Key Characteristics of Accounting Information
Content
key characteristics of accounting information
There is general agreement that, before it can be regarded as useful in satisfying the needs of various user groups, accounting information should satisfy the following criteria: Understandability This implies the expression, with clarity, of accounting information in such a way that it will be understandable to users - who are generally assumed to have a reasonable knowledge of business and economic activities Relevance This implies that, to be useful, accounting information must assist a user to form, confirm or maybe revise a view - usually in the context of making a decision (e.g. should I invest, should I lend money to this business? Should I work for this business?) Consistency This implies consistent treatment of similar items and application of accounting policies Comparability This implies the ability for users to be able to compare similar companies in the same industry group and to make comparisons of performance over time. Much of the work that goes into setting accounting standards is based around the need for comparability. Reliability This implies that the accounting information that is presented is truthful, accurate, complete (nothing significant missed out) and capable of being verified (e.g. by a potential investor). Objectivity This implies that accounting information is prepared and reported in a "neutral" way. In other words, it is not biased towards a particular user group or vested interest
introduction to accounting
Introduction It is not easy to provide a concise definition of accounting since the word has a broad application within businesses and applications. The American Accounting Association define accounting as follows: "the process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of the information!. This definition is a good place to start. Let's look at the key words in the above definition:
- It suggests that accounting is about providing information to others. Accounting information is economic information - it relates to the financial or economic activities of the business or organisation. - Accounting information needs to be identified and measured. This is done by way of a "set of accounts", based on a system of accounting known as double-entry bookkeeping. The accounting system identifies and records "accounting transactions". - The "measurement" of accounting information is not a straight-forward process. it involves making judgements about the value of assets owned by a business or liabilities owed by a business. it is also about accurately measuring how much profit or loss has been made by a business in a particular period. As we will see, the measurement of accounting information often requires subjective judgement to come to a conclusion - The definition identifies the need for accounting information to be communicated. The way in which this communication is achieved may vary. There are several forms of accounting communication (e.g. annual report and accounts, management accounting reports) each of which serve a slightly different purpose. The communication need is about understanding who needs the accounting information, and what they need to know! Accounting information is communicated using "financial statements" What is the purpose of financial statements? There are two main purposes of financial statements: (1) To report on the financial position of an entity (e.g. a business, an organisation); (2) To show how the entity has performed (financially) over a particularly period of time (an "accounting period"). The most common measurement of "performance" is profit. It is important to understand that financial statements can be historical or relate to the future. Accountability Accounting is about ACCOUNTABILTY Most organisations are externally accountable in some way for their actions and activities. They will produce reports on their activities that will reflect their objectives and the people to whom they are accountable.
Accounting: A Necessity for Small Businesses Owners
By Brian Van Ness and Sueann Allen
Lets face it - most of us don't find accounting particularly exciting and would rather have someone else do it for us, right?
This is a fine stance for those who are completely disassociated with the business world, but as a small business owner, you and your business will benefit greatly from gaining knowledge on the subject of accounting.
Why not just leave it to the experts?
Well, for one thing, when first starting your business, you may be struggling financially and may not be able to afford too many "experts". Even if you can afford an accounting department, it is wise to understand accounting principles.
It is never wise to be ignorant of how any department in your company works.
With no knowledge of accounting, you have no way to monitor the effectiveness of your accounting department. You won't know if payments are prompt, taxes are being handled properly or records are accurate without at least a limited knowledge of accounting principles.
Don't wait for the tax return to find out how your company is doing.
Knowledge of accounting helps you understand financial records, such as the balance sheet and profit/loss statement, which reveal the worth of your company and whether it is profitable. This allows you to make decisions to correct or adjust any areas of financial concern in your business before you receive your annual tax return. If you wait until you receive your tax return, it may be too late to detect vital errors that could save your business.
Accounting helps you make wise decisions concerning the future of your company.
Accounting based decisions may include anything from expansion to correctly pricing the goods you manufacture. It is easy to focus on the cost of goods versus the sales of the product to estimate a profit; however, this can lead to financial disaster when the many liabilities of your company are taken into account. Accounting keeps track of loans, money owed, equipment depreciation, salaries and other items that must be included in expenses. It also analyzes trends to help you make adjustments in policy to increase profit and cash flow.
Accounting is important as a source of information for others.
Bankers use financial records to determine the risk involved in giving you a loan. From this information they will approve or deny your loan applications. They also use these statements to figure the amount of credit they will give your business. With knowledge of accounting principles, you can spot potential errors in your company's financial position ahead of time and discuss them with your banker in advance.
Accounting is vital to employee management.
You must use accounting skills when determining salaries, vacation policies, sick leave, paid time off, benefits and other aspects of employment.
Accounting can help you keep up on competitors' success.
Annual reports are not easy for the untrained eye to understand. It takes knowledge of accounting terms and principles to interpret your competitors' annual reports.
You can help detect fraud, waste and carelessness.
When you compare your bank statement with your company's checkbook, you can quickly locate any discrepancies. With your accounting skills, you can locate these differences and detect any avoidable errors in the future.
Cash flow - one of the most valuable of accounting benefits.
Cash flow is the rate at which money enters and exits your company. By referring to your financial statements frequently, you will know if your cash flow is positive or negative and you can make adjustments as needed. Negative cash flow, whether or not the business is profitable, is a major reason for small business failure.
So, how can you gain this knowledge?
One of the quickest ways to learn accounting skills is by enrolling in a few classes. Another way is to purchase accounting software. Software can be a useful tool to organize, compute and produce reports for your company. It can also ease the tedious process of assigning credits and debits by prompting you to enter the amount and the payee and then automatically recording the entry in the two appropriate accounts. Some software even includes a "primer" that teaches you basic accounting principles. It can ease the tedious work of number crunching and make accounting a little more enjoyable.
Why is cost accounting essential for management?
In: Business Accounting and Bookkeeping [Recategorize] [Edit]
[Edit]
Answer
Cost accounting is used to calculate the per unit cost of product so if the management does not know the per unit product price they will not able to set the selling price of product and determine the profit per unit which they can earn and so many other important decision like these are dependent on cost accounting. cost accounting The field of accounting that measures, classifies, and records costs. A cost accountant, for example, might be required to establish a system for identifying and segmenting various production costs so as to assist a firm's management in making prudent operating decisions.
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Cost accounting
From Wikipedia, the free encyclopedia
Jump to: navigation, search This article does not cite any references or sources. Please help improve this article by adding citations to reliable sources. Unverifiable material may be challenged and removed. (June 2007) In management accounting, cost accounting is that part of management accounting which establishes budget and actual cost of operations, processes, departments or product and the analysis of variances, profitability or social use of funds. Managers use cost accounting to support decision making to reduce a company's costs and improve its profitability. As a form of management accounting, cost accounting need not follow standards such as GAAP,
because its primary use is for internal managers, rather than external users, and what to compute is instead decided pragmatically. Costs are measured in units of nominal currency by convention. Cost accounting can be viewed as translating the Supply Chain (the series of events in the production process that, in concert, result in a product) into financial values. There are several managerial accounting approaches:
• • • • •
Standardized or Standard Cost Accounting Activity-based Costing Resource Consumption Accounting Throughput Accounting Marginal Costing / Cost-Volume-Profit Analysis
Classical Cost Elements are: 1. Raw Materials 2. Labor 3. Indirect Expenses / Overhead
•
[edit] Origins
Cost accounting has long been used to help managers understand the costs of running a business. Modern cost accounting originated during the industrial revolution, when the complexities of running a large scale business led to the development of systems for recording and tracking costs to help business owners and managers make decisions. In the early industrial age, most of the costs incurred by a business were what modern accountants call "variable costs" because they varied directly with the amount of production. Money was spent on labor, raw materials, power to run a factory, etc. in direct proportion to production. Managers could simply total the variable costs for a product and use this as a rough guide for decision-making processes. Some costs tend to remain the same even during busy periods, unlike variable costs which rise and fall with volume of work. Over time, the importance of these "fixed costs" has become more important to managers. Examples of fixed costs include the depreciation of plant and equipment, and the cost of departments such as maintenance, tooling, production control, purchasing, quality control, storage and handling, plant supervision and engineering. In the early twentieth century, these costs were of little importance to most businesses. However, in the twenty-first century, these costs are often more important than the variable cost of a product, and allocating them to a broad range of products can lead to bad decision making. Managers must understand fixed costs in order to make decisions about products and pricing. For example: A company produced railway coaches and had only one product. To make each coach, the company needed to purchase $60 of raw materials and components, and pay 6 laborers $40 each. Therefore, total variable cost for each coach was $300. Knowing that making a coach required spending $300, managers knew they couldn't sell below that price without losing money on each coach. Any price above $300 became a contribution to the
fixed costs of the company. If the fixed costs were, say, $1000 per month for rent, insurance and owner's salary, the company could therefore sell 5 coaches per month for a total of $3000 (priced at $600 each), or 10 coaches for a total of $4500 (priced at $450 each), and make a profit of $500 in both cases.
[edit] Standard Cost Accounting
In modern cost accounting, the concept of recording historical costs was taken further, by allocating the company's fixed costs over a given period of time to the items produced during that period, and recording the result as the total cost of production. This allowed the full cost of products that were not sold in the period they were produced to be recorded in inventory using a variety of complex accounting methods, which was consistent with the principles of GAAP (Generally Accepted Accounting Principles). It also essentially enabled managers to ignore the fixed costs, and look at the results of each period in relation to the "standard cost" for any given product. For example: if the railway coach company normally produced 40 coaches per month, and the fixed costs were still $1000/month, then each coach could be said to incur an overhead of $25 ($1000/40). Adding this to the variable costs of $300 per coach produced a full cost of $325 per coach. This method tended to slightly distort the resulting unit cost, but in mass-production industries that made one product line, and where the fixed costs were relatively low, the distortion was very minor. For example: if the railway coach company made 100 coaches one month, then the unit cost would become $310 per coach ($300 + ($1000/100)). If the next month the company made 50 coaches, then the unit cost = $320 per coach ($300 + ($1000/50)), a relatively minor difference. An important part of standard cost accounting is a variance analysis which breaks down the variation between actual cost and standard costs into various components (volume variation, material cost variation, labor cost variation, etc.) so managers can understand why costs were different from what was planned and take appropriate action to correct the situation.
[edit] Weaknesses of Standard Cost Accounting for Management Decision Making
As time went on, standard cost accounting lost its usefulness for management decision making due to a variety of reasons:
• •
• •
The practice of paying workers on a 'set-piece' basis changed in favour of paying on an hourly rate. Modern companies tend to have relatively low truly variable costs (primarily raw material, commissions or casual workers) and very high fixed costs (worker salaries, engineering costs, quality control, etc.). Equipment has become more complex and specialized and may be a very significant proportion of total costs. Changes in the level of full cost inventory create swings in profitability that are difficult to explain or understand. An increase in inventory can "absorb" costs of production and increase profits, while a decrease in inventory level will decrease profits.
•
Organizations with a wide range of products or services have processes which are common to several finished items, making cost allocation irrelevant or misleading.
As a result of the above, using standard cost accounting to analyze management decisions can distort the unit cost figures in ways that can lead managers to make decisions that do not reduce costs or maximize profits. For this reason, managers often use the terms "direct costs" and "indirect costs" to replace the standard costing, to better reflect the way allocation of overhead is actually calculated. Indirect costs (often large) are usually allocated in proportion to either labor cost, other direct costs, or some physical resource utilization. For example: If the railway coach company now paid its workforce a fixed monthly rate of $8,000 (total) and its other fixed costs had risen to $2,600/month, the total fixed costs would then be $10,600/month. The unit cost to make 40 coaches per month would still be $325 per coach ($60 material + ($10,600/40)), but producing 100 coaches would result in a unit cost of $166 per coach ($60 + ($10, 600/100)), provided the company had the capacity to increase production to that level. Managers using the standard cost for 40 coaches per month would likely reject an order for 100 coaches (to be produced in one month) if the selling price was only $300 per unit, seeing that it would result in a loss of $25 per unit. If they analyzed the fixed vs. variable cost distinction, they would see clearly that filling this order would result in a contribution to fixed costs of $240 per coach ($300 selling price less $60 materials) and would result in a net profit for the month of $13,400 (($240 x 100) - 10,600). [editThe company was at full capacity making 40 rail coaches each month. And since the foundry was expensive to operate, and purchasing brass as a raw material for the streetcars was expensive, the accountant determined that the company would lose money on any streetcars it built. He showed an analysis of the estimated product costs based on standard cost accounting and recommended that the company decline to build any streetcars.
After the presentations from the company accountant and the operations manager, the president understood that the metal shop capacity was limiting the company's profitability. The company could make only 40 rail coaches per month. But by taking the contract for the streetcars, the company could make nearly all the railway coaches ordered, and also meet all the demand for streetcars. The result would increase throughput in the metal shop from $6.25 to $10.38 per hour of available time, and increase profitability by 66 percent.
[edit] Activity-based costing
Main article: Activity-based costing Activity-based costing (ABC) is a system for assigning costs to products based on the activities they require. In this case, activities are those regular actions performed inside a company. "Talking with customer regarding invoice questions" is an example of an activity performed inside most companies. Accountants assign 100% of each employee's time to the different activities performed inside a company (many will use surveys to have the workers themselves assign their time to the different activities). The accountant then can determine the total cost spent on each activity by summing up the percentage of each worker's salary spent on that activity. A company can use the resulting activity cost data to determine where to focus their operational improvement efforts. For example, a job based manufacturer may find that a high percentage of their workers are spending their time trying to figure out a hastily written customer order. Via ABC, the accountants now have a currency amount that will be associated with the activity of "Researching Customer Work Order Specifications". Senior management can now decide how much focus or money to budget for the resolutions of this process deficiency. Activity-based management includes (but is not restricted to) the use of activity-based costing to manage a business.
[edit] Marginal Costing
See also: Cost-Volume-Profit Analysis See also: Marginal cost
This method is used particularly for short-term decision-making. Its principal tenets are:
• •
Revenue (per product) - Variable Costs (per product) = Contribution (per product) Total Contribution - Total Fixed Costs = Total Profit or (Total Loss)
Thus it does not attempt to allocate fixed costs in an arbitrary manner to different products. The short-term objective is to maximize contribution per unit. If constraints exist on resources, then Managerial Accounting dictates that marginal cost analysis be employed to maximize contribution per unit of the constrained resource (see Development of Throughput Accounting, above).
There is general agreement that, before it can be regarded as useful in satisfying the needs of various user groups, accounting information should satisfy the following criteria: Understandability This implies the expression, with clarity, of accounting information in such a way that it will be understandable to users - who are generally assumed to have a reasonable knowledge of business and economic activities Relevance This implies that, to be useful, accounting information must assist a user to form, confirm or maybe revise a view - usually in the context of making a decision (e.g. should I invest, should I lend money to this business? Should I work for this business?) Consistency This implies consistent treatment of similar items and application of accounting policies Comparability This implies the ability for users to be able to compare similar companies in the same industry group and to make comparisons of performance over time. Much of the work that goes into setting accounting standards is based around the need for comparability. Reliability This implies that the accounting information that is presented is truthful, accurate, complete (nothing significant missed out) and capable of being verified (e.g. by a potential investor). Objectivity This implies that accounting information is prepared and reported in a "neutral" way. In other words, it is not biased towards a particular user group or vested interest
introduction to accounting
Introduction It is not easy to provide a concise definition of accounting since the word has a broad application within businesses and applications. The American Accounting Association define accounting as follows: "the process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of the information!. This definition is a good place to start. Let's look at the key words in the above definition:
- It suggests that accounting is about providing information to others. Accounting information is economic information - it relates to the financial or economic activities of the business or organisation. - Accounting information needs to be identified and measured. This is done by way of a "set of accounts", based on a system of accounting known as double-entry bookkeeping. The accounting system identifies and records "accounting transactions". - The "measurement" of accounting information is not a straight-forward process. it involves making judgements about the value of assets owned by a business or liabilities owed by a business. it is also about accurately measuring how much profit or loss has been made by a business in a particular period. As we will see, the measurement of accounting information often requires subjective judgement to come to a conclusion - The definition identifies the need for accounting information to be communicated. The way in which this communication is achieved may vary. There are several forms of accounting communication (e.g. annual report and accounts, management accounting reports) each of which serve a slightly different purpose. The communication need is about understanding who needs the accounting information, and what they need to know! Accounting information is communicated using "financial statements" What is the purpose of financial statements? There are two main purposes of financial statements: (1) To report on the financial position of an entity (e.g. a business, an organisation); (2) To show how the entity has performed (financially) over a particularly period of time (an "accounting period"). The most common measurement of "performance" is profit. It is important to understand that financial statements can be historical or relate to the future. Accountability Accounting is about ACCOUNTABILTY Most organisations are externally accountable in some way for their actions and activities. They will produce reports on their activities that will reflect their objectives and the people to whom they are accountable.
Accounting: A Necessity for Small Businesses Owners
By Brian Van Ness and Sueann Allen
Lets face it - most of us don't find accounting particularly exciting and would rather have someone else do it for us, right?
This is a fine stance for those who are completely disassociated with the business world, but as a small business owner, you and your business will benefit greatly from gaining knowledge on the subject of accounting.
Why not just leave it to the experts?
Well, for one thing, when first starting your business, you may be struggling financially and may not be able to afford too many "experts". Even if you can afford an accounting department, it is wise to understand accounting principles.
It is never wise to be ignorant of how any department in your company works.
With no knowledge of accounting, you have no way to monitor the effectiveness of your accounting department. You won't know if payments are prompt, taxes are being handled properly or records are accurate without at least a limited knowledge of accounting principles.
Don't wait for the tax return to find out how your company is doing.
Knowledge of accounting helps you understand financial records, such as the balance sheet and profit/loss statement, which reveal the worth of your company and whether it is profitable. This allows you to make decisions to correct or adjust any areas of financial concern in your business before you receive your annual tax return. If you wait until you receive your tax return, it may be too late to detect vital errors that could save your business.
Accounting helps you make wise decisions concerning the future of your company.
Accounting based decisions may include anything from expansion to correctly pricing the goods you manufacture. It is easy to focus on the cost of goods versus the sales of the product to estimate a profit; however, this can lead to financial disaster when the many liabilities of your company are taken into account. Accounting keeps track of loans, money owed, equipment depreciation, salaries and other items that must be included in expenses. It also analyzes trends to help you make adjustments in policy to increase profit and cash flow.
Accounting is important as a source of information for others.
Bankers use financial records to determine the risk involved in giving you a loan. From this information they will approve or deny your loan applications. They also use these statements to figure the amount of credit they will give your business. With knowledge of accounting principles, you can spot potential errors in your company's financial position ahead of time and discuss them with your banker in advance.
Accounting is vital to employee management.
You must use accounting skills when determining salaries, vacation policies, sick leave, paid time off, benefits and other aspects of employment.
Accounting can help you keep up on competitors' success.
Annual reports are not easy for the untrained eye to understand. It takes knowledge of accounting terms and principles to interpret your competitors' annual reports.
You can help detect fraud, waste and carelessness.
When you compare your bank statement with your company's checkbook, you can quickly locate any discrepancies. With your accounting skills, you can locate these differences and detect any avoidable errors in the future.
Cash flow - one of the most valuable of accounting benefits.
Cash flow is the rate at which money enters and exits your company. By referring to your financial statements frequently, you will know if your cash flow is positive or negative and you can make adjustments as needed. Negative cash flow, whether or not the business is profitable, is a major reason for small business failure.
So, how can you gain this knowledge?
One of the quickest ways to learn accounting skills is by enrolling in a few classes. Another way is to purchase accounting software. Software can be a useful tool to organize, compute and produce reports for your company. It can also ease the tedious process of assigning credits and debits by prompting you to enter the amount and the payee and then automatically recording the entry in the two appropriate accounts. Some software even includes a "primer" that teaches you basic accounting principles. It can ease the tedious work of number crunching and make accounting a little more enjoyable.
Why is cost accounting essential for management?
In: Business Accounting and Bookkeeping [Recategorize] [Edit]
[Edit]
Answer
Cost accounting is used to calculate the per unit cost of product so if the management does not know the per unit product price they will not able to set the selling price of product and determine the profit per unit which they can earn and so many other important decision like these are dependent on cost accounting. cost accounting The field of accounting that measures, classifies, and records costs. A cost accountant, for example, might be required to establish a system for identifying and segmenting various production costs so as to assist a firm's management in making prudent operating decisions.
[Collapse]
Donate Now »
Cost accounting
From Wikipedia, the free encyclopedia
Jump to: navigation, search This article does not cite any references or sources. Please help improve this article by adding citations to reliable sources. Unverifiable material may be challenged and removed. (June 2007) In management accounting, cost accounting is that part of management accounting which establishes budget and actual cost of operations, processes, departments or product and the analysis of variances, profitability or social use of funds. Managers use cost accounting to support decision making to reduce a company's costs and improve its profitability. As a form of management accounting, cost accounting need not follow standards such as GAAP,
because its primary use is for internal managers, rather than external users, and what to compute is instead decided pragmatically. Costs are measured in units of nominal currency by convention. Cost accounting can be viewed as translating the Supply Chain (the series of events in the production process that, in concert, result in a product) into financial values. There are several managerial accounting approaches:
• • • • •
Standardized or Standard Cost Accounting Activity-based Costing Resource Consumption Accounting Throughput Accounting Marginal Costing / Cost-Volume-Profit Analysis
Classical Cost Elements are: 1. Raw Materials 2. Labor 3. Indirect Expenses / Overhead
•
[edit] Origins
Cost accounting has long been used to help managers understand the costs of running a business. Modern cost accounting originated during the industrial revolution, when the complexities of running a large scale business led to the development of systems for recording and tracking costs to help business owners and managers make decisions. In the early industrial age, most of the costs incurred by a business were what modern accountants call "variable costs" because they varied directly with the amount of production. Money was spent on labor, raw materials, power to run a factory, etc. in direct proportion to production. Managers could simply total the variable costs for a product and use this as a rough guide for decision-making processes. Some costs tend to remain the same even during busy periods, unlike variable costs which rise and fall with volume of work. Over time, the importance of these "fixed costs" has become more important to managers. Examples of fixed costs include the depreciation of plant and equipment, and the cost of departments such as maintenance, tooling, production control, purchasing, quality control, storage and handling, plant supervision and engineering. In the early twentieth century, these costs were of little importance to most businesses. However, in the twenty-first century, these costs are often more important than the variable cost of a product, and allocating them to a broad range of products can lead to bad decision making. Managers must understand fixed costs in order to make decisions about products and pricing. For example: A company produced railway coaches and had only one product. To make each coach, the company needed to purchase $60 of raw materials and components, and pay 6 laborers $40 each. Therefore, total variable cost for each coach was $300. Knowing that making a coach required spending $300, managers knew they couldn't sell below that price without losing money on each coach. Any price above $300 became a contribution to the
fixed costs of the company. If the fixed costs were, say, $1000 per month for rent, insurance and owner's salary, the company could therefore sell 5 coaches per month for a total of $3000 (priced at $600 each), or 10 coaches for a total of $4500 (priced at $450 each), and make a profit of $500 in both cases.
[edit] Standard Cost Accounting
In modern cost accounting, the concept of recording historical costs was taken further, by allocating the company's fixed costs over a given period of time to the items produced during that period, and recording the result as the total cost of production. This allowed the full cost of products that were not sold in the period they were produced to be recorded in inventory using a variety of complex accounting methods, which was consistent with the principles of GAAP (Generally Accepted Accounting Principles). It also essentially enabled managers to ignore the fixed costs, and look at the results of each period in relation to the "standard cost" for any given product. For example: if the railway coach company normally produced 40 coaches per month, and the fixed costs were still $1000/month, then each coach could be said to incur an overhead of $25 ($1000/40). Adding this to the variable costs of $300 per coach produced a full cost of $325 per coach. This method tended to slightly distort the resulting unit cost, but in mass-production industries that made one product line, and where the fixed costs were relatively low, the distortion was very minor. For example: if the railway coach company made 100 coaches one month, then the unit cost would become $310 per coach ($300 + ($1000/100)). If the next month the company made 50 coaches, then the unit cost = $320 per coach ($300 + ($1000/50)), a relatively minor difference. An important part of standard cost accounting is a variance analysis which breaks down the variation between actual cost and standard costs into various components (volume variation, material cost variation, labor cost variation, etc.) so managers can understand why costs were different from what was planned and take appropriate action to correct the situation.
[edit] Weaknesses of Standard Cost Accounting for Management Decision Making
As time went on, standard cost accounting lost its usefulness for management decision making due to a variety of reasons:
• •
• •
The practice of paying workers on a 'set-piece' basis changed in favour of paying on an hourly rate. Modern companies tend to have relatively low truly variable costs (primarily raw material, commissions or casual workers) and very high fixed costs (worker salaries, engineering costs, quality control, etc.). Equipment has become more complex and specialized and may be a very significant proportion of total costs. Changes in the level of full cost inventory create swings in profitability that are difficult to explain or understand. An increase in inventory can "absorb" costs of production and increase profits, while a decrease in inventory level will decrease profits.
•
Organizations with a wide range of products or services have processes which are common to several finished items, making cost allocation irrelevant or misleading.
As a result of the above, using standard cost accounting to analyze management decisions can distort the unit cost figures in ways that can lead managers to make decisions that do not reduce costs or maximize profits. For this reason, managers often use the terms "direct costs" and "indirect costs" to replace the standard costing, to better reflect the way allocation of overhead is actually calculated. Indirect costs (often large) are usually allocated in proportion to either labor cost, other direct costs, or some physical resource utilization. For example: If the railway coach company now paid its workforce a fixed monthly rate of $8,000 (total) and its other fixed costs had risen to $2,600/month, the total fixed costs would then be $10,600/month. The unit cost to make 40 coaches per month would still be $325 per coach ($60 material + ($10,600/40)), but producing 100 coaches would result in a unit cost of $166 per coach ($60 + ($10, 600/100)), provided the company had the capacity to increase production to that level. Managers using the standard cost for 40 coaches per month would likely reject an order for 100 coaches (to be produced in one month) if the selling price was only $300 per unit, seeing that it would result in a loss of $25 per unit. If they analyzed the fixed vs. variable cost distinction, they would see clearly that filling this order would result in a contribution to fixed costs of $240 per coach ($300 selling price less $60 materials) and would result in a net profit for the month of $13,400 (($240 x 100) - 10,600). [editThe company was at full capacity making 40 rail coaches each month. And since the foundry was expensive to operate, and purchasing brass as a raw material for the streetcars was expensive, the accountant determined that the company would lose money on any streetcars it built. He showed an analysis of the estimated product costs based on standard cost accounting and recommended that the company decline to build any streetcars.
After the presentations from the company accountant and the operations manager, the president understood that the metal shop capacity was limiting the company's profitability. The company could make only 40 rail coaches per month. But by taking the contract for the streetcars, the company could make nearly all the railway coaches ordered, and also meet all the demand for streetcars. The result would increase throughput in the metal shop from $6.25 to $10.38 per hour of available time, and increase profitability by 66 percent.
[edit] Activity-based costing
Main article: Activity-based costing Activity-based costing (ABC) is a system for assigning costs to products based on the activities they require. In this case, activities are those regular actions performed inside a company. "Talking with customer regarding invoice questions" is an example of an activity performed inside most companies. Accountants assign 100% of each employee's time to the different activities performed inside a company (many will use surveys to have the workers themselves assign their time to the different activities). The accountant then can determine the total cost spent on each activity by summing up the percentage of each worker's salary spent on that activity. A company can use the resulting activity cost data to determine where to focus their operational improvement efforts. For example, a job based manufacturer may find that a high percentage of their workers are spending their time trying to figure out a hastily written customer order. Via ABC, the accountants now have a currency amount that will be associated with the activity of "Researching Customer Work Order Specifications". Senior management can now decide how much focus or money to budget for the resolutions of this process deficiency. Activity-based management includes (but is not restricted to) the use of activity-based costing to manage a business.
[edit] Marginal Costing
See also: Cost-Volume-Profit Analysis See also: Marginal cost
This method is used particularly for short-term decision-making. Its principal tenets are:
• •
Revenue (per product) - Variable Costs (per product) = Contribution (per product) Total Contribution - Total Fixed Costs = Total Profit or (Total Loss)
Thus it does not attempt to allocate fixed costs in an arbitrary manner to different products. The short-term objective is to maximize contribution per unit. If constraints exist on resources, then Managerial Accounting dictates that marginal cost analysis be employed to maximize contribution per unit of the constrained resource (see Development of Throughput Accounting, above).
