MSE608C – Engineering and Financial
Cost Analysis
Introduction to Cost Accounting
Cost Accounting
Techniques that develop detailed information about
the cost of products or services.
• Internal (Managerial Accounting) for
– budgeting,
– variance analysis and making a
– variety of business decisions.
• External (Financial Statements).
– Income Statement
• “Cost of Goods Sold” for Manufacturing operations
• “Purchases” for Merchandising and Service organizations
– Balance Sheet
• Inventory
A Historical Perspective
• Pre-Industrial Revolution
– Luca Pacioli developed cost accounting techniques for cash
budgeting and variance analysis.
– Most manufacturing was performed by craftsman who were paid
piece-rate;
– Minimal manufacturing overhead compared to labor and materials
A Historical Perspective (cont)
• 19th Century Post-Industrial Revolution
– More capital investment and higher overhead, primarily in process
industries;
– Throughout the 1800s there were no well-defined cost accounting
systems.
– Development of absorption and variable accounting methods to
allocate fixed costs.
– Alexander Hamilton Church developed the machine-hour method
for allocating fixed costs (land, building, equipment).
An Historical Perspective (cont)
• Early 20th Century
– Increased capital investment in assembly
industries.
– Variable costing method grew in acceptance but
was still less commonly used than the
Absorption costing method.
An Historical Perspective (cont)
• End of 20th Century
– Congress established the Cost Accounting
Standards Board in 1970 to standardize
methods and reporting for defense contractors.
– President Reagan eliminated the CASB in
1982.
– Development of Activity-Based Costing (ABC)
method.
How Are Costs Classified???
• There are two methods used by the Cost
Accountant to apply costs consistently:
– Manufacturing or Non-manufacturing Costs
• This distinction determines if costs are associated with product
or services or with support functions.
– Period or Product Costs
• This distinction used to determine when costs are expensed.
Manufacturing Costs
• Manufacturing is the conversion of
materials into finished goods.
• It requires:
– Direct Labor
– Direct Material
– Overhead
Direct Labor
• Wages and other payroll costs that can be
directly associated with a unit of output.
– Commonly called “Touch Labor”
• Indirect Labor cannot be directly traced or
cost-effectively associated with the product
(included in Overhead).
Direct Material
• All raw materials added during the conversion
process
– become an integral part of the finished goods.
• Indirect Material
– difficult to determine the amount of some raw materials
that are consumed during the conversion process for a
specific product (included in Overhead)
• Prime Costs = Direct Material + Direct Labor
Overhead
• All other factory costs required for production but
are not directly associated with each unit of
production.
– Indirect Labor
– Indirect Material
– Overhead
Non-Manufacturing Costs
• Marketing and selling costs:
– Required to get finished goods to customers.
• Administrative costs:
– Required to provide the administrative function of the
business.
Product and Period Costs
Emphasize the timing of expenses.
• Product Costs
– Costs that can be directly “attached” with Product and will be
expensed when the product is sold (not necessarily the period they
were incurred).
• Period Costs
– Costs not easily “attached” to product and will be expensed in the
period in which they were incurred.
Collecting Costs
• Job Order
– Production of individual or batches of many
different types of products.
– Costs can be collected for independent orders.
• Process
– Continuous processing of a single type of
product for relatively long periods of time.
– Costs can not be cost-efficiently collected for
independent orders.
Job Order Costing
• Costs for independent orders are charged to
a Work Order, or Job number.
– Direct Labor
• Charged to the work order number using a time card,
production traveler (a.k.a. router), or other type of time sheet.
– Direct Material
• Purchased directly to the Work Order number or will be issued
from general inventory and charged to the job.
– Applied Overhead
• The Cost Accountant will determine the amount of factory
overhead costs to apply to each Work Order; usually based on
the amount of labor hours, labor-wages, machine-hours or
material costs.
Process Costing
Steps for determining Process costs:
1) Identify the Processing Centers
• the processing activity is consistent for all the product; and
• the output is homogeneous.
2) Accumulated labor, material and overhead costs for
each Processing Center over a specific time period
3) Calculate the average cost per unit over that period of
time.
Average unit cost = Total Costs/Number of units output
Actual vs. Standard Costs
• Actual Costs
– The actual costs paid for resources used in the conversion
processes.
• Evidenced by transaction documents.
• Standard Costs
– Predetermined costs assigned for each unit of a resource used in
the conversion processes.
• Standards are established by:
– Time studies;
– Historical data; and
– Educated guesswork.
• Standards are based on past results but must consider future events.
Actual vs. Standard Costs (cont)
Both systems have advantages and disadvantages.
Advantages
Disadvantages
Actual Costs
•More accurate
•Costs must be available when
inventory is sold
•Raw materials may have
different cost in inventory.
Standard Costs
•Provides a vehicle for future planning
and variance analysis.
•Less record keeping
•Does not consider raw materials with
different costs.
•Handy costing information for
planning and decision making.
•The cost to prepare Standards
Standard Costing is the predominate system in business.
Assessment
• What determines Manufacturing vs. Nonmanufacturing Costs?
• What goes into Manufacturing Overhead?
• What is the difference in using Product
versus Period Cost designation?
• What are the two ways to collect Costs?