Cost Management I: Cost Flow and Allocation
Chapter 11. Cost Management I: Cost Flow and Allocation
Until now, we have learned about reporting for external investors (Financial Accounting). Now, we learn about internal data for managers: Cost Accounting. You must know the true cost of making one product to set prices and generate profits.
1. Three Elements of Manufacturing Cost
Resources used in production are managed in three broad categories.
2. Cost Allocation
The core of cost accounting is finding out “Who is responsible?” The profitability of a product can look different depending on how un-trackable common costs (overhead) are allocated.
| Category | Traditional Costing | Activity-Based Costing (ABC) |
|---|---|---|
| Allocation Basis | Volume-based (Hours, qty, etc.) | Analysis of various activities (drivers) |
| Precision | Low (Simple) | Very High |
| Suitable Environment | Mass production of few products | Many products, small volumes / complex processes |
| Cost/Effort | Low | High (Requires system building) |
3. Cost Flow
From input to sale, costs flow through the following accounts and are finally reflected in the Income Statement.
Value of materials waiting in the warehouse
In the process of being machined (Conversion costs added)
Production complete and waiting for shipment
Converted to expense at the point of sale
Professor’s Word: There is a saying that “Costs are not measured, but calculated by managers.” Choosing a rational allocation basis determines the success or failure of managerial decision-making.
Next time, we will explore various costing systems based on production methods, such as mass production and job-order production.
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