Cost Accounting

Abstract

This article explains the essential concepts of cost accounting. The overview provides an introduction to the basic cost accounting objectives and techniques, the roles of the controller and cost accountant within the corporate management structure, and the ethical considerations that guide cost accountants. This article also explains the basic cost accumulation methods that are used in cost accounting systems. These methods include job order costing, process costing, backflush costing, hybrid costing, and joint and by-product costing. Further, explanations of the most common costs that companies must plan for and control are included, such as direct labor, direct material and factory overhead costs. Finally, this overview describes how cost accounting techniques affect business considerations in areas such as budgeting, pricing and inventory costing methods, which include throughput, direct, absorption and activity-based costing systems.

Keywords Activity-Based Costing; Activity-based Management (ABM); Actual Cost System; Backflush Costing; Balance Sheet; By-product; Controller; Cost Accounting; Cost Accumulation; Cost Driver; Direct Labor; Direct Materials; Factory Cost; Factory Overhead; Fixed Cost; Indirect Cost; Job Order Costing; Joint Cost; Labor Productivity; Process Costing; Sunk Cost; Variable Cost

Accounting > Cost Accounting

Overview

Cost accounting is the application of accounting and costing principles to the tracking, recording and analysis of the costs associated with the products or services a business produces and the activities involved in the production process. Broadly speaking, cost accounting objectives include the preparation of statistical data, application of cost accumulation and cost control methods to production processes and analysis of an organization's profitability as compared with previous periods of time and projected budgets. Cost accountants use basic accounting techniques to compile and analyze data to meet these objectives. In performing these tasks, cost accountants work within the controller's office or the accounting department of most companies. And in addition to any internal company policies that govern their duties, cost accountants must consider the ethical principles that guide the accounting and financial reporting industries. The following sections provide a more in-depth explanation of these concepts.

Introduction to Cost Accounting

Cost accounting identifies, defines, measures, reports and analyzes the various elements of direct and indirect costs associated with producing and marketing goods and services. Cost accounting also measures performance, product quality and productivity. Direct costs can be directly traced to producing specific goods or services, such as the cost of raw materials used in the production of a final consumer good. Indirect costs are expenditures on labor, materials or services that cannot be economically identified with a specific saleable cost unit. Indirect costs include salaries for employees and rental or lease payments for office or factory space.

Cost Accounting Objectives & Techniques

The main objective of cost accounting is to compile, analyze and transmit both financial and non-financial information to management for planning, controlling and operational evaluation purposes. At its most basic, cost accounting measures the economic sacrifice an organization makes to achieve its goals. Costs are generally categorized by expenditure type. For instance, product costs represent the monetary measurement of resources an organization uses, such as material, labor and overhead. Service costs are the monetary sacrifices it makes to provide the goods or services. Cost accounting tracks these costs and provides this information to management so that the management team can make more informed business and administrative decisions. For this reason, modern cost accounting often is called "management accounting" because managers use accounting data to guide their decisions. In addition, managers oversee and distribute resources to most efficiently meet an organization's goals. Managers use the information produced by cost accounting techniques to direct day-to-day operations and supply feedback to evaluate and control performance.

Data Compilation & Analysis

To compile data for management, cost accountants obtain cost information on product and service costs from a variety of sources. For instance, they may use vendor invoices, engineering studies of production processes, employee timesheets and planning schedules from production supervisors. Once they have compiled sufficient records, cost accountants use various means of analyzing the data, depending on the results they are seeking to obtain. Cost analysis techniques include break-even analysis, comparative cost analysis, capital expenditure analysis and budgeting techniques.

• The break-even point for a product is the point at which the total revenue generated equals the total costs associated with the production and sale of a given product.
• Break-even analysis is the study of when it is profitable for a business to introduce a new product as opposed to modifying an existing product so that it becomes more lucrative.
• Comparative cost analysis involves identifying the costs associated with the baseline materials and processes and any available alternatives, and calculating the comparative costs between them.
• Capital expenditure analysis involves reviewing the funds spent for the acquisition of long-term assets.

Interpretation

After performing their analyses, cost accountants then use their professional judgment to interpret the results of each costing technique as they apply to different aspects of a company's financial analysis. For example, although breakeven analysis indicates the capacity at which operations become profitable, it assumes a static condition in which sales prices and expenses are constant. However, such factors do not remain constant in the real world. Inflation, supply and demand cause sales prices and expenses to vary. Cost accountants therefore work with many people in other departments of a company (such as marketing, engineering, manufacturing, financial accounting and human resources personnel) to obtain current information that may account for some of these fluctuations.

Finally, cost accountants collect all costs involved in the process of making goods or providing services and use such cost data for income measurement and inventory valuation. This information also helps management plan and make operational decisions. Because of these responsibilities, cost accountants must exercise initiative and good judgment and meet high ethical standards. Further, cost accountants must provide management with information that may indicate adverse economic conditions when these situations arise, such as reports about poor product quality, cost overruns or abuses of company policies.

Roles of Controllers & Cost Accountants

A controller is the title that is often given to a company's chief accounting officer or manager of the accounting department. A controller plays a significant role in planning and guiding a company's financial decisions and is often charged with the tasks of designing systems to prepare internal reports for management and external reports for public and government users. A cost accountant is a member of the controller's department and is responsible for collecting product costs and preparing accurate and timely reports to evaluate and control company operations. As such, cost accountants assemble, classify and summarize financial and economic data on the production and pricing of goods or services.

In addition, cost accountants play an important role in coordinating external and internal data so managers can formulate better planning and control activities. In the planning phases, cost accountants help management by preparing budgets that provide cost estimates of material, labor and technology. A company uses this data to review alternative courses of action and to select the best methods of achieving its goals and profit objectives. Cost accounting data are used for both planning and control activities. These activities differ in that planning activities are focused on future goals while control activities involve monitoring present production processes and tracking any variations from estimated budgets and plans. Cost accountants monitor these activities and issue progress reports that summarize the costs of these activities and the efficiency of the processes associated with them. By comparing actual results with the forecasted budget amounts, cost accountants are able to identify areas of deviation where problems may be developing. Cost accountants also compile and relay this information to management so that appropriate decisions can be made to shore up inefficient or failing processes within an organization.

Ethical Considerations Facing Cost Accountants

There are several types of ethical problems that cost accountants may face. One of the major ethical issues that a cost accountant must consider is confidentiality. This issue is particularly important because cost accountants typically have detailed access to sensitive information, such as payroll records, product costs and individual product or departmental profits. Cost accountants must carefully safeguard such information because if improperly disclosed, it could be improperly used by other entities or even by hostile personnel within an organization.

Another issue that cost accountants face is integrity, particularly when faced with difficult tasks that may surpass their training or level of experience. This is critical because the reports and analyses that cost accountants generate become the foundation upon which management teams stake critical decisions, and thus it is imperative that the information contained in these materials be complete and accurate. Finally, cost accountants must maintain the ability to view information and strategies objectively. Objectivity allows a cost accountant to present cost analyses in a fair, well-balanced format that discloses all relevant information pertaining to a decision. Cost accountants may face considerable pressure from managers whose operations are being reviewed to skew reported information in such a way as to make the departments or products they oversee appear to be in better financial standing than they actually are. Thus, ethical considerations such as confidentiality, integrity and objectivity are an important part of the responsibilities that cost accountants face and their observance, or lack thereof, can have a significant impact on a company's future.

Cost Accumulation

One of the most important tasks that cost accountants must accomplish is to gather or accumulate cost information and then assign that information to appropriate products or orders or other processes using a cost management system. The most commonly used costing methods are job order costing and process costing. However, many companies also use joint product or by-product costing or a hybrid costing system. The nature of the activities being analyzed determines which cost management system is most appropriate. The following sections describe these systems in more detail.

Job Order Costing

Job order costing is the typical method for compiling cost accounting information into a usable format. In job order costing systems, costs are assigned to each job, which may be an order, a contract, a unit of production or a batch that is processed according to customer specifications. Thus, job order costing is appropriate for manufacturing and service industries such as design or publishing companies, manufacturing companies that produce special order products, accounting firms that perform audits or any organization producing a tailor-made good or service according to customers’ specific requirements. For example, a graphic design company would likely use job order costing because graphic designers usually produce each design order to a specific customer request. Thus, job costing links all material and direct labor costs directly to a job or batch and all direct and overhead costs associated with that job or batch are accumulated for closer analysis (Bragg, 2005).

One of the major benefits of job costing is that a company’s management team can easily determine all of the various costs being generated for each job being completed. This information allows management to examine each cost to determine why it was necessary and how it can be managed better in the future, thereby contributing to greater levels of profitability in the future. Another reason that companies use job costing is that they can more closely track the costs for each job as it is being fulfilled. Accounting software allows companies to use a job costing system to track costs as they arise rather than waiting until the job is complete to compile and assess overall costs. This is advantageous in that a company can oversee the costs incurred for more complex jobs during the production process so that there is sufficient time to make changes to the production process or sales price before the jobs close, based on the costing information provided by the job costing system (Bragg, 2005).

However, there are also considerable problems associated with job costing. An initial problem is that it concentrates attention on the costs incurred by specific products rather than on costs associated with different departments or activities. Another difficulty is that job costing is not always relevant. For example, some software manufacturers have high development costs but little direct costs associated with the marketing or advertising of its products. Finally, job costing requires a significant amount of data entry and data accuracy for the analysis to tender significant results. Minute data related to materials, labor, overhead, indirect labor, scrap, spoilage and supplies must be entered into a system that can accurately assign these costs to their corresponding jobs. This process is open to errors stemming from keying errors or the misidentification of jobs or customers (Bragg, 2005).

Process Costing

Process costing is used in many industries where there are such large quantities of similar products that it makes no sense to track the cost of individual or small batches of products. Instead, costs are averaged over large quantities of production, which yields the same unit costs for all items in a production run. This type of costing requires accounting calculations that are considerably different from those used for job costing. Using a process costing system, accountants accumulate costs for each department for a time period and allocate these costs among all the products manufactured during that period. Companies that mass produce similar goods such as chemicals, bakery goods, or canned food in a continuous production process use process accounting. Direct material, direct labor and factory overhead costs are accumulated for each department for a set period of time; usually a month. At the end of the period, departmental cost is divided by the number of units produced to obtain a cost per unit.

For instance, one type of process costing is known as first-in first-out ("FIFO") costing. This involves a complex calculation that creates layers of costs, one for units of production started in the previous production period but not completed, and another layer for production started for the current period. This type of costing is used when there are ongoing, significant changes in product costs from period to period-to such an extent that management needs to know the new costing levels so that it can reprice products appropriately, determine if there are internal costing problems requiring resolution or even replace managers or restructure their compensation or bonus packages.

Backflush Costing

Backflush costing is a simplified cost accumulation method that is sometimes used by companies that adopt just-in-time ("JIT") production systems. The JIT system is an approach that aims to reduce costs through the elimination of inventory. All materials and components are designed to arrive at a work station exactly when they are needed. Similarly, products are aimed to be completed and available to customers just when the customers want them.

In a backflush cost system, costing is deferred until products are completed. Standard costs are then run backwards through the system to determine which costs are associated with which products. The result is that time consuming meticulous tracking of costs is eliminated. The system is beneficial for companies that keep small inventories because costs are directly linked to the cost of products sold and manufacturing costs accrue in fewer inventory accounts than when using other methods. In extreme backflush systems, most accounting records are no longer needed because a higher percentage of the manufacturing costs become direct product costs and thus fewer cost allotments are necessary. However, the drawback to the JIT principle is that although the eradication of inventory stockpile eliminates storage and carrying costs, it also eliminates the cushion against production errors and imbalances that inventories provide.

Joint Product & By-Product Costing

Many industrial companies are faced with the difficult problem of assigning costs to their by-products and joint products. Chemical companies, petroleum refineries, flour mills, coal mines, meat packers and other similar producers' process, and sometimes create products to which some costs must be assigned, particularly for use in the preparation of financial statements.

Joint products are two or more products that are produced simultaneously by a common process or series of processes, with each product possessing a more than nominal value in the form in which it is produced. Pricing for joint products is somewhat more complex than pricing for a single product as fluctuations in demand may create a higher demand, and thus a higher price, for one product over another. A joint cost can be defined as the cost that arises from the simultaneous processing or manufacturing of products produced from the same process. Joint costs may be allocated to the joint products based on a physical measurement such as volume or weight, or they may be allocated to the joint products according to their relative sales value once they emerge as individually identifiable products.

By-products are products with a comparatively low total value that are produced concurrently with a product with a greater total value. The product with the greater value, commonly called the main product, is usually produced in greater quantities than the by-products. Thus, a by-product is an additional product that arises from a production process but with a potential sales value that is much smaller than that of the main product or joint products that were produced from the same process.

The split-off point is defined as the point at which joint products emerge as individual units. Before the split-off point, the cost of the products is almost inseparable and is often attributed to the process itself rather than the individual products. However, generally accepted accounting principles require that costs be assigned to products for inventory valuation purposes. Though costs incurred by a production process up to the split-off point cannot be clearly assigned to a single product, it is still necessary to find some reasonable allocation method for doing so in order to comply with standard accounting rules. By-product and joint product costing methods enable cost accountants to assign costs as accurately as possible while also furnishing management with data that can be useful in planning and managing various types of costs and in evaluating the actual profit performance of individual products and manufacturing processes.

Hybrid Costing

Hybrid or mixed costing systems are used when multiple cost accumulation methods are required. For example, some companies may use process costing to track direct materials and job order costing for such costs as direct labor and factory overhead. Other companies may use job order costing for direct materials and process costing for direct labor and overhead costs. Further, different departments or areas of focus within a company might need to use different cost accumulation methods. This is why hybrid or mixed cost accumulation methods are sometimes used so that the most effective cost accumulation system for each activity is used to record, track and analyze costs.

Cost Management

Effective cost management is essential for businesses in order for them to provide the best price and service to customers, streamline production processes and control their investment in inventories. In addition, businesses need systems to track and control costs involving direct materials, direct labor and factory overhead expenses. These costs are fundamental to almost every business and comprise a significant portion of the costs associated with the production of goods and services. The following sections explain these basic costs in more detail.

Direct Material

Direct material is any raw material that becomes an identifiable part of the finished product. For example, in manufacturing women's clothing, the fabric is direct material. Accountants separately record and trace all direct material required in manufacturing to specific products. Companies buy direct materials in various forms. They buy some direct material in a finished state and assemble the component parts into their final product. Manufacturers of consumer electronic goods often purchase electronic components that workers assemble into finished appliances. Other companies purchase direct material in a raw state and apply labor, machinery and equipment to change it into another form. Bakeries, for instance, obtain basic ingredients that are combined and baked in order to create a finished product.

The acquisition, control and storage of direct materials requires different costing processes. To purchase direct materials, companies use purchase requisitions and purchase orders. When the materials are received, the receiving department inspects the items for quantity and quality and to ensure that all items have arrived. Materials must then be stored in a safe, secure and environmentally stable area until they are used. Finally, inventories must be continually monitored to ensure the steady flow of sufficient materials.

Labor

Direct labor costs are the wages earned by workers who transform direct materials from their raw state to a finished product. For example, the wages paid to factory workers who assemble parts and monitor the machinery are direct labor costs. However, only the wages earned by those workers involved in the physical manufacture of products are direct labor costs. Thus, labor costs consist of basic pay and fringe benefits. The basic pay for work performed is called the base rate. An equitable base rate or salary structure requires an analysis, description and evaluation of each job within a plant or office. Fringe benefits also form a substantial element of labor costs. Fringe benefits include the employer's share of FICA tax, unemployment taxes, holiday pay, vacation pay, overtime premium pay, insurance benefits and pension costs. Fringe benefits must be added to the base rate to arrive at the full labor cost.

Factory Overhead

Factory overhead consists of all the costs that are incurred in production (not marketing and administration) and not traced directly to jobs. For example, the commissions earned by sales or product representatives are generally marketing expenses while salaries earned by top management are often classified as administrative expenses. However, the wages earned by a line manager in charge of overseeing production clerks are generally factory overhead costs. In addition, factory overhead includes indirect materials, which are the operating, repair and janitorial supplies used in the factory. Also, factory overhead includes such costs as rent, taxes, insurance and depreciation on manufacturing facilities, as well as occupancy costs such as the light, heat and power used to run the manufacturing facility.

Applications

Cost Accounting in Business Considerations

Cost accounting plays an important role in the growth and development of a business organization. As businesses grow, their management teams set goals and objectives for future development benchmarks and then create and implement plans for achieving these aspirations. These plans developed by management are evaluated and tracked through the budgeting and accounting processes. In particular, cost accounting provides management with detailed statements of the actual cost of materials, labor, factory overhead, marketing expenses and administrative expenses incurred in the development of the business. By analyzing and comparing a company's actual costs with those budgeted for specific time periods or processes, management is able to identify areas of both strength and weakness in a company. This knowledge enables management to make clearer and more informed decisions about a company's operations. In particular, by identifying significant deviations from a company's budget, a management team can develop and implement appropriate corrective action that is tailor made for any situation. Some of the steps that a management team may take are to redesign a more suitable budget, restructure product pricings and monitor inventory flow and valuation. The following sections describe these processes in more detail.

Budgeting

A budget is an estimation of the revenue and expenses an organization will incur over a specified future period of time. Beyond its financial component, budgeting provides a way for an organization to develop an informed plan of action to attain future objectives based on relevant indicators of past performance and expenses. This plan of action can then be communicated to key personnel and decision makers within an organization so that the entire management team is clear on the growth objectives of the organization. Without the discipline and framework a budget provides, individual managers may take actions that are in their best interest, but not ideal for the company as a whole.

During the budget-making process, cost accounting plays a critical role in helping to shape some or all of the key figures. Cost accountants may develop the entire budget, or may be assigned a partial role in developing a master budget. For instance, cost accountants may calculate overhead rates for the valuation of projected inventory levels, calculate unit or individual product costs during a production process or evaluate the overall cost of producing each item in the company's sales budget. Cost accounting also helps a company's management establish target costs for new products that are in the development stage and construct budgets for future time periods or significant investments. For instance, cost accountants may assist in developing a budget for capital expenditures. Capital expenditures are funds used by a company to acquire or upgrade physical assets such as property, industrial buildings or equipment. Thus, because capital expenditures tie up significant resources of a company for an extended period of time, these acquisitions are considered more risky than short-term investments and much thought and planning goes into the evaluation of their acquisition.

Thus, the budget process is a critical component of the overall plan by which a company allocates its resources. Budgeting enables a company to channel funds to the most profitable activities while tracking and controlling expenditures in other, perhaps less profitable departments. This process enables a company to capture the information it needs to achieve its operational and financial objectives. Cost accounting plays an important role in assisting a company's management by providing key data on unit and production costs, capital expenditures, target costs and departmental expenses that are central components of the budgeting process.

Pricing Issues

Some products — for instance such commodities as oil, wheat, corn or gold — are priced based upon forces in the market. However, most of the time companies set and alter the prices they charge for their products. In establishing price points for a product, a company's management works closely with its cost accountants to determine a fair price for each product that is low enough so that the product is competitive in the market, but high enough so that the company is able to make a profit from its sales. Cost accounting also plays an important role in helping companies to set pricing levels for both short-range and long-range pricing objectives. Short-range pricing scenarios occur when a company receives a special request from a customer to order products at a low or below-market price. When this occurs, the customer may be pitting one of its suppliers against another in an attempt to purchase goods at the lowest price, or it may desire to place a large order and is seeking to buy items in bulk at a lower price. When this occurs, the company must determine whether it will honor the request.

In order to determine whether a short-range pricing scenario is feasible for a company, the cost accountant will likely be asked to perform several types of analyses so that management has the information necessary to make a final decision. The basic rule for short-range pricing is that the lowest price that a company can charge for a product is one that at least covers all variable costs of production, plus a small profit. Anything lower would cost company money to produce the product and therefore would not be an economically sound price point for a company. To complete these calculations, cost accountants must weigh the variable costs that are included in their analysis, which could include direct labor costs, direct machine costs, inventory carrying costs, raw materials, quality costs and scrap costs. Once these costs have been calculated, the cost accountant can provide management with the minimum price that must be charged in order for a company to cover its expenditures and recoup at least some profit.

Another form of pricing that company must consider is long-range pricing, which is a common method for pricing sales of products sold in bulk. Long-range pricing factors several forms of overhead costs into the final price of products, including product-specific overhead costs, batch-specific overhead costs, product line-specific overhead costs and facility-specific overhead costs.

• Product-specific overhead costs include the expenses incurred in the production process of a single unit of a product.
• Batch-specific overhead costs include the cost of labor required to set up or break down a machine for a production process, such as the utility cost of running the machines throughout the production process, the cost of transporting component parts to the production area and finished products from the production area to a shipping area and the depreciation on all machinery used in the production process.
• Product line-specific overhead costs include the cost of maintaining a production manager, design team, quality control personnel, customer service representatives and distribution and advertising staff to monitor the production of a product line and promote its sales.
• Finally, facility-specific overhead costs include the costs of building depreciation on the production facility, and the taxes, insurance and maintenance costs involved in running the site.

All of these costs must be factored into the calculations of a final sales price for each product. Long-range pricing is difficult in that it can be challenging for cost accountants to accurately predict all of the overhead costs that will be incurred in the production and promotion of an individual product. Thus, pricing is an extremely complex area of budget development, and cost accountants must often work closely with the marketing and business development departments to develop appropriate short-range and long-range pricing strategies. In addition, cost accountants must be mindful of federal laws that prevent collusive or predatory pricing, and must ensure that all pricing policies stay within the guidelines set by these laws.

Inventory Costing Methods

Cost accountants use different methods to track and analyze the costs associated with obtaining, storing and restocking inventories. Traditionally, the most common inventory costing methods used by cost accountants were throughput or direct costing systems. However, many cost accountants have begun to use activity-based costing methods because of the holistic perspective this method affords of the entire production process. The following sections explain these inventory costing methods in greater detail.

Throughput Costing

The throughput method involves tracking the least amount of cost to the inventory. Using this method, only direct material costs are charged to the inventory. All other costs are expensed during the period. The throughput method does not provide proper matching, whereby expenses are recognized in the same reporting period as the related revenues for purposes of generally accepted accounting principles, except when direct materials are expensed at the time they are incurred rather than being capitalized in inventory costs. Therefore, the throughput method is not sufficient for external reporting in audits for public use, although it provides many advantages for internal reporting for management purposes (Martin, n.d.).

Direct Costing

In direct costing, more of the cost is traced than in the throughput method, but less than with the absorption method. In direct costing only the changeable manufacturing costs are charged to the inventory. Fixed manufacturing costs flow into expenses in the period during which they are acquired. This method has both advantages and disadvantages in regards to internal reporting. It does not allow proper matching for purposes of generally accepted accounting principles because the current fixed costs that accompany producing the inventory are charged to expense costs regardless of whether or not the output is sold during the designated time period. For this reason, direct costing is not useful for external reporting (Martin, n.d.).

Absorption Costing

Absorption costing is a traditional method where all manufacturing costs are capitalized or charged to the inventory, thereby becoming assets. Therefore these costs do not become expenses until the inventory is sold. In this way, matching is more closely estimated, although sales and administrative costs are charged to expense costs. Absorption costing is necessary for external reporting, and is also frequently used for internal reporting.

Activity-Based Costing

Activity-based costing ("ABC") defines production processes, identifies costs associated with those processes, determines the unit costs of products and services, and create reports that assign the costs of resources to specific activities as a way of measuring the expenditures and profitability involved in specific processes. ABC is considered a more accurate cost management system than traditional costing systems because it enables managers to improve business process effectiveness and efficiency by determining the "true" costs involved in the production of a product or service.

ABC differs from traditional costing measures in several significant ways. First, traditional systems allocate costs to products using such allocation bases as units, direct labor input, machine hours and revenue dollars. ABC systems allocate costs to products and services using allocation bases that correspond to cost drivers, or the factors that have the greatest effect upon activity costs, such as number of machine setups, run times or special inspection requirements. Also, because of the inability of traditional costing methods to align allocation bases with cost drivers, these methods can lead to overcosting and undercosting problems. ABC methods enable cost accountants to associate allocation bases with cost drivers, which provide managers with the most accurate information to support their decisions. Finally, ABC methods summarize the costs of organizational, or multi-department, activities while traditional costing techniques generally focus on the costs incurred in single departments.

Conclusion

Cost accounting is an important means by which businesses may compile, track, record and analyze all aspects of the costs associated with producing, marketing and selling goods and services. Cost accounting includes cost accumulation methods that enable cost accountants to compile the most accurate information about production processes, such as job order costing, process costing, backflush costing, hybrid costing and joint and by-product costing systems. Cost accounting also involves helping an organization's management to monitor and contain ongoing expenditures, which include direct labor, direct material and factory overhead costs. To properly manage business operations, managers rely on the records and analyses prepared by cost accountants to create budgets, set prices and control inventories. Thus, cost accountants play a critical role in the life cycle and development of individual products, product lines and even businesses themselves.

Terms & Concepts

Activity-based costing (ABC): A system in which multiple overhead cost pools are allocated using bases that include one or more non-volume-related factors.

Activity-based Management (ABM): Detailed analysis of activities and the expenses created by those activities (used as a basis for controlling and improving efficiency) or the use of information obtained from activity-based costing to make improvements in a firm.

Actual Cost System: A method of collecting cost information as cost is incurred.

Backflush Costing: A method of cost accumulation that works backward through the available accounting information after production is complete. This is useful in settings in which processing speeds are extremely fast.

Balance Sheet: A financial statement showing financial position (assets, liabilities and owners equity at the end of a period. The balance sheet complements the income statement.

By-product: By-products are products with a comparatively low total value that are produced concurrently with a product with a greater total value.

Cost Accounting: Calculation of costs for the purpose of planning and controlling activities, improving quality and efficiency and making decisions. Also referred to as management accounting.

Direct Labor: Labor that converts direct materials into the finished product and can be assigned feasibly to a specific product.

Direct Materials: Materials that form an integral part of the finished product and that are included explicitly in calculating the cost of the product.

Factory Cost: Usually, the sum of three cost elements: Direct materials, direct labor and factory overhead.

Factory Overhead: Indirect materials, indirect labor and all other factory costs that cannot be conveniently identified with specific jobs, products or final cost objectives.

Job Order Costing: A costing method in which costs are accumulated for each job, batch, lot or customer order.

Joint Cost: The cost that arises from the simultaneous processing or manufacturing of products produced from the same process.

Labor Productivity: The measurement of production performance using the expenditure of human effort as a yardstick; the amount of goods or services a worker produces.

Process Costing: A method in which materials, labor and factory overhead are charged to cost centers. The cost assigned to each unit of product manufactured is determined by dividing the total cost charged to the cost center by the number of units produced.

Sunk Cost: An expenditure that has already been made and cannot be recovered.

Variable Cost: A cost that increases in total proportionately with an increase in activity and decreases proportionately with a decrease in activity.

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Norfleet, D. (2007). The theory of indirect costs. AACE International Transactions, 12.1–12.6. Retrieved September 29, 2007, from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=25912705&site=ehost-live

Ocneanu, L., & Bucsa, R. (2012). Advantages of using standard cost method in managerial accounting. Economy Transdisciplinarity Cognition, 15, 96–102. Retrieved November 15, 2013, from EBSCO online database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=90541018&site=ehost-live

Tsai, W. & Lai, C. (2007). Outsourcing or capacity expansions: Application of activity- based costing model on joint products decisions. Computers & Operations Research, 34, 3666–3681. Retrieved September 29, 2007, from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=24971893&site=ehost-live

Williams, C. (2007). Are your cost allocations up-to-date? Nonprofit World, 25, 28. Retrieved September 29, 2007, from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=25039149&site=ehost-live

Suggested Reading

Dowless, R. (2007). Your guide to costing methods and terminology. Nursing Management, 38, 52–57. Retrieved September 29, 2007, from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=24855977&site=ehost-live

Liston, P. & Byrne, P. (2007). An evaluation of simulation to support contract costing. Computers & Operations Research, 34, 3652–3665. Retrieved September 29, 2007, from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=24971892&site=ehost-live

Shields, M. D. (2015). Established management accounting knowledge. Journal of Management Accounting Research, 27(1), 123–132. Retrieved December 3, 2015, from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=108501833&site=bsi-live

Wu, S. & Li, H. (2007). Warranty cost analysis for products with a dormant state. European Journal of Operational Research, 182, 1285–1293. Retrieved September 29, 2007, from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=25033741&site=ehost-live