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Cost
Accounting Basics
Cost
accounting basics include capturing costs, organizing these costs and
reporting these costs. That's really what it is.
However, it can
be made complicated with complex products and a large volume of
business.
To understand cost accounting basics lets keep it very simple
to start. Lets
assume You and I own a bird house manufacturing
company. We make the very best Tufted Titmouse
birdhouses in the
world. However, we are just getting our business started and
we
only have a few costs to start. These costs include:
- Building rent $1000 per month
- Heat and electric costs of $300 per month
- One birdhouse assembly person we pay $2000 per
month
- One truck driver we pay $2000 per month
- Wood to make the birdhouses cost $7 per
birdhouse
- Office expenses of $500 per month
We estimate that we can manufacture and sell 40 birdhouses in one day
or 800 in a month.
So what are
our costs to make a birdhouse:
- Building rent = $1000 per month / 800
birdhouses = $1.25 per house
- Heat and electric = $300 per month /
800 houses = $.38 per house
- One assembly person = $2000 per month / 800 =
$2.50 per house
- One truck driver = $2000 per month / 800 =
$2.50 per house
- Wood to make one birdhouse = $7.00 per house
- Office expenses = $500 per month / 800
= $.63 per house
So,
if we add up all or costs for one birdhouse we come up $14.26 per
birdhouse. Excellent, now we know what it costs to make one
of
our wonderful birdhouses.
Cost
accountant types like to organize costs so they put costs into three
basic categories:
- Direct material costs
- Direct labor costs
- Burden costs
But,
don't let this confuse you. Accountants have an easier way to
look at these costs. They think of each of these costs as a bucket.
Think of three buckets on the floor. One labled
direct
material, one labled direct labor and one labled burden. Now
lets
throw our costs to make a birdhouse into the correct bucket:
So, after organizing our costs they look like this:
- Direct Labor cost = $2.50
- Direct Material cost = $7.00
- Burden costs = $4.76
You
may be asking yourself why we bother to put costs into different
buckets. The simple answer is so we can analyze these cost
and
determine better ways to run the business.
For example:
Assume that our assembly labor person can make 50% more
birdhouses in the same amount of time. Lets see what happens
to
our costs:
- Direct labor cost is now $1.67 per birdhouse
- Direct material remains at $7.00 per birdhouse
- Burden costs are now $3.17 per birdhouse
We
now make our birdhouses for $11.84 instead of $14.26. I hope
you
can see the advantage to organizing our costs. Look at how
each
category of cost acted when we increased our production.
Cost accounting basics can be exciting when your analysis and hard work
results in cost improvements for the company. Also, when management
knows exactly what the costs are to make their
product, it can quote on new work and be certain of the profit it will
make. Many companies don't know what their costs are to make a product.
The ones that do, have a tremendous advantage.
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