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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What is Job Costing?

By Arnold S. Grundvig, Jr.

Here is a fact that will surprise few contractors: Construction is the highest risk industry in the US economy. There are more business failures in construction than any other industry, both in number and as a percentage. The reason for this gloomy statistic is the reality that most contractors fail to monitor construction costs, so they get out of control. Before the contractor knows it, a job has lost money and the business has deteriorated toward insolvency. If things are not turned around, the owner’s home is soon being foreclosed on and another marriage ends up in divorce court.

Here is a real life example, with a twist. A contractor had just finished a job that he bid with a $100,000 built-in profit. He complained that when he paid the last bill, instead of making $100,000, he had lost $120,000. He was fortunate that this $220,000 swing would not cause his business to fail. His big concern was the reality that he had no idea where things went wrong, so he didn’t know what to fix!

In response to this risk, some contractors reason that the best solution is to keep their business small, thereby reducing the risk of failure. Surprisingly, the same study that documented how risky construction was (done by the US Small Business Administration) also concluded that staying small actually increased the odds that a contractor would fail. In fact, of all the industries in the study, the one that benefited most by growth was construction!

How can a contractor monitor costs AND grow, thereby increasing the chance for success? The answer is to use job costing. There is an old axiom, “Use the right tool for the job.” When it comes to construction, the right tool for accounting is job costing. That is why contractors need it.

Now, we get to the heart of the question. What exactly is job costing? Job costing is a special accounting process that was designed specifically for contractors. It’s nothing mysterious and it doesn’t require a high-priced accountant or high-priced software. It is simple a two-step process. The first step is to set up a job and enter a “budget” for that job. Where does the budget come from? The budget is nothing more than the “estimate” that was created by the estimator when this marvelous visionary calculated the expected costs for the job, line by line, phase by phase, from start to finish, for the job. Logically, an estimate is not a single figure, but a series of small estimates, each covering a different phase of the job. For instance, how much concrete at what cost per yard will it take for the foundation? How many hours of labor, at what cost per hour to prepare and then pour the foundation? What will the costs be for subcontractors, if any? Will it be necessary to rent some equipment, like a concrete pump, and what will it cost?

Each phase of each job has a potential budget for labor, material, subcontracts, equipment, and a general, catch-all “other” category. In addition, there may be a “burden” category, which adds a portion of general and administrative overhead to each job, thereby spreading the whole cost of operation back to each job. This is a powerful way to determine if each job is carrying its share of the load.

In actual practice, setting up a budget is not as complicated as it might sound. Estimators do it all of the time. In fact, the Construction Specification Institute (CSI) created a numbering system to help contractors budget and track costs. This numbering system is called the CSI Cost Code. This is a tool created specifically for contractors to help them do job costing.

The next step is nothing special. In fact, the accountant does what the accountant always does: Enter vendor invoices and subcontractor billings, enter payroll, and do customer billings as usual. As costs are “accrued,” they are tracked. “Accrual accounting” recognizes an expense as soon as it is incurred, not waiting until it is paid. With job costing software, it is not necessary to actually pay an invoice or a payroll for that cost to be included. The fundamental difference in job costing is that as each cost is entered, it is assigned to one of the CSI cost codes for one of the jobs. The result is that individual actual costs are compiled and compared to individual budgeted costs. True job costing software will actually go one step further and forecast the “cost to complete” for each cost code, based on a series of “algorithms.” If a contractor uses “field reports” that show what remains to be done on each phase of each job, job costing software can override the algorithms and add those numbers to actual “costs-to-date” and then compare them to the budgeted costs, line by line, phase by phase, job by job. The result is up-to-the-minute cost information. That means contractors can sleep well at night, knowing that they are making money as the job progresses. They never have to wait until the job is completed to see if there is anything “left over” for them. Job costing provides peace of mind to contractors.

If a contractor is using job costing software and actual costs get out of line, there is time to find out why. This should be an ongoing process, not done after the fact. Was the contractor double billed? Was an invoice double-paid? Was more work done than was originally budgeted? Is a change order necessary? Only by knowing that costs are out of line can management address the causes on a timely basis. Job costing allows management to monitor and thereby control costs. The result is reduced risk, increased profitability, and something sweet, something called “success.” Job costing is more than a tool that contractors need in order to avoid becoming a statistic; it is the key to their success. Perhaps it is bold, but one accountant said, “Contractors that don’t use job costing are either lucky or bankrupt, and no one likes to hang their future on luck!”

Yes, the professionals are right; contractors NEED to use job costing. Taking that a step further, they need to use REAL job costing software to do it right.

Article Source:,_Jr.

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