The Importance of Cost Accounting

By Uma A Ilango

Managers rely on cost accounting to provide an idea of the actual expenses of  processes, departments, operations or product which is the foundation of their  budget, allowing them to analyze fluctuation and the way funds are used socially  for profit. It is used in management accounting, where managers justify the  ability to cut expenses for a company in order to increase that company´s  profit. As a tool for internal use, versus a tool for external users like  financial accounting, cost accounting does not need to follow the GAAP standards  (Generally Accepted Accounting Principles) because its use is more  pragmatic.

It creates a financial value out of the production of a product, measuring  currency that is nominal into units that are measured by convention. By taking  recorded historic costs a bit further, it allocates a company´s fixed costs over  a specific time period to what items are actually produced during that period of  time, creating a total cost of product production. Products that were not sold  during that period of time produced a “full cost” of those products, recording  them in a complex inventory system that uses accounting methods of its own that  are in compliance with the GAAP standards. Managers are then able to focus on  each period’s results as it relates to the “standard cost” of any product.

Any distortions in expenses that were caused by calculating what the overhead  of a product is versus what a unit cost is for companies that specialize in only  one specific product are very minor in industries that mass produce that product  with a low fixed one. Understanding why it varies compared to what was actually  planned helps a manager to save a company money by taking actions that are  appropriate to correct that variation in the future. Variance analysis is a very  important part of cost accounting because it breaks down each variances into  many different components of standard and actual one. Some of these components  are material expenses variation, volume variation and labor expenses  variation.

It is a very important part of the management accounting process. In order  for managers to determine the best methods to increase a company’s  profitability, as well as saving a company money in the future, cost accounting  is a necessary system in the management of a company’s budget, providing  important data to analyze fluctuation in company production expense.

Executive level pay is based upon company performance. If the performance of  a company is not reported in a proper manner, executives make money that far  exceeds what the business is capable of and creates a false picture of a  company’s performance. This false reporting causes the stock market to balloon  by rewarding stock to companies who do not deserve it, and these methods have a  bad effect on our economy. Business accounting that honor the GAAP (Generally  Accepted Accounting Practices) creates a transparent persona, an air of trust  and respect, from the users of their financial statements.

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Peter DeSmidt, BA, MBA, PA