Why is Cost Accounting So Important to the Success of the Firm - Research Paper Example

? Accounting is one of the basic business functions of an organization. Accountants are responsible for keeping track of the economic activity of thebusiness. The two most important branches of accounting are financial and cost accounting. Financial accounting deals with the recording of financial transactions and determining profits and losses, while the purpose of cost accounting is to analyze, ascertainment and control of cost (Assar, 2011). Cost accounting is very important because it provides relevant information that can be used by the managerial staff to make decisions. The information provided by cost accounting is mainly used internally by corporations. The purpose of this paper is to describe the importance of cost accounting for a firm. Cost accounting provides relevant information that can be used by both managers and financial accountants. It can be used to measure and report financial and non-financial information that relates to the cost of acquiring or consuming resources by an organization (Horngren & Foster & Datar, 2000). Accountants can be flexible in their applications of cost accounting due to the fact that cost accounting does not have to comply with the generally accepted accounting principles (GAAP). Accountants also use cost accounting to describe the future activities of an organization. The information compiled by cost accounting can be useful both in the short and long term. The planning function of an organization benefits a lot from cost accounting. Another important benefit of cost accounting is that it allows companies to compute the cost of a product. There are different techniques and methods in cost accounting that are used by companies to make better decisions. Cost accounting can help a company establish the correct pricing for its products. A technique that can be used to set the price of a product is mark-up pricing. Mark-up pricing sets a price taking into consideration the cost of a product. For instance if the company determines that mark-up price is 50% and the cost of a product is $100, then the price of the product is $150. Another method in cost accounting that can be very valuable to make operating decisions is cost-volume-profit relationships (CVP). CVP analysis is one of the most powerful tools managers have at their command (Garrison & Noreen, 2003). The use of CVP analysis helps managers understand the relationship between cost, volume and profit. One of the most popular and useful CVP applications is breakeven analysis. The breakeven analysis is an analysis to determine the point at which revenues received equals the costs associated with receiving the revenue (Investopedia, 2011). The net profit of a company at the breakeven point is exactly cero. The formula to calculate break even in units sold is fixed expenses divided by unit contribution margin. The use of break-even analysis can be used to determine the viability of a new project. A very important cost accounting method that is used by accountants and managers in all industries is budgeting. Budgeting is a planning function that displays in quantitative form a proposed plan of action by management for a future period of time and is an aid to the coordination and implementation of the plan (Horngren, et al., 2000). The preparation of budgeted financial statements is referred too as pro forma statements. Three advantages of the use of budgets are planning, creation of performance criteria, and promotion of coordination and communication. The most comprehensive budget prepared by organizations is the master budget. The master budget is composed of a series of interrelated budgets. Some of the subcomponents of the master budget are: Revenue budget Production budget Direct materials budget Ending inventory budget Manufacturing overhead budget R&D costs budget Marketing budget Distribution costs budget Customer service costs budget Administrative costs budget Capital budget Cash budget A technique that is used to evaluate the results of a budget or pro forma financial statement is variance analysis. A variance can be defined as the difference between actual results and the budgeted amount. Information from variances can assist managers in their planning and control activities. A favorable variance occurs when the variance increases operating income relative to the budgeted amount, while an unfavorable variance decreases operating income relative to the budgeted amount (Horngren, et al., 2000). The use of variance can be helpful to determine the efficiency and effectiveness of a budget. Two additional cost accounting methods that are very useful are activity-based costing (ABC) and balance scorecards. “Activity-based costing is a costing method that is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore fixed costs” (Garrison, et al., 2003, pg. 316). The application of activity-based costing is intended to supplement the costing system of a company instead of replacing it. Its emphasis is to help managers make better decisions. The six step of an activity based accounting system are: 1) identify and define activities and activity cost pools; 2) directly trace overhead cost to activities and cost objects; 3) assign costs to activity cost pools; 4) calculate activity rates; 5) assign costs to cost objects; 6) prepare management reports. Another important cost accounting method is balance scorecards. A balance scorecard can be defined as a strategic planning and management system that is used by companies to align business activities to the vision and strategy of the organization, improve internal and external communication, and monitor organizational performance against strategic goals (Balancedscorecard, 2011). Cost accounting is a very important branch of accounting that has many applications that can be used by managers to improve their decision making process. The use of cost accounting can help a company increase its profitability by identifying activities that are increasing the operating costs of a company. Some of the cost accounting methods that accountants use to analyze information are mark-up pricing, break-even analysis, master budget, variance analysis, activity-based costing, and balance scorecards. Companies that utilize cost accounting as a strategic tool are more likely to have business success. Cost accounting will continue to positively impact the business environment of the 21st century. References Assar, R. (2011). What are the difference between Cost Accounting and Financial Accounting? Retrieved March 10, 2012 from http://www.publishyourarticles.org/knowledge-hub/cost-accounting/what-are-the-difference-between-cost-accounting-and-financial-accounting.html Balancedscorecard.org (2011). What is the Balance Scorecard? Retrieved March 10, 2012 from http://www.balancedscorecard.org/BSCResources/AbouttheBalancedScorecard/tabid/55/Default.aspx Garrison, R., Noreen, E. (2003). Managerial Accounting (10th ed.). Boston: McGraw-Hill Irwin. Horngren, C., Foster, G., Datar, S. (2000). Cost Accounting: A Managerial Emphasis (10th ed.). New Jersey: Prentice Hall. Investopedia.com (2012). Definition of ‘Break-Even Analysis.’ Retrieved March 10, 2012 from http://www.investopedia.com/terms/b/breakevenanalysis.asp#axzz1ol8ujGNx Read More