Fine-Tune Your Costing Function

BY STEVEN BRAGG

Cost accounting reports give a company’s management feedback about the profitability of its product portfolio and the efficiency of its production processes. Unfortunately, internal departments don’t always provide staff accountants with the most accurate information from which to construct their reports. Here are some steps cost accountants can take to rectify this problem.
Audit bills of materials at regular intervals. The primary information upon which you rely when calculating the cost of a company’s product is the bill for component materials, and accurate records are very important to the outcome. However, sometimes the department creating the bill-of-materials record—usually the industrial engineering staff—may not be systematic about entering it into a database. To improve accuracy, ask a third party such as the internal audit staff for regular comparisons of the bills of materials with actual product components.

Review labor routings several times a year. When a factory assembles products in several successive departments, the labor that goes into them is said to be “routed.” Company accountants rely on a labor-routing database to determine the standard amount of labor cost assigned to each product. To make sure the department or staff member responsible for updating that information does so accurately, have internal auditors review the labor routing records several times a year.

Eliminate disproportionate overhead allocation bases. Overhead costs often are allocated to products based on the number of direct labor dollars they consume, even when those dollars constitute an ever-shrinking proportion of the items’ total costs. For greater accuracy, separate total overhead into cost pools that logically relate to different functions. For example, allocate

All machine-related costs to one pool. Budget the pool according to how many machine hours go into making a product.
A labor-cost pool based on direct labor time used.
A building-expenses pool based on the square footage used for manufacturing or storage.

Assign overhead salaries to specific subplants. Manufacturers that create products in several stages in discrete production areas often include the aggregate salaries of all manufacturing staff in the general overhead pool and allocate those costs to all company products. Those allocations may not accurately reflect the amount of staff-position overhead devoted to specific products. To show actual expense usage, assign staff salary expenses to cost pools for those company subplants on which staff members spend the bulk of their time.

Eliminate labor variance reporting. Direct labor accounts for less than 20% of the cost of most manufactured products but more than 80% of all variance reporting. If the company isn’t using its labor variance reports to improve its process efficiency, suggest eliminating them.

Implement target costing. Once regular production has begun, it is usually too late to modify a product’s manufacturing expenses. Instead, during the design process, implement a target costing system that makes the attainment of specific product costs an integral factor.

Source: Steven Bragg, CPA, is the CFO of Premier Data Services, Englewood, Colorado, and author of 23 business books. His e-mail address is steve.bragg@premierdata.com .

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