Cost accounting in the new era has completely moved away from the simple act of identifying direct costs, indirect costs and overhead, then using the traditional cost allocation method to allocate the costs.
I remember the good old days when cost accounting was all about collecting prime costs and overhead costs, apply some simple arithmetic and you will be pretty confident that you have accurately costed your product(s).
Well, time and things has moved on from those era, in today’s business world, not only do you strive to allocate overhead costs in proportion to the amount of resources used to produce a product in the form of activities triggered by producing the product, you also want to include pre and post production cost.
Our discussion of cost accounting in new era will be based on three concepts namely, activity based cost accounting, lifecycle cost accounting and target cost accounting.
The nature of modern day factories are very complex that more and more costs are incurred in the form of overhead and more difficult to allocate using simple traditional ways of allocating costs.
Activity Based Costing
The concepts of Activity based costing (ABC) and life cycle costing lead the park as far as cost accounting in the new era is concerned. Activity based costing ensures that processes that consume more resources are allocated proportionate resulting cost. The activities that consume resources are called ‘drivers’. ABC is more suitable for modern and complex manufacturing environment.
Some criticism levelled against ABC costing method is that it is very expensive in terms of time and financial commitment that is required in gathering the required information. But, the truth is that the rapid advancement in technological breakthrough and the increasing integration in business processes had made it not so expensive to deploy a reasonable ERP (Enterprise Resources Planning) system like SAP.
Accountants have now fully embraced technology and this makes the adoption of the new era cost accounting easy to implement. And this is why there should be no reason why the philosophies of new era cost accounting should not be encouraged.
On the other hand, life cycle costing makes sure that costs from start to finish of the production cycle are included in the product cost. Take installation and dismantling costs as example. Life cycle costing ensures that accurate accounting information is gathered for this process.
The rationale behind this thinking is to ensure that the whole cost incurred during the life product life cycle are all captured. This will give a truer picture of what it really costs to manufacture a piece of commodity.
The lifecycle product costing has 5 phases VIZ: developmental phase, introductory phase, growth phase, maturity phase and decline phase. Lifecycles costing varies from product to product. The conventional accounting period is ignored when dealing life cycle cost accounting.
Another concept that is gaining ground in cost accounting is the concept of target costing. Target costing is not all that new but its application to real life company is relatively new. The idea here is to survey the market first, find out what customers are willing to pay for a particular product or service and then set a profit margin.
Rather than source materials from available sources, the function of management at this point will be to cut cost at any slightest opportunity in order to close the target gap that has been identified.
Care should be taken not to compromise the quality of the product. Those features that are valued by should not be tampered no matter what happens. It will be foolish to produce cheap product using substandard material that could potentially damage the reputation of the company.
Imagine what would happen to the reputation of a car manufacturer- Bentley for example if in the bid to reduce the cost of manufacturing their car resort to using substandard material for brake pad. This obviously will lead to astonishingly expensive legal costs and ultimately cost the loyalty of the customers.
If you are the cost accountant of a company and still rely on the crude way of cost controlling, my advice is that you have a rethink and embrace the concepts that are briefly introduced in this article before competition swallows the company you represent.
The three new era cost accounting concepts that are discussed in this post are not just tools that make the job of a cost accountant easy, they also assist in strategic planning and cost management.