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Cost Accounting: The Missing Component of Supply Chain Management
One of the first questions I ask our warehouse management students is, “Do you know your operating costs?”, and our production planning management students, “Do you know your cost of production per item?” After five years of training, I can count on one hand how many students can answer these questions, which immediately tells me that their company does not use cost accounting.
The reason why students cannot answer this question is because their company only has what is called management and financial accounting. Management accounting focuses on historical and forecast data management needs for ongoing operations and long-range planning. The purpose of management accounting is to accumulate financial information for making financial decisions.
Financial accounting focuses on the collection of historical financial information used to prepare financial statements that meet the needs of investors, creditors, and other external users of financial information. Statements include the balance sheet, income statement, retained earnings statement, and statement of cash flows. Although these financial statements are useful to management as well as external users, management’s use in planning and control operations requires additional reporting, scheduling, and analysis.
Management and financial accounting focuses entirely on the company’s operations and cannot provide the details necessary to accurately determine product costs and prices. The best they can do is provide an average. In addition, cost accounting provides detailed cost information management requirements to control current operations and plan for the future. Management uses this information to decide how to allocate resources to the most efficient and profitable areas of the business.
Cost accounting enables management to properly allocate costs such as raw materials, labor, and other factory resources to the products actually used instead of averaging them over all products. Apart from cost accounting, costs such as capital investment in physical assets, labor development, depreciation, taxes, insurance, utilities, machine maintenance and repair, material handling, production setup, production scheduling sales and administrative costs are usually combined to form overhead. A rate added to a product as an overhead markup. The true cost of a product is never determined which means the company is charging too much for some products and not enough for others.
The principles of cost accounting have been developed to enable manufacturers to process the many different costs associated with production and to provide built-in control features. The information produced by a cost accounting system provides a basis for determining accurate production costs and selling prices, and it helps management plan and control operations.
Determining production costs and pricing
Cost accounting procedures provide a means of determining product costs that enable the preparation of meaningful financial statements and other reports necessary for managing a business. A cost accounting information system must be designed to permit the determination of unit costs as well as total production costs. Unit cost information is also useful for making important marketing decisions such as determining the selling price of a product, meeting competition, bidding on contracts, and analyzing profitability.
Planning and Control
One of the most important aspects of cost accounting is the preparation of reports that management can use to plan and control operations. Planning is the process of establishing goals or objectives for a firm and determining the means to achieve them. Effective planning is facilitated by clearly defined goals of the manufacturing operation and a production plan that helps and guides the company in reaching its goals.
Cost accounting information enhances the planning process by providing historical costs that serve as a basis for future projections. Management can analyze the data to estimate future costs and operating results and make decisions regarding acquisition of additional facilities, any changes in marketing strategies, and availability of capital.
Effective control is achieved by assigning responsibility for every detail of the production plan through the establishment of cost centers. All managers should know exactly what their responsibilities are in terms of efficiency, operations, production and costs. The key to proper control involves the use of responsibility accounting and cost centers by measuring and comparing results over time and taking necessary corrective action.
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