MSE 608 C Engineering and Financial Cost Analysis

MSE 608 C – 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) • 19 th Century Post-Industrial Revolution – More capital investment and higher overhead, primarily in process industries; – Throughout the 1800 s 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 20 th 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 20 th 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?