Principles and Critiques of Cost Accounting

COST ACCOUNTING OBJECTIVE development of detailed information on the cost of producing a product or service INTENDED USE (1) by the financial system, for valuation of inventory and cost of goods sold (2) by management, for making pricing, design engineering, production operations, and other management decisions SERIOUS FLAWS based on turn-of-the-century manufacturing firms Cost Accounting attempts to ALLOCATE "product"-related costs to "inventory" at each stage of the "manufacturing" process PRODUCT and PERIOD EXPENSES Just sey, in care Accounting is to datine PRODUCT EXPENSES those that are selected to be matched in an accounting period to (probably future period) revenues derived from delivering the corresponding goods or services PERIOD EXPENSES all remaining expenses, which are expensed during the period in which they are incurred, irrespective of what or how much was produced or sold in that period TIMING the classification of costs (expenses) as either Product or Period affects the timing of expenses and therefore the timing of profit (Example follours) ILLUSTRATION Given: • $3,000 raw material in Inventory • Work on product during month, incurring $2,000 in Production Line Costs • Product unsold at the end of the month If Production Line Costs are recorded as a Period Expense for the month: • then Net Income declines by $2,000, and • Inventory value remains at $3,000 If Production Line Costs are recorded as a Product Expense for the month (and thus added to the Inventory value): • then Net Income is not affected, and Inventory value increases from $3,000 to $5,000 DEFINING PRODUCT COSTS • Material Only [Direct Material] • Material and Labor [Prime Costs] (Direct material and Lirect Labor) • Material, Labor, and Production Overhead [Direct (Variable) or Full- Absorption Costingl (Includes Indirat Production Coato) • Material, Labor, Production Overhead, Engineering, Selling, and Administrative Expenses [Virtual elimination of Period Costs] COST ACCOUNTING UNREALISTIC ASSUMPTIONS • Primary costs to be controlled are production costs • Direct Labor is the key production cost • Product costs based on Direct Material, Direct Labor, and production overhead yield relevant management information • Primary costs to be reduced are production costs are wortre studying