Fundamentals of Cost Accounting

Cost accounting is a very obscure area of accounting expertise, and most accountants that work with cost accounting are hired by corporate America to perform private cost analysis and evaluation on the products manufactured by that particular company.

Cost accounting can be helpful, however if you’re going to have a need to establish prices for your business, or set cost of goods limits in relation to selling price.  So, we’re going to keep it very simple, but informative.

Understanding Cost Accounting
How do you determine the selling price of an item?  Do you simply add up the cost of all the components?  Do you know how to accurately factor in labor?  How about the cost of the building rent and insurance, should they be considered?

I’ll bet you didn’t realize there were so many pieces to the cost accounting puzzle.  These aren’t all the pieces, either.  The pieces we’re going to discuss here, are basic cost accounting factors, and will apply to most businesses, across the board.

As a cost accountant, it is your responsibility to accurately determine the precise cost of the product or service your business or company provides or produces.  In order to determine this cost, you’ll need access to information such as, piece cost for each item needed to create the finished product, labor costs for each part of the production or assembly process, packaging costs, overhead costs, inventory costs, and waste costs.  How do you determine these figures?

In many environments, sample orders are created, purely for the purpose of conducting a cost analysis through each phase of the production or assembly process.  Figures such as packaging, inventory and waste can only be determined after an initial production or assembly run.  The overhead figures are determined by figuring the amount of man hours a piece of equipment must be run, in order to produce the part in a production setting, or in the case of a service industry, in the number of hours an employee spends servicing a customers needs.  There are some pretty confusing formulas that are used to compute the overhead charge to be applied to each individual unit or piece, and they’re not worth trying to decipher, in this article.

The cost account, as I stated earlier, is an obscure branch of the accounting profession, and unless you’re properly trained, a really good grasp of this process would be to simply understand the components that are used to determine the individual item cost.

What do companies and cost accountants do with this information?  Now, here’s something worth discussing.  They use this information to determine what to charge you when you purchase the product.  Every business is in business to make money.  Unless you have a clear understanding of the cost associated with your product, you aren’t sure if your selling price is enough to cover your expense.  A successful company is one that keeps a very close check on the expense of an item, and adjusts the selling price to maintain some level of profitability.

No profit spells no business at some point.  Cost accounting, while quite obscure, is also a very important part of maintaining a profitable, healthy business.

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