ACC 206 Week 5- Final Paper Cost Accounting
ACC 206 Week 5- Final Paper Cost Accounting fin571
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Date Created: 11/11/15
Running head: COST 1 Cost Accounting ACC206: Principles of Accounting II Professor Students Name Date Running head: COST 2 Cost Accounting Accounting is the collection and aggregation of information for decision makers including managers, investors, regulators, lenders, and the public. Accounting systems affect behavior and management and have affects across departments, organizations, and even countries. This paper will give the reader an understanding about cost accounting. This paper will discuss: Why is cost accounting so important to the success of the firm; what are the various methods of cost accounting and how are they used; how does an operating budget work to discipline a firm’s management; what are the elements of a budget; how are budgets constructed; what is variance analysis and how it is used. Cost accounting can be described as the process of accumulating, measuring, analyzing, interpreting and reporting cost information that is both useful and relevant to the internal and external stakeholders of a business entity. One of the many benefits of cost accounting is that it turns data into information, knowledge and wisdom about a business entity's operations that is useful for: measuring performance, reducing or managing costs, determining the fees or prices for goods and services, deciding to authorize, modify or discontinue a program or activity. Another benefit is that information on the costs programs and activities may be used as a basis to estimate future costs in preparing and reviewing budget requests. Once budgets are approved and executed, cost information serves as a useful feedback on performance. Moreover, costs may be compared to known or assumed benefits to identify valueadded and nonvalue added activities. Running head: COST 3 “Reliable information on the cost of programs and activities is crucial for the effective management of a business entity's operations. Cost accounting is especially important for fulfilling the objective of assessing operational performance. The objective is to improve the efficiency and effectiveness of operations by furnishing program managers and others with timely and relevant costbased performance information to allow for continuous improvement in delivering outputs and outcomes to stakeholders (Devilliers, 2007)”. In short, cost accounting is important to a firm because it helps managers make better decisions. “There are many different methods of cost accounting. Different industries follow different methods for ascertaining cost to their products. The method to be adopted by business organizations will depend on the nature of their production and the type of output (http://rajubrotherhood.com/)”. The following are methods of cost accounting and it uses: • Job Costing: Job costing is concerned with the finding of the cost of each job or work order. Under this system a job cost sheet is required to be prepared to find out the profits or losses for each job or work order. This type of costing is generally used in construction and hospitals. • Batch Costing: A batch is a group of identical products. Under batch costing a batch of similar products is treated as a separate unit for the purpose of ascertaining cost. This type of costing is generally used in clothing, furniture, and automobile industry. • Process Costing: This method is used in industries where production is carried on through different stages or processes before becoming a finished product. Costs are determined separately for each process. The main feature of process costing is that output of one process Running head: COST 4 becomes the raw materials of another process until final product is obtained. This type of costing is generally used in industries like petroleum and paint. • Operation Costing: This is suitable for industries where production is continuous and units are exactly identical to each other. Under this system cost sheet is prepared to find out cost per unit and profits or loss on production. This method is applied in industries like mines or drilling, cement works etc. To put it simply, an operating budget is the plan you use to make sure you have the money to operate your business. But a budget is a guide by which you can plan, assess the performance of your business and adjust your operations when the real figures start to roll in. Clearly an operating budget is a tool you can use to prevent unexpected crises in product or service delivery due to lack of cash, credit, tools or inventory. You need an operating budget to stay in business, pure and simple. An operating budget is part of any business plan. It is the projection of what it will cost to run your business and what money will be coming in to cover those costs. “There are five parts to an operating budget: the sales budget, the production budget, the operating expenses budget, your budgeted income statement and your cash budget. Each of these five budgets should be developed at startup as parts of a shortrange plan and a longrange plan. Startup expenses include the costs of licenses and permits, of equipment, and of legal fees. Both short and longrange operating budgets cover the same costs and income categories outlined below, but creating both helps you plan, track, and assess the growth and viability of your business over the near term as well as the long haul (Hawthorne, 2008)”. Businesses use budgets to plan for future activities and to set various goals and objectives within the company. They help the organization set specific expectations which aid in evaluating Running head: COST 5 performance throughout the company. Budgeting helps organizations implement specific strategies to meet goals and objectives. It is important to note that a budget is an estimate and will often need to be adjusted over time. In order to properly plan and set goals, several different budgets must be created Understanding the budget is important for a manager, and a smart executive knows how to utilize this resource. “The budget provides the manager with basic information about the unit's operations, supplies raw material to make better sense out of those operations, and helps to avoid operations that are using up money too fast “(Iaconetti, 1986, p. 22)”. Expenditure, in any budget, is shown in three categories: labor, materials, and services (sometimes called overhead and indirect cost). Within each element of the budget the items will be: fixed costs which are expenses that stay the same regardless of the amount of activity in the project or variable costs which are expenses that increase with the level of activity in the project. Labor costs consist of the wages, salaries and honoraria paid to individuals directly involved in implementing the project. Labor costs are calculated by multiplying the personnel time needed in the project by the unit cost of the resource. The unit costs for personnel are usually in hours or days. Cost of materials includes the costs of supplies, equipment and tools actually used during the activity. Service costs are all the costs of the project other than labor and materials. These are costs that cannot be assigned as costs directly to activity within the project. For capital items, depreciation is a way of allocating part of the cost of the item to a particular project. Running head: COST 6 ” Depreciation is used in projects to allocate a reasonable part of the cost of the item to the project. When an expensive capital item is needed for an activity, there is a need to allow funds to use this – if the item is to be rented externally to the organization, and then the rental cost would appear as a service cost. However, if the item is owned by the organization, then it is necessary to place a cost in the budget which can be paid to the organization and used to replace the item when it’s useful life is over, the way in which this ‘reasonable’ fee is calculated is called, ‘depreciation’ (Price Knowledge Bank, 2009)”. “When actual results are compared to budgeted, or planned, results, there is almost always a difference, or variance. Variance analysis uses the difference between actual performance and budgeted performance to evaluate the performance of individuals and business units and identify possible resources of deviations between budgeted and actual performance. As with all management accounting practices, individual firms and organizations may develop many variances of their own needs. The basic idea is the same: Calculate the difference between a planned (budget) number and actual performance and attempt to explain the causes of the difference. (Anderson, Lanen & Maher, 2008, p.537)”. Variance analysis looks afterthefact at what caused a difference between plan vs. actual. Good management looks at what that difference means to the business. Variance analysis ranges from simple to complex. Some costaccounting systems separate variances into many types and categories. Sometimes a single result can be broken down into many different variances, both positive and negative. In theory, the positive variances are good news because they mean spending less than budgeted. The negative variance means spending more than the budget. Every variance should stimulate questions. Why did one project cost more or less? Were objectives met? Is a positive variance a cost saving or a failure to implement? Is a negative variance a change in plans, a management failure, or an unrealistic budget? Running head: COST 7 “Although variance analysis can be very complex, the main guide is common sense. In general, going under budget is a positive variance, and over budget is a negative variance. But the real test of management should be whether or not the result was good for business (Berry, 2009). By using variance analysis to identify areas of concern, management has another tool to monitor project and organizational health. People reviewing the variances should focus on the important exceptions so management can become aware of changes in the organization, the environment and so on. Without this information, management risks blindly proceeding down a path that cannot be judged as good or bad. In conclusion, generally, cost accounting is the result of the decisions managers in an organization make and the business environment in which they make them. In this paper I have explained why cost accounting is important to the success of the firm; the various methods of cost accounting and how they are used; how an operating budget work to discipline a firm’s management; the elements of a budget and how it is constructed; what is variance analysis and how it is used. Running head: COST 8 References Administrator. (n.d). Various Methods of Costing. Retrieved February 24, 2011, from http://www.rajpubrotherhood.com. Anderson, S.W., Lanen, W.N., & Maher, M.W. (2008). Fundamentals of cost Accounting 2e. New York: McGrawHill Irwin. Berry ,T. (2009). Plan vs. Actual Part 3: Understanding Variance Analysis. Retrieved February 24, 2011, from http://articles.bplans.com/growingabusiness/planvsactualpart3 understandingvarianceanalysis/81. DeVilliers, H. (2007). What is cost accounting?. Retrived February 22, 2011 from http://EzineArticles.com/?expert=HendrickDevilliers. Hawthorne, N. (2008). How to Build an Operating Budget for your Small Business. Retrived February 25, 2011 from http://www.esight.org. Iaconetti, J., & O’Hara, P. (1986). Working Woman Vol. 11 (8) pg. 22. Retrieved February 26, 2011 from Proquest database. Running head: COST 9 Rice Knowledge Bank. (2009). The basic elements of a budget. Retrieved February 26, 2011 from http://www.knowledgebank.irri.org.
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