## Learn Cost Accounting Basics the Easy Way

### Lesson 8 in the Basic Accounting series:

Cost accounting basics is all about learning how to use different accounting methods to determine the cost of producing your product and then how to use that information to make a profit.

That is why cost accounting is often referred to as cost management accounting.

As a small business owner your number one goal is to make a profit.

You do this by keeping a close eye on the expense of producing your product and adjusting your selling price to keep an acceptable level of profitability.

Basic cost accounting is a very important part of maintaining a healthy profitable small business.

### Cost Accounting Basics:

To better understand cost accounting basics, I will use a very simple cost accounting example using the fictional bakery I used in figuring a break-even-point.

Our costs include:

• \$900 per month for our rent
• \$300 per month for utilities
• \$1600 per month for a person to help us
• \$10 per cake for sugar, flour, etc. to make our cakes

We estimate we can make and sell 90 cakes a week or 360 in a month.

We are using a basic cost accounting method that uses both fixed and variable costs to determine our unit cost.

Quick accounting definitions refresher:

• Variable Costs: These are expenses that are associated with producing your product. They are directly proportioned to the production of your product. For example, if you owned a bakery, your variable cost would be your flour, sugar, etc.
• Fixed Costs: These are expenses that would be the same even if you did not sell any of your product such as rent, insurance, etc.

Our unit cost is:

• Building rent = \$900 per month / 360 cakes = \$2.50 per cake
• Utilities = \$300 per month / 360 cakes = \$.83 per cake
• Our helper =\$1600 per month / 360 cakes = \$4.44 per cake
• Ingredients = \$10 per cake

So the actual cost to produce a single cake is \$17.77.

### Organizing Costs:

Now to analyze these costs and determine how we can increase our profit…let’s organize our costs. We do this by putting them into three cost accounting basic categories:

• Direct Material Cost: The actual cost of all the materials or ingredients we need to produce our product
• Direct Labor Cost: The actual wages associated with producing our product

Now we will organize our bakery unit costs:

• Direct Material cost = \$10
• Direct Labor cost = \$4.44
• Burden cost = \$3.33

Analyzing these three categories, we decide we cannot for the time being change or improve the burden and labor cost, but we have shopped around and found a wholesale store where we can purchase bigger quantities and different brands of our ingredients and cut our direct material cost down to \$7.50 per cake. This will affect our break-even-point and our profitability in a positive way.

We could also use this cost accounting basic method to see if hiring an additional baker would be a wise decision assuming demand was there.