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
  • Burden Cost: Overhead

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.

Next Section: Lesson 9

Previous Section: Break Even Point

 

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