Cost accounting, according to Dr. Larry Walther, Ph.D., a Utah State University accounting professor and textbook author, is the “collection, assignment, and interpretation of cost”. Simply put, it is the capture and analysis of cost data. In a manufacturing environment, various types of cost contribute to producing the product. Accounting for these costs in financial and managerial reports enhances understanding of the manufacturing operation’s profitability and enables decision making. For costs, the primary two cost accounting methodologies are job costing and process costing.
In job costing, actual costs are tracked and allocated to a specific product or batch. Job costing is used most often when one-of-a-kind or distinct batches of product are produced. Raw materials are easily traceable to a finished product. Different products will have different costs. The total cost of a job is determined by summing the materials, labor and overhead costs then dividing by the total units manufactured.
When the manufacturing process is continuous and produces largely homogenous products, like breakfast cereal or sheet metal, process costing may be utilized. Manufacturing costs are pooled and divided among total output. This method is useful when it is difficult to attach specific costs to each unit produced. In product costing, the average cost of materials per unit is determined for a particular reporting period.
Manufacturing Cost Components
Direct materials, direct labor and factory overhead are the three components of manufacturing cost. Direct, or raw, materials have a physical presence in the final product, and will be most accurate in job costing. Examples include containers, knobs, handles and similar distinct items.
Direct labor captures the wage costs associated with those who work directly on the physical product. Other labor costs, wherein the workers efforts do not directly touch the product, such as custodial services and administrative resources, falls into indirect labor. The sum of the cost of direct materials and direct labor is sometimes referred to as “prime costs.”
Indirect costs are known as “overhead.” Manufacturing overhead includes the cost of indirect labor, depreciation, insurance, taxes, maintenance and similar expenses. Since these costs cannot be tied to a specific product, they are allocated across all units produced on the basis of direct labor hours, direct labor cost or some other measure. The sum of direct labor plus manufacturing overhead is referred to as “conversion costs.”
Both the job costing and process costing methods focus on product cost. There are, however, other costs incurred by a manufacturer. These costs, known as period costs, are non-manufacturing costs that lack future value, like the cost of selling, advertising, human resources recruitment and other administrative costs. These costs are treated as expenses in financial reporting rather than inventory-related costs. The cost of acquiring buildings and land, and their subsequent depreciation, are also excluded from product cost accounting.