MSE608C – Engineering and Financial Cost Analysis

Introduction to Cost Accounting

Cost AccountingTechniques that develop detailed information about

the cost of products or services. • Internal (Managerial Accounting) for

– budgeting,

– variance analysis and making a

– variety of business decisions.

• External (Financial Statements).– Income Statement

• “Cost of Goods Sold” for Manufacturing operations• “Purchases” for Merchandising and Service organizations

– Balance Sheet• Inventory

A Historical Perspective

• Pre-Industrial Revolution– Luca Pacioli developed cost accounting techniques for cash

budgeting and variance analysis.

– Most manufacturing was performed by craftsman who were paid piece-rate;

– Minimal manufacturing overhead compared to labor and materials

A Historical Perspective (cont)

• 19th Century Post-Industrial Revolution– More capital investment and higher overhead, primarily in process

industries;

– Throughout the 1800s there were no well-defined cost accounting systems.

– Development of absorption and variable accounting methods to allocate fixed costs.

– Alexander Hamilton Church developed the machine-hour method for allocating fixed costs (land, building, equipment).

An Historical Perspective (cont)

• Early 20th Century– Increased capital investment in assembly

industries.– Variable costing method grew in acceptance

but was still less commonly used than the Absorption costing method.

An Historical Perspective (cont)

• End of 20th Century– Congress established the Cost Accounting

Standards Board in 1970 to standardize methods and reporting for defense contractors.

– President Reagan eliminated the CASB in 1982.

– Development of Activity-Based Costing (ABC) method.

How Are Costs Classified???

• There are two methods used by the Cost Accountant to apply costs consistently:– Manufacturing or Non-manufacturing Costs

• This distinction determines if costs are associated with product or services or with support functions.

– Period or Product Costs• This distinction used to determine when costs are expensed.

Manufacturing Costs

• Manufacturing is the conversion of materials into finished goods.

• It requires:– Direct Labor– Direct Material– Overhead

Direct Labor• Wages and other payroll costs that can be

directly associated with a unit of output.– Commonly called “Touch Labor”

• Indirect Labor cannot be directly traced or cost-effectively associated with the product (included in Overhead).

Direct Material

• All raw materials added during the conversion process– become an integral part of the finished goods.

• Indirect Material – difficult to determine the amount of some raw materials

that are consumed during the conversion process for a specific product (included in Overhead)

• Prime Costs = Direct Material + Direct Labor

Overhead

• All other factory costs required for production but are not directly associated with each unit of production.– Indirect Labor

– Indirect Material

– Overhead

Non-Manufacturing Costs

• Marketing and selling costs:– Required to get finished goods to customers.

• Administrative costs:– Required to provide the administrative function of the

business.

Product and Period Costs

Emphasize the timing of expenses.

• Product Costs– Costs that can be directly “attached” with Product and will be

expensed when the product is sold (not necessarily the period they were incurred).

• Period Costs – Costs not easily “attached” to product and will be expensed in the

period in which they were incurred.

Collecting Costs• Job Order

– Production of individual or batches of many different types of products.

– Costs can be collected for independent orders.

• Process– Continuous processing of a single type of

product for relatively long periods of time. – Costs can not be cost-efficiently collected for

independent orders.

Job Order Costing• Costs for independent orders are charged to

a Work Order, or Job number.– Direct Labor

• Charged to the work order number using a time card, production traveler (a.k.a. router), or other type of time sheet.

– Direct Material• Purchased directly to the Work Order number or will be issued

from general inventory and charged to the job.

– Applied Overhead• The Cost Accountant will determine the amount of factory

overhead costs to apply to each Work Order; usually based on the amount of labor hours, labor-wages, machine-hours or material costs.

Process Costing

Steps for determining Process costs:1) Identify the Processing Centers

• the processing activity is consistent for all the product; and

• the output is homogeneous.

2) Accumulated labor, material and overhead costs for each Processing Center over a specific time period

3) Calculate the average cost per unit over that period of time.

Average unit cost = Total Costs/Number of units output

Actual vs. Standard Costs

• Actual Costs– The actual costs paid for resources used in the conversion

processes.• Evidenced by transaction documents.

• Standard Costs– Predetermined costs assigned for each unit of a resource used in

the conversion processes.• Standards are established by:

– Time studies;– Historical data; and– Educated guesswork.

• Standards are based on past results but must consider future events.

Actual vs. Standard Costs (cont)

Both systems have advantages and disadvantages.

Standard Costing is the predominate system in business.

•The cost to prepare Standards•Provides a vehicle for future planning and variance analysis.

•Less record keeping

•Does not consider raw materials with different costs.

•Handy costing information for planning and decision making.

Standard Costs

•Costs must be available when inventory is sold

•Raw materials may have different cost in inventory.

•More accurateActual Costs

DisadvantagesAdvantages

Assessment

• What determines Manufacturing vs. Non-manufacturing Costs?

• What goes into Manufacturing Overhead?

• What is the difference in using Product versus Period Cost designation?

• What are the two ways to collect Costs?