MANAGEMENT ACCOUNTING

Cost Classification is fundamentally important when managing the Performance of a Business



Cost Classification is fundamentally important when managing the Performance of a Business

Introduction

As a human resource manager for a manufacturing company, is my job to understand the current budget and how cost affects this budget. Cost can be defined as an amount paid or required in payment for a purchase. Cost can be classified in many ways: fixed, variable, direct, indirect and sunk just to name a few. Fixed costs were mostly associated with administrative cost. Fixed costs include items like rent, utilities and insurance. Variable cost are cost that vary directly with the number of products produced (Ward, 2006). Direct costs are identified with a specific product, department or activity. Indirect cost can not be identified with a specific product.

The Cost Concept

Cost concepts have developed according to the needs of accountants, economists, and engineers. Accountants have defined cost as “an exchange price, a forgoing, a sacrifice made to secure benefit. In financial accounting, the forgoing or sacrifice at date of acquisition is represented by a current or future diminution in cash or other assets”. (Sprouse and Moonitz, 1962). Frequently the term cost is used synonymously with expense. However, an expense may be defined as a measured outflow of goods or services, which is matched with revenue to determine income, or as: …the decrease in net assets as a result of the use of economic services in the creation of revenues or of the imposition of taxes by governmental units. Expense is measured by the amount of the decrease in assets or the increase in liabilities related to the production and delivery of goods and the rendering of services…expense in its broadest sense includes all expired costs which are deductible from revenues (Ibid, p.49).

To contrast cost and expense, consider a purchase of raw materials for cash. Because net assets are unaffected, there is no expense. The firm's resources are simply converted from cash to materials. The materials are acquired at some cost, but they are not yet an expense. When the firm later sells the output into which the raw materials have been incorporated, the cost of the materials is written off among expenses on the income statement. Every expense is a cost, but not every cost is an expense; assets are costs, for example, but they are not (yet) expenses.

The term cost is made specific when is modified by such descriptions as direct, prime, conversion, indirect, fixed, variable, controllable, product, period, joint, estimated, standard, sunk, or out of pocket. Each modification implies a certain attribute that is important in measuring cost. Each of these costs is recorded and accumulated when management assigns costs to inventories, prepares financial statements, plans and controls costs, makes strategic plans and decisions, chooses among alternatives, motivates personnel, and evaluates performance. The accountant involved in planning and decision making must also work with future, replacement, imputed, differential, and opportunity costs, none of which is recorded and reported in external financial ...