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.
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
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