Cost accounting is a type of accounting whose main objective is to establish the cost of operations, products, raw materials, analysis variances, create budgets and assign costs to various cost centers and profits centers too. It is for this reason that managers depend on cost accounting in decision making to be able to predict revenues and costs, as well as match them to the available resources. Managers use cost accounting for various purposes some of which are discussed below.
Cost behavior and reduction
The most significant step in decision-making is the evaluation of costs that are incurred before engaging in any venture. The management needs to ascertain how various costs behave at different times and levels: “will the cost increase if production increases or will the cost remain the same?”(Banker, Hansen.2002). The most popular function of cost behavior accounting is forecasting the total costs for all the units of products that will be produced in a certain time. Forecasting costs is carried out using various methods such as: the high-low method, a scatter-graph, and least-squares regression and many more depending on the type of cost being estimated. These methods attempt to separate costs into components that remain constant (fixed) in total regardless of the number of units produced and those that vary in total in proportion to changes in the number of units produced” (Birnberg, 2008). This therefore makes it easy for decision makers to estimate the amount of resources required for a particular venture.
After the management has estimated the costs, they can set the prices for the units that will be produced. This too will involve several things. The first issue to consider is; the price must cover for the total costs incurred and still earn sufficient profit. Companies dealing with normal sales can not determine the prices independently and therefore they will have to go by the laws stipulated. For companies with patented products or those which have a specific product made according to customer’s preference; these companies are allowed to set their prices at will. The best way to achieve good prices is by setting a mark-up through adding the variable costs instead of using the full costs. This method is especially effective when pricing special orders or when the capacity is in excess. “ In both of these cases, production and sales at normal prices to regular customers will be sufficient to cover the total fixed and variable costs for typical sales levels and the concern is only for the incremental units above normal sales levels” (Banker, Hansen.2002)
The management uses cost accounting in preparing budgets to help in planning and controlling operations. A budget usually is a plan of how the company intends to spend its resources for a given period of time. It enables the managers to detect any problems that might arise in future and hence try to put measures to avoid them. Budgeting also enables coordination of operations in a company and makes them relate to the goals of the business. It results in greater management awareness of the company’s overall operations including the impact of external factors such as economic trends. By considering these trends the management can create a budget that is consistent with the market changes.
Cost accounting can also be used when making investment decisions especially on how to manage excess funds. Through cost accounting the management can evaluate the cost of engaging in long-term projects that require capital budgeting. Such projects usually involve large amounts of funds and therefore if well managed; they can lead to huge losses for the company. There are many ways of capital budgeting such as: the payback period method, the net present value method, and the internal rate of return method. By applying cost accounting, managers can be able to cut down costs and maximize revenues for a company. The budget will guide them towards making sound decisions that will increase profitability without comprising quality. Cost accounting enables managers to realize any change that occurs in operations by use of standard variances. When operations vary from the standard, the management is informed and they can therefore intervene. This helps to prevent fraud, damage and stop any problem that could arise and result in losses. Cost accounting also enables the management to monitor the performance of employees by placing standards and limits that they should achieve. It also enables the managers to determine the wages and salaries that their workers deserve: it also enables them to give bonuses, pay overtime and also determine increments. (Birnberg, 2008).
The current management theories require that companies should make forecast before engaging in any operation and especially considering the emergent global competition. Companies have to deal with new business strategies such as globalization downsizing and new capitalism. Cost accounting is therefore a useful tool because it provides, product or service cost information for use in planning, directing, and controlling the operations of the business.
Banker, R. & Hansen S. (2002). the adequacy of full-cost-based pricing heuristics. Journal of Management Accounting Research (14): 33-58.
Birnberg, J. G. (2008). John K. Shank: Recipient of Distinguished Contribution to Management Accounting Award. Journal of Management Accounting Research (20): 15-15.