Cost Accounting For Dummies

Take control of overhead, budgeting, and profitability with cost accounting

Cost accounting is one of the most important skills in business, and its popularity as a course in undergraduate and graduate business and management programs speaks to its usefulness. But if you’ve ever felt intimidated by the subject’s jargon or concepts, you can stop worrying. Cost accounting is for everyone!

In Cost Accounting For Dummies, you’ll be taken step-by-step through the basic and advanced topics found in a typical cost accounting class, from how to define costs and how to allocate them to products or services. You’ll learn how to determine if a capital expenditure is worth it and how to design a budget model that forecasts changes in costs based on activity levels.

Whether you’re a student in your first cost accounting course or a professional trying to get a grip on your books, you’ll benefit from:

• Simple methods to evaluate business risks and rewards
• Explanations of how to manage and control costs during periods of business change and pivots
• Descriptions of how to use cost accounting to price IT projects

Cost Accounting For Dummies is the gold standard in getting a firm grasp on the challenging and rewarding world of cost accounting.

Ken Boyd is Co-Founder of Accountinged.com and owns St. Louis Test Preparation. He tutors and coaches people on the principles of accounting and prepares them for challenging accounting licensing exams by making accounting interesting and fun.

Introduction 1

About This Book 1

Foolish Assumptions 2

Icons Used in This Book 2

Beyond the Book 3

Where to Go from Here 3

Part 1: Understanding the Fundamentals of Costs 5

Chapter 1: So You Want to Know about Cost Accounting 7

Comparing Accounting Methods 8

Considering your shareholders 8

Mulling over creditors 9

Addressing concerns of regulators 9

Using management accounting 9

Fitting in cost accounting 10

Using Cost Accounting to Your Advantage 11

Starting with cost-benefit analysis 11

Planning your work: Budgeting 12

Controlling your costs 12

Setting a price 13

Improving going forward 14

Chapter 2: Brushing Up on Cost Accounting Basics 17

Understanding the Big Four Terms 17

Comparing direct and indirect costs 18

Mulling over fixed and variable costs 20

Fitting the costs together 21

Covering Costs in Different Industries 22

Reviewing manufacturing costs 22

Considering costs for retailers 23

Adding up costs for e-commerce firms 23

Finding costs most companies incur 24

Why Are You Spending? Cost Drivers 25

Pushing equipment too hard and relevant range 25

Previewing inventoriable costs 26

Following the Rules of the Cost Accounting Road 27

Understanding generally accepted accounting principles (GAAP) 27

Deciding on accrual basis or cash basis 29

Finishing with conservatism 30

Chapter 3: Using Cost-Volume-Profit Analysis to Plan Your Business Results 31

Understanding How Cost-Volume-Profit Analysis Works 32

Calculating the breakeven point 32

Financial losses: The crash of your cash 34

Contribution margin: Covering fixed costs 35

Lowering the breakeven point to reach profitability sooner 36

Target net income: Setting the profit goal 37

Using operating leverage 38

Assessing e-commerce businesses 40

Timing is everything when it comes to costs 41

Using Cost-Volume-Profit Analysis to Make Savvy Business Decisions 42

Deciding to advertise 43

Lowering your price without losing your profit 44

Combining the results of two products 45

Costing and pricing a new product 48

The Tax Man Cometh, the Profits Goeth 51

Understanding pre-tax dollars 51

Adjusting target net income for income taxes 52

Chapter 4: Estimating Costs with Job Costing 53

Understanding How Job Costing Works 54

Cost objects: The sponges that absorb money 55

Charging customers for direct and indirect costs 56

Implementing job costing in manufacturing: An example 57

Deciding on costing for IT consulting projects 61

Taking a Closer Look at Indirect Costs using Normal Costing 64

Budgeting for indirect costs 65

Following a normal job costing system 66

Following the Flow of Costs through a Manufacturing System 67

Control starts with control accounts 67

Explaining the debit and credit process 68

Walking through a manufacturing cost example 70

Applying the methodology to other control accounts 73

Chapter 5: More Activity, More Cost: Activity-Based Costing 75

Avoiding the Slippery Peanut Butter Costing Slope 76

Recognizing a single indirect cost allocation 77

A fly in the peanut butter: Dealing with different levels of client activity 77

Missing the mark: Undercosting and overcosting 79

Designing an Activity-Based Costing System 81

Refining your approach 81

Grouping costs using a cost hierarchy 82

Testing your ABC design 83

Using Activity-Based Costing to Compute Total Cost, Profit, and Sale Price 87

Allocating indirect costs evenly by product 88

Analyzing and reallocating cost activities 88

Changing allocations to cost pools 89

Changing prices after ABC 90

Implementing ABC Costing for a Business Pivot 91

Deciding whether to pivot 92

Mulling over a pivot example 93

Using ABC Costing for a New Business Model 94

Considering sunk costs 94

Reviewing food and labor costs 95

Allocating new overhead costs 95

Applying ABC costing to overhead costs 96

Evaluating your results 98

Part 2: Planning and Control 99

Chapter 6: What’s the Plan, Stan? Budgeting for a Better Bottom Line 101

Brushing Up on Budgeting Basics 102

Seeing the master budget and its component parts 102

Why budgeting is important 103

Considering the costs and benefits of data collection 104

Leveraging AI and data analytics for effective budgeting 106

Planning strategically 107

Planning How to Plan: Factors That Impact Your Budgeting Process 108

Experience counts 109

Timing is everything 109

People get you headed in the right direction 110

Sales projections pay off 111

The Nuts and Bolts (and Washers) of Budgeting 112

Understanding the budgeting financials 113

Reviewing revenue and production budgets 116

Budgeting with Cash Accounting or Accrual Accounting 119

Cash basis accounting: Using your checkbook to budget 119

I accrue, you accrue, we all accrue with accrual accounting 121

Budgeting to Produce the Income Statement and Balance Sheet 122

The well-balanced balance sheet 122

The incredible income statement 123

Chapter 7: Constant Change: Variance Analysis 125

Variance Analysis and Budgeting 126

Using management by exception to recognize large variances 126

Seeing the problem in using a static budget 127

Opting for a flexible budget 131

Investigating budget variances 134

Analyzing in Material Price and Efficiency Variances 135

Applying price variances to direct materials 136

Applying efficiency variances to direct materials 137

Implementing price variances for direct labor 139

Sizing up efficiency variances for direct labor 139

Using Your Findings to Make Decisions 140

Following up on variances 141

Judging the effectiveness of your employees 143

Tying supply chain concepts to variance analysis 145

Attaching ABC costing concepts to variance analysis 145

Chapter 8: Focusing on Overhead Costs 149

Using Cost Allocation to Minimize Overhead 150

Paying for the Security Guard: Fixed Overhead Costs 151

Planning fixed overhead costs 151

Allocating fixed overhead costs 152

Assessing potential causes of fixed overhead variances 155

Those Vexing Variable Manufacturing Costs 156

Working with variable overhead costs 156

Implementing variance analysis 159

Finding the reasons for a variable overhead variance 161

Chapter 9: What’s on the Shelf? Inventory Costing 163

Working with Inventoriable Costs 164

Using the matching principle to calculate profit on sale 164

Erring on the conservative side 166

Costing Methods for Inventory 166

Using the first-in, first-out (FIFO) method 168

Accounting with the last-in, first-out (LIFO) method 169

Weighing the merits of weighted-average cost 170

Considering specific identification method 171

Analyzing profit using FIFO and LIFO 171

Using Variable and Absorption Costing to Allocate Fixed Manufacturing Costs 173

Defining period costs and product costs 174

Applying variable and absorption costing 175

Relating Capacity Issues to Inventory 177

Reviewing theoretical and practical capacity 178

Understanding capacity issues for e-commerce firms 179

Using normal and master-budget capacity 181

Choosing a capacity level 182

Part 3: Making Decisions 185

Chapter 10: Cost Drivers and Cost Estimation Methods 187

Working with Cost Behavior 188

Understanding linear and nonlinear cost functions 188

Discovering how cost drivers determine total costs 189

Considering Cost Estimation Methods 190

Walking through the industrial engineering method 190

Agreeing on the conference method 191

Reviewing the account analysis method 191

Checking out the quantitative analysis method 192

Choosing a cost estimation method 196

Exploring Nonlinear Cost Functions 197

Changing cost functions and slope co-efficients 198

Understanding the impact of quantity discounts 198

Assessing the Impact of Learning Curves 198

Considering how AI and Data Analytics Impact Learning Curves 200

Reviewing AI and data analytics 200

Throwing in the learning curve 200

Simplifying a procedure 201

Finding and using better data 201

Chapter 11: Making Smart Business Decisions with Relevant Information 203

Navigating the Geography of Relevance 204

Introducing the decision model 205

Applying a model to an equipment decision 206

Understanding IT purchasing issues 208

Considering relevant qualitative factors in decision-making 210

Special Orders Don’t Upset Us, Do They? 211

Deciding between Outsourcing and In-house Production 213

Weighing opportunity costs 217

Contemplating the carrying cost of inventory 218

Maximizing Profit When Capacity Is Limited 220

Managing capacity and product mix 220

Analyzing customer profit and capacity 222

Chapter 12: Making Smart Pricing Decisions: Figuring Total Costs 227

Understanding Influences on Prices 228

Customers 228

Competitors 228

Suppliers 229

Special orders 229

Pricing for Profits Down the Road 231

Reviewing market-based and cost-based pricing 231

Aiming at the target: Target costing 232

Arriving at a Reasonable Profit 236

Using cost-plus pricing 237

Using product life-cycle budgeting 239

Managing IT product costs and pricing 245

Part 4: Allocating Costs and Resources 249

Chapter 13: Analysis Methods to Improve Profitability 251

Processing Cost Allocation 252

Why bother? Purposes of cost allocation 252

Justifying cost allocation decisions 253

Implementing Cost Allocation 254

Using cost hierarchy to allocate costs 254

Allocating tricky corporate costs 256

Keeping track of customer revenues and costs 260

Going Over Sales Mix and Sales Quantity Variances 264

Remembering variances and contribution margin 265

Getting the story about sales mix variance 265

Calculating sales quantity variance 269

Chapter 14: Behind the Scenes: Accounting for Support Costs and Common Costs 271

Not Everyone Generates Revenue: Support Costs 272

Introducing single rate cost allocation method 272

Checking out dual rate cost allocations 275

Using practical capacity to determine cost allocation rates 277

Going Over Variance Analysis and Department Costs 281

Choosing budgeted versus actual rate of usage 281

Implications for the rate of usage selected 284

Allocating to multiple departments 285

Focusing on Common Costs 290

Mulling over stand-alone cost allocation 290

Stepping up to incremental cost allocation 291

Making a Commitment: Contracts 292

Contracting with the government 292

Thinking about reasonable and fair costs 293

Chapter 15: Joint Costs, Separable Costs, and Using Up the Leftovers 295

Working with Joint Costs 296

Explaining joint cost terms 296

Appreciating the importance of allocating joint costs 297

Considering joint cost allocation methods 298

Continuing Production: Computing Separable Costs After Splitoff 301

Exploring the net realizable value method 301

Introducing the constant gross margin percentage NRV method 303

Choosing a Joint Cost Allocation Method 308

Making the case for sales value at splitoff 308

Falling back to other joint costing methods 308

Deciding to sell or process further 309

Holding a Garage Sale: Making the Most of Byproducts 310

Chapter 16: Tracing Similar Products with Process Costing 313

Process Costing: Presenting the Basic Approach 314

Leading off with direct material costs 314

Following up with conversion costs 315

Sitting on the Factory Floor: Dealing with Work in Process 315

Using Equivalent Units to Compare Apples to Apples 316

Counting the units for equivalent units 317

Hunting down the total costs of production 318

Putting units and costs together 319

Seeing different percentages of completion 321

Using the Weighted Average Method for Process Costing 325

Handling beginning work in process 325

Continuing with equivalent units 326

Introducing the First In, First Out Method of Process Costing 328

Comparing Processing Costing Methods 331

Mulling over weighted average and FIFO methods 331

Debating transferred-in costs 333

Part 5: Considering Quality Issues 335

Chapter 17: What a Waste! Getting the Most from Spoilage, Scrap, and Reworked Products 337

Accounting for Waste 338

Determining the inspection point 338

Understanding spoilage and scrap 338

Spoilage and process costing 341

Reworking a product to recoup some profit 346

Applying Process Costing Methods to Spoilage 346

Weighing in on the weighted average costing method 347

Doing the FIFO Hokey Pokey: Put your first in first, take your first out first 349

Job Costing for Spoilage, Reworked Products, and Scrap 352

Making adjustments for normal and abnormal spoilage 352

Reworking and selling a product 355

Making allocation decisions about scrap 357

Chapter 18: Making Smart Ordering Decisions 359

Considering the Costs of Inventory 360

Going through the ordering sequence 361

Taking a closer look at stockout costs 362

Calculating Inventory Quantity with the Economic Order Quantity Formula 363

Figuring a Favorable Reorder Point 365

Introducing safety stock: Creating a cushion 366

Computing safety stock 366

Evaluating Prediction Error 367

Calculating relevant total costs 367

Acting on a prediction error 369

Buying more and ignoring EOQ 370

Practicing Just-In-Time Purchasing 371

Kicking around JIT benefits and risks 371

Putting in a JIT purchasing system 373

Adjusting total purchasing cost 376

SCM and Customer Demand Issues 377

Pulling apart the supply chain 378

Analyzing demand 378

Chapter 19: Quality: Building a Better Mousetrap 381

Considering Quality Benefits and Costs 382

Listing the benefits of quality 382

Listing the costs of quality 383

Taking steps to ensure quality 384

Compiling a Cost of Quality Report 385

Putting Quality Practices in Place 387

Quality in job costing 387

Taking a spin through inventory 388

Customer Satisfaction: Measuring and Improving It 389

Customer satisfaction’s non-financial measurements 389

Is measuring customer satisfaction worth the effort? 391

Doing More in Less Time 392

Analyzing performance related to time 392

Calculating average waiting time 394

Adding in manufacturing lead-time 395

Eliminating the Constraint of the Bottleneck 396

Fewer bottlenecks mean increased contribution margin 396

Clearing bottlenecks 397

Part 6: The Part of Tens 401

Chapter 20: Ten Common Costing Mistakes and How to Avoid Them 403

Pricing a Product Incorrectly 403

Listing Fixed Costs As Variable Costs 404

Labeling Period Costs As Product Costs 404

Misusing Target Net Income 404

Forgetting About Taxes 405

Assigning Costs to the Wrong Product 405

Not Reviewing Variances Correctly 406

Redlining: Pushing Production Activity Above Relevant Range 406

Ignoring the Timing of Costs 407

Not Implementing Activity-Based Costing 407

Chapter 21: Ten Ways to Increase Profits Using Costing 409

Selling More Of The Right Products 409

Implementing Sales Mix Analysis to Increase Total Profits 410

Building a Higher Margin of Safety 410

Deciding How Much You Need: Production and Scheduling Issues 410

Who Does What: Handling Costs and Employee Issues 411

Reducing and Managing Scrap 411

Moving It off the Shelf: Inventory Issues 411

Effectively Taking Special Orders 412

Making Accurate Cost Allocations 412

Addressing the Issue of Spoilage 412

Index 415

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