Costing Systems

Traditional Manufacturing Costing Systems
Traditional costing systems are one way to estimate cost of a product or customer or job. Cost is direct cost (such as labor and materials) and indirect costs (also known as overhead).Traditional costing uses cost centers or departments to accumulate and allocate overhead costs to products or jobs. Usually, the allocation is based on a volume metric such as labor hours or machine hours. The result may be meaningful where only a few similar products are produced. However, where numerous diverse products are manufactured, the total costs associated with each product are lost through the arbitrary allocation process. Traditional Cost Accounting (or TCA) is unable to calculate the “true” cost of a product when there isn’t a single cost driver for ALL the indirect costs.

Activity-Based Costing Systems
Activity-Based Costing (or ABC) Systems are another method to determine cost of a product or job or customer, etc. ABC is more accurate cost management system than Traditional Cost Accounting (TCA). ABC attempts to determine the true cost for a product, a job, a service, or a customer by focusing on indirect costs and tracing those costs to individual products, services, or customers (rather than simply allocating arbitrarily). Essentially, it makes indirect costs “direct costs” by tracing and assigning them to particular products or jobs, etc. If a product requires certain activities that consume certain resources, that consumption of resources should be included in the total cost.

Information about true costs helps companies identify where they are and are not making money. It assists in computing and evaluating break-even points and in evaluating different options for new improvements and business plans. Strategic decision-making should improve with better cost information.

Sunk Costs
Sunk costs are irrelevant costs to decision-making. Sunk costs are costs that have already occurred. They include expenditures on equipment or inventory. Just because money has been spent on assets or time spent on projects, those asset costs are sunk and are not relevant to the future inflows and outflows. Spending $5 million on a project and abandoning it may not make sense initially, but if the future inflows do not outweigh the future outflows, the $5 million in incurred project costs should not be considered in the decision to keep the project active or discontinue it.

Manufacturing Decisions
Manufacturing decisions relate to product-mix and the relative profitability of products. Manufacturers may make decisions with respect to cost control, such as making a sub-assembly or buying it, going out of the plant for maintenance (outsourcing) or performing maintenance in-house, or replacing old equipment or replacing it with new equipment. Each of these decisions requires information about costs. To the extent the cost information is misleading because of traditional costing systems, the decisions made will not be optimal.

Quality Issues
Quality relates to ensuring that products and services perform to customer or industry standard requirements. Customers have certain expectations as to quality. Automobiles should be reliable, safe, and perform to the expectations of the type of car. Users of audited financial statements also require also quality with respect to reliability and full disclosure.
Regardless of the context, once we understand what quality is, companies still must determine how to maintain and control quality. Accountants in some companies assist in the development of cost of preventing or fixing poor quality. In total quality management systems, accountants focus on controlling production to eliminate poor quality at the earliest stages rather than to detect and fix poor quality.