Cost systems and methods at a glance

The accounting system of an organization is the most important segment of its information system. It comprises financial accounting, cost accounting and management accounting.

Financial accounting caters to external information needs in conformity with generally accepted accounting principles. Cost accounting generates information on costs. Management accounting seeks to provide information useful for planning, decision making, and control.

Costs are classified in accounting in different ways to meet different purpose. In terms of the relationship to the cost object, accountants distinguish between direct and indirect costs. In terms of their behavior, costs may be classified as fixed or variable. Manufacturing costs comprise three elements, viz., direct material, direct labor, and manufacturing overhead. Non-manufacturing costs consist of selling and distribution cost, administration cost, financial cost, and research and development cost. Service costs are usually divided into five major components, viz., service labor, materials and supplies, occupancy costs, technology costs, and other service overheads. Inventory costs are called products costs. Costs that are not falling into inventory are called period costs. In the context of decision making, three concepts are commonly considered: relevant cost, opportunity cost and sunk cost.

The process of costing involves five broad steps: (1) Define the cost object (2) Accumulate costs (3) Determine the direct costs (4) Allocate indirect sales cost (5) Calculate the total cost of production.

There are two systems of product costing: job cost system and process cost system.

The job cost system is normally used in industries here individual jobs, lots or batches are identifiable. It is applicable to industries such as ship building, housing, construction, book publication, and manufacture of special purpose machines. The cost object in a job system is the individual job. Every job is given a number and a separate job cost sheet is maintained for it. As the job progresses through different departments, various elements of production costs namely direct material cost, direct labor cost, and manufacturing overhead cost are recorded on the job cost sheet.

In a process cost system, production is viewed as a continuous flow rather than as a series of identifiable jobs or lots. This kind of system is applied to industries such as steel, cement, glass, and petrochemicals, where the production process is of continuous and repetitive nature.

In a process cost system, cost is accumulated by processes (departments) rather than by jobs. For each process, the unit cost of production is calculated. To get the total unit cost of a product, the unit cost of each process through which the product passes is summated.

For determining the product cost, two problems have to be solved: (1) measurement of direct costs, and (2) accumulation and allocation of indirect costs.

In the early stages of the development of cost accounting historical costing was used. This kind of costing suffers from certain drawbacks. To overcome these shortcomings, standard costing was developed. Under a system of standard costing (1) standards are developed for various elements of manufacturing cost, namely, material, labor and overhead (2) actual costs are compared with standard costs and variances are determined, and (3) variances are analyzed for their causes to identify corrective action.

Activity based costing identifies the key activities that consume a firm’s resources, accumulates overhead costs of each of these activities, determines the drivers of these activities and finally assigns the costs of these activities to the ultimate cost objects (products, services, or whatever). Activity based costing may be viewed as an amplification and refinement of the traditional accounting system.

Total cost management encompasses strategy as well as operations, covers all functions, spans different dimensions, and subsumes everything and everywhere.

The four ingredients of a system of total cost management are: total cost consciousness, total cost measurement, total cost responsibility, and total cost improvement.

An organization committed total cost management should pay heed to the following guidelines:

(1) Understand cost drivers. (2) Focus on the entire value chain. (3) Marry total cost management to business process reengineering. (4)Do it right the first time as total quality management demands (5) Exercise rigorous cost control at the design and product development stage. (6) Team up with vendors. (7) Benchmark against the best. (8) Resort to flexible manufacturing systems (9) witch to just-in-time system (10) Rely on activity based costing (11) Stretch your brands. (12) Watch adspend. (13) Rationalize distribution and servicing structure. (14) Use Infotech to cut costs. (15) Manage HR costs effectively. (16) Trim non-manufacturing overheads.