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Everyone knows that revenue is a precursor to profits, but how much profit; that is the impedance behind Cost Accounting. Tax purposes and Wall Street projections are all about the aggregate revenue minus expenses. But this doesn't help make the micro level business decisions on whether individual products are profitable, the advantage of switching suppliers or if that last advertising campaign was worth the investment.

Fundamentally Cost Accounting deals with the collection and allocation of expenditures to the products that those expenses support, whether it is raw materials, services, labor or overhead. This allocation is a continual activity as prices and costs fluctuate. Even with new product ideas need to go through a cost accounting evaluation to help set pricing levels to cover the costs to produce and deliver the product to the customer.

Businesses care if individual deals and specific products are profitable. The more that a company can relate tangible costs to their goods and services, the more intelligently they can make decisions on the viability and projection of the benefit of further commitment and investment into that product line or model as a whole or each sale in itself.

The cost structure of products managed by the cost account is typically made up of three major components: Material, Labor, and Overhead. The material component is the raw material or purchased components which go into making or assembling the product. Labor is the cost of personnel used to assemble these material components into a finished and sellable product. The labor is usually applied through a computer system used to capture or record the labor time a resource applies to a "work order" to make or assemble one or more products. This labor time is multiplied by the resource rate (or cost) to apply the labor portion of the cost. The overhead is an attempt to capture the indirect costs, such as sales and administration, which is difficult to assign to individual products. This is usually applied as a fixed amount or as a percentage of the labor applied.

The challenge of applying overhead costs appropriately and in a more detailed basis, as opposed to an aggregate burden figure has driven many companies into a activity-based cost accounting effort which instead of applying a flat rate or percentage of labor, indirect cost are applied as incurred or over a period of cost adjustments using cost drivers and sometimes applying these cost to other bases besides products; like customers, markets or projects.

Where accounting in general "provides quantitative information about the finances of a business entity", Cost Accounting focuses on the collection and management of the cost structure of individual products and the business operating costs within a business entity.

Learn more about this author, Chuck Moyer.
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