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 transactions.
To understand cost accounting basics lets keep it very simple
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
only have a few costs to start. These costs include:
We estimate that we can manufacture and sell 40 birdhouses in one day
or 800 in a month.
- Building rent $1000 per month
- Heat and electric costs of $300 per month
- One birdhouse assembly person we pay $2000 per
- One truck driver we pay $2000 per month
- Wood to make the birdhouses cost $7 per
- Office expenses of $500 per month
So what are
our costs to make a birdhouse:
if we add up all our costs for one birdhouse we come up $14.26 per
birdhouse. Excellent, now we know what it costs to make one
our wonderful birdhouses.
- 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
accountant types use these cost accounting basics to organize costs into three
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 labeled
material, one labeled direct labor and one labeled burden.
throw our costs to make a birdhouse into the correct bucket:
- Direct material costs
- Direct labor costs
- Burden costs
So, after organizing our costs they look like this:
labor is our cost for our assembly person. This
person adds value to our birdhouse.
material is the wood we use to make the birdhouse
- Burden costs
are the other costs
may be asking yourself why we bother to put costs into different
buckets. The simple answer is so we can analyze these costs
determine better ways to run the business.
- Direct Labor cost = $2.50 ($2000 for labor
divided by 800 birdhouses)
- Direct Material cost = $7.00
- Burden costs = $4.75 ($3800 for
burden costs divided by 800 birdhouses)
Assume that our assembly labor person can make 50% more
birdhouses in the same amount of time. Let's see what happens
now make our birdhouses for $11.84 instead of $14.25. I hope
can see the advantage to organizing our costs. Look at how
category of cost acted when we increased our production. If we are able
to manufacture another line of birdhouses without increasing our burden
costs, then our burden costs per birdhouse would go down for all the
birdhouses we manufacture. Since it still costs us $3800 per month for
our burden costs, these costs are then spread out over more birdhouses,
therefore, reducing the amount per birdhouse.
- Direct labor cost is now $1.67 per birdhouse
($2000 for labor divided by 1200 birdhouses)
- Direct material remains at $7.00 per birdhouse
- Burden costs are now $3.17 per birdhouse
($3800 for burden costs divided by 1200 birdhouses)
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 know their costs have a tremendous advantage.