- Performance measurement;
- Cost reduction and control;
- Determination of reimbursement and fee or price setting;
- Program authorization, modification, and discontinuation decisions; and
- Decisions to contract out work or make other changes in the methods of production or delivery of services.
Cost accounting provides various tools for example: Cost-benefit analysis, break-even analysis,
and CVP to help management in making decisions.
Role of Ethics in Cost Accounting
Webster's Dictionary defines ethics as "...the principles of conduct governing an individual or a profession: the discipline dealing with what is good or bad or right and wrong, or with moral duty and obligation; a particular theory or system of moral values". Ethics are very important in any field. In cost accounting also ethics play an important role. Ethical situations can easily arise in any business setting when money is involved. . The whole Enron saga was the result of unethical behavior. Collapse of other firms like Arthur Anderson, Worldcom and Martha Stewart was also the outcome of unethical attitude of owner, management or employees. In cost accounting, the lack of understanding of the accounting and finance process by the business manager is an incentive for the unethical employee to manipulate the system. Ethics help management in:
- Providing factual and true information to its users,
- Determining the nominal price of its products,
- Maintaining appropriate professional relationships, and
- Maintaining efficacy
In today’s world of corporate scandals, an appreciation of ethical standards and a commitment to the proper reporting and disclosure of financial information needs to be constantly reinforced within the area of accounting.
Absorption and Variable Costing:
Absorption Costing: All costs (fixed and variable) of production are product costs. Which means under absorption costing, both variable and fixed manufacturing costs are included as a part of the cost of the product manufactured.
Variable Costing: Only those costs of production that vary directly with activity (variable costs) are treated as product costs. Under variable costing, only the variable manufacturing costs are included as a part of the cost of the product manufactured. The fixed manufacturing costs are treated as an expense of the period in which they are incurred.
Cost classification under absorption and variable costing:
The basic difference between absorption and variable costing relates to the handling of fixed manufacturing overhead. Under absorption costing, fixed manufacturing overhead is treated as a product cost and hence is an asset until products are sold. Under variable costing, fixed manufacturing overhead is treated as a period cost and is deducted in full from the current period’s revenues. Selling and administrative expenses are treated as period costs under variable costing, the same as under absorption costing.
The amount of income from operations determined by absorption costing would be more than the amount determined by variable costing. This effect on the magnitude of income is also caused by the difference between the two methods in treating fixed factory overhead costs. In the short run, income from operations is maximized if the revenue from the sale of the product exceeds the variable cost of making and selling the product. For example, when sales increase, other things being equal, income will also increase under variable costing. Under absorption costing, however, income will not necessarily increase when sales increase. Under variable costing, these relevant costs are readily available.
Many accountants and managers believe absorption costing is a better method of matching costs with revenues than variable costing. According to the supporters absorption costing, all manufacturing costs must be assigned to products to properly match the costs of producing units of product with the revenues from the units when they are sold. They believe that the fixed costs of depreciation, taxes, insurance, supervisory salaries, and so on, are just as essential to manufacturing products as are the variable costs.
Supporters of variable costing believe that fixed manufacturing costs are not really the cost of any particular unit of product. If a unit is made or not, the total fixed manufacturing costs will be exactly the same. These fixed costs are incurred to have the capacity to make products during a particular period and should be charged against that period as period costs according to the matching principle.
Conclusion:
Cost accounting is an important tool that can help management in making informed decision. Though it is not legally required but still it is necessary to run an entity effectively. Cost accounting is turned toward the future. There are different methods of costing in Cost Accounting: Absorption costing and Variable costing. Both have some merits over the other.
An entity can use both of them for different uses. Absorption costing can be used for external reporting, managers need to review the effect of their decision on financial reporting to outsiders whereas Variable costing can be used by managers to review the effect of management decisions on production, costs and profits.
References:
Absorption, Variable, and Throughput Costing. Retrieved on December15, 2004 from
Hilton, Ronald W: Cost Management: Strategies for Business Decisions, Second Edition:
Marshall: Accounting, What the Numbers Mean, Sixth Edition: 3-8
Turner, Robert M: Ethics and professionalism: the CPA in industry, April1990. Retrieved on December15, 2004 from