs. This type of costing is typically utilized in the clothing, furniture, and automobile industry.
Process costing is employed in industries where production goes through multiple stages or processes before resulting in a finished product.
The costs for each individual process are determined separately in process costing. The key aspect of this type of costing is that the output of one process becomes the raw materials for another process until the final product is obtained. This method is typically used in industries such as petroleum and paint. Alternatively, operation costing is applicable in industries with continuous production where the units are identical. In this system, a cost sheet is prepared to calculate the cost per unit and determine the profits or losses on production.
The use of this method is common in industries such as mines, drilling, and cement works. An operating budget is a plan that ensures you have sufficient funds to run your business. Additionally, it serves as a guide for planning, evaluating business performance, and making adjustments based on actual figures. Furthermore, an operating budget is valuable for avoiding unforeseen issues in product or service delivery caused by inadequate cash, credit, tools, or inventory. In summary, having an operating budget is essential for sustaining your business.
The operating budget is a crucial part of a business plan as it predicts the costs needed to run the business and the revenue that will cover those costs. It consists of five components: the sales budget, production budget, operating expenses budget, budgeted income statement, and cash budget. It is recommended to create these budgets for both short-term and long-term plans when starting a business. Startup costs include expenses for licenses and permits, equipment, and legal fees.
Both short and long-range operating budgets encompass the identical cost and income categories specified below. However, by creating both budgets, you are able to strategize, monitor, and evaluate the progression and sustainability of your business in the immediate future and the long run (Hawthorne, 2008)”. Businesses employ budgets to anticipate forthcoming activities and establish diverse goals and objectives within their company. Budgets facilitate the organization in establishing precise expectations, which in turn assist in evaluating performance across the entire company. Implementation of particular strategies to accomplish goals and objectives is facilitated through budgeting.
It should be emphasized that a budget is a rough estimate and may require adjustments in the future. To effectively plan and establish objectives, multiple budgets must be developed. Comprehending the budget is crucial for managers, and astute executives know how to utilize this valuable source. As stated by Iaconetti (1986, p. 22), “The budget provides the manager with fundamental information regarding the unit’s operations, enables better understanding of those operations, and helps prevent excessive expenditure.”
The budget categorizes expenditure into three categories: labor, materials, and services (sometimes referred to as overhead and indirect cost). Each category of the budget includes fixed costs, which remain consistent regardless of project activity, and variable costs, which increase with project activity. Labor costs include wages, salaries, and honoraria paid to individuals directly involved in project implementation. To calculate labor costs, multiply the personnel time required for the project by the unit cost of the resource.
The cost breakdown for a project typically includes personnel costs, material costs, service costs, and depreciation for capital items. Personnel costs are measured in hours or days, while material costs encompass supplies, equipment, and tools used during the project. Service costs encompass all other project expenses that cannot be directly assigned to specific activities. Depreciation is utilized to allocate a portion of a capital item’s cost to a particular project.
When considering the allocation of funds for an activity that requires an expensive capital item, it is important to take into account whether the item will be rented or owned. If rented from an external organization, the cost will be treated as a service expense. However, if owned by the organization, a budget should include a cost to cover replacement once the item reaches its useful life. This cost, known as “depreciation,” is calculated based on a reasonable fee.
When comparing actual results to planned or budgeted results, variances are typically present. Variance analysis is used to evaluate individual and business unit performance by examining differences between actual and planned performance. This analysis helps identify potential reasons for deviations from budgeted performance. It’s important to note that each firm or organization may develop their own variances based on their specific requirements.
According to Anderson, Lanen, and Maher (2008, p. 537), the basic concept remains unchanged – calculating the variance between budgeted and actual performance and striving to comprehend its causes. Variance analysis examines the reasons behind the deviation after it has occurred, while effective management focuses on understanding the implications of this discrepancy for the business. Variance analysis can be simple or intricate, with certain cost-accounting systems classifying variances into multiple types and categories.
In some cases, a single outcome can be divided into multiple variations, both positive and negative. Positive variations indicate spending less than expected, which is considered good news. On the other hand, negative variations mean exceeding the budget. Every variance should raise questions. What caused a project to cost more or less? Were the goals achieved? Is a positive variance a result of cost savings or a failure to implement? Is a negative variance due to changes in plans, management shortcomings, or an unrealistic budget?
Although variance analysis can be complex, common sense serves as the main guide. Generally, being under budget is seen as a positive variance, while being over budget is classified as a negative variance. However, the ultimate measure of management’s effectiveness should be whether the outcome is beneficial for the business (Berry, 2009).
By utilizing variance analysis to identify areas of concern, management gains another tool for monitoring project and organizational well-being. Those reviewing the variances should focus on significant exceptions to ensure management stays informed about changes within the organization and the surrounding environment.
Without this information, management risks blindly proceeding down a path that cannot be judged as good or bad. Generally, cost accounting is the result of the decisions managers in an organization make and the business environment in which they make them. This paper explains the importance of cost accounting to the success of the firm, the various methods of cost accounting and how they are used, how an operating budget works to discipline a firm’s management, the elements of a budget and how it is constructed, and what variance analysis is and how it is used.
References
Administrator. (n. d). Various Methods of Costing. Retrieved February 24, 2010, from http://www.rajpubrotherhood.com.
Anderson, S. W., Lanen, W. N., & Maher, M. W. (2008). Fundamentals of cost Accounting 2e. New York: McGraw-Hill Irwin.
Berry, T. (2009). Plan vs. Actual Part 3: Understanding Variance Analysis. Retrieved February 24, 2010, from http://articles.bplans.com/growing-a-business/plan-vs-actual-part-3-understanding-variance-analysis/81.
DeVilliers, H. (2007). What is cost accounting?. Retrieved February 22, 2010 from http://EzineArticles.com/?expert=HendrickDevilliers.
Hawthorne, N. (2008). How to Build an Operating Budget for your Small Business. Retrieved February 25, 2010 from http://www.esight.org.
Iaconetti, J., & O’Hara, P. (1986). Working Woman Vol. 11 (8) pg. 22. Retrieved February 26, 2010 from Proquest database.
Rice Knowledge Bank. (2009). The basic elements of a budget. Retrieved February 26, 2010 from http://www.knowledgebank.irri.org.
