This article is part of a series on the financial aspects of manufacturing.

By Eric Aronson
CliftonLarsonAllen LLP

Cost accounting is a specialized discipline not always found within a manufacturing company’s accounting department. Leaders may have a feel for how their company is performing overall, but they may not have a clear sense of which parts of their business are helping or impairing overall performance.

Cost accounting is a method of allocating expenses associated with production. Common uses of costing calculations for internal purposes include:

• Helping to set pricing
• Driving business strategy decisions
• Monitoring production

While the complexity of costing calculations varies significantly depending on available information and intricacies of a company, there are some basic concepts and definitions.

Cost pools

Cost pooling is the grouping of all identified expenses (costs) associated with production.

Costs typically fall into one of four basic categories:

• Direct costs
• Variable costs
• Overhead
• Fixed costs

Cost drivers

A cost driver is a costing model factor used to apply expenses within cost pools to the units of production.

Questions often arise as to which costs to include as part of the allocations and which costs to exclude. While the answer to this question depends on the purpose of the calculation, most internal costing systems consider all company expenses.

An effective cost accounting system is one that — to the greatest extent possible — aligns the cost pools with the drivers of the behaviors and incorporates the concepts of capacity utilization and increased efficiency. When putting together a cost accounting system, consider collaborating with a team of experienced operational and cost accounting professionals.

Common mistakes of costing

Basic misconceptions in costing include:

• Not understanding the differences between GAAP reporting and management cost accounting
• Oversimplification
• Not accounting for excess capacity and assuming optimal efficiency
• Relying on costing as sole determination for pricing
• Failing to monitor changes in cost structures or behavior

Costing challenge: Not collecting or tracking accurate data

Accurate costing starts with accurate production data. Unfortunately, many manufacturers still rely on manual processes and spreadsheets, creating challenges in understanding true costs.

Technology has come a long way. Manufacturers have access to affordable shop floor data collection systems integrating directly with ERPs, providing real-time visibility into production activity, labor utilization, machine performance, and inventory movement. From barcode scanners and tablets to machine monitoring and IoT-enabled devices, collecting accurate operational data has never been easier.

Profitability and costing go hand-in-hand

Misunderstanding of costing can lead to a downward spiral of costing errors and poor business decisions. In a worst-case scenario, a manufacturing company eliminates products that are marginally profitable or even unprofitable, and reallocates the fixed cost covered by those products to the remaining products.

This can lead to the perception that something must be done to improve the profitability of the remaining products. Eventually the business increases prices and loses business due to not being competitive in their market.

If you have questions about accounting in manufacturing, CLA is convening two upcoming roundtables:

Register for Quincy, October 21, 8:30 – 10 a.m.

Register for Worcester, October 22, 8:30 – 10 a.m.

For more information on manufacturing in Massachusetts, contact Jon Hughes at 617-701-4777.

The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment, or tax advice or opinion provided by CliftonLarsonAllen LLP (CLA) to the reader. For more information, visit CLAconnect.com.