Cost Accounting

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Harvard Business School

9-192-068
Rev. May 1, 1993

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A Brief Introduction to Cost Accounting

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Organizations and managers are almost always interested in and concerned about costs. Control of past, present, and future costs is part of every manager’s job. In companies that try to earn profits, control of costs directly affects the amount of profit earned. Knowledge of the cost of products or services is indispensable for decisions about pricing or product and service mix. In nonprofit organizations, control of costs influences the level of services that can be provided and the future survival of the organization.

Cost accounting systems can be important sources of information for managers. For this reason, effective managers understand the strengths and limitations of cost accounting systems and actively participate in the evaluation and evolution of cost measurement and management systems. Unlike accounting systems that support the preparation of periodic financial reports, cost accounting systems and reports are not subject to rules or standards such as generally accepted accounting principles. Managers are permitted to exercise as much creativity and ingenuity as they wish in the quest for information on costs. As a result, there is much variety in cost accounting systems used in different companies and sometimes even in different parts of the same organization.

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This brief introduction to cost accounting will review the principal uses of cost data, provide some vocabulary for cost accounting, and present several of the questions managers have to answer in designing or using a cost accounting system. Its purpose is to provide the beginner with some vocabulary and ideas to use in learning about and exploring how cost management systems are designed and used by managers. While many of the references are to products and manufacturing environments, the vocabulary and concepts are equally applicable to services.

Some Uses of Information About Costs

Information about costs is used for two purposes in most organizations. Cost accounting systems provide information for evaluating the performance of an organizational unit or its manager. They also provide a means for estimating the costs of units of product or service that the organization may manufacture or provide to others.

Professor William J. Bruns, Jr., prepared this note as the basis for class discussion. Copyright © 1991 by the President and Fellows of Harvard College. To order copies, call (617) 495-6117 or write the Publishing Division, Harvard Business School, Boston, MA 02163. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School. 1

192-068

A Brief Introduction to Cost Accounting

Performance Measurement

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Reports on the costs incurred by part of an organization—department or a division, for example—are one means by which efficiency and effectiveness can be evaluated. By comparing actual costs to those that were expected—to standard costs or budgeted costs—the degree to which costs have been controlled can be judged. Deviations from expectations—variances—can be identified, evaluated, and discussed by managers. If needed, corrective actions can be taken or expectations can be modified to incorporate previously unexpected efficiencies. Performance measurement reporting is usually periodic and systematic. Costs are assigned to parts of an organization that are identified as cost centers. When managers are held accountable for the costs incurred in a cost center, they are sometimes called responsibility centers. Performance reports provide information on the achievement of established objectives, efficiency of operations, and opportunities for cost control or cost reduction. Performance reports are used for both...
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