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When a business has a better idea of exactly how its money is being spent, it can
better budget for the future. A company’s accountant is typically already aware of the
business’s fixed costs (utilities, rent, property taxes, etc.), but it’s variable costs (such
as labor and raw materials) change with output. Those costs need to be tracked and
estimated for, for the creation of the next budget. As well, the business will want to
know that the money being spent now is being done in ways that help maximize the
company’s profit.
Variable Costs
These are costs directly related to the production of a product, such as material and
labor costs. Often these types of costs fluctuate.
Fixed Costs
These are costs not directly related to production, but needed for production to
happen, like utilities and rent charges for a production facility. Often these types of
prices do not fluctuate, or if they do, they’re not by much.
Cost Accounting systems let a company know how much money it takes to produce
something. They are two types:
Job order costing organizes costs by each job. Job order costing is good for
companies with unique products. For instance, take a furniture company that produces
10 different types of chairs. By distinguishing between their production costs, the
company can know which chairs bring in more profit.
Process Costing
Process costing assigns costs based on a ‘process’. A cola bottling plant may use
process costing because all the bottles (or products) are indistinguishable from one
another.
Also known as “ABC”, this is a very popular costing method. ABC takes into
account all activities required to manufacture a product, and assigns a value to them.
For instance, two products may have the exact same ‘machine time’ to produce
something. But the set up or testing times for one of the products may be significantly
longer.
Help to determine which products are not profitable (because every cost
associated with it has been identified).
Determine whether a product’s price is too high, related to the market, and
whether the company can afford to lower it.
Provide information to help eliminate inefficiencies by reorganizing
production.
Environmental Accounting
Environmental accounting is important because the extra costs associated with the
production of a product, outside of manufacturing it, may make management decide
that a product is just too expensive to keep producing.
Project Accounting
Target Costing
Target costing is when a company knows in advance what it wants to pay for a
product’s production (perhaps because of very competitive market conditions). The
“target” cost is the most the company is willing to pay. Target costing helps a
company achieve consistent profitability.
Life cycle costing is the total cost of product ownership from inception to completion.
For instance, perhaps in order to produce a new product, a company needs to buy a
$600 machine. But how much is the financing, maintenance and disposal of that
machine going to add to the $600? What about the environmental costs (as listed
above)? As you can see, life cycle costing helps a company to get a complete picture
of all of a product’s related costs.
Throughput Accounting