Learn Cost Accounting Basics the Easy Way

You do this by keeping a close eye on the expense of producing your product and adjusting your selling price to keep an acceptable level of profitability.

Basic cost accounting is a very important part of maintaining a healthy profitable small business.

To better understand cost accounting basics, I will use a very simple cost accounting example using the fictional bakery I used in figuring a break-even-point.

Our costs include:

• $900 per month for our rent
• $300 per month for utilities
• $1600 per month for a person to help us
• $10 per cake for sugar, flour, etc. to make our cakes

We estimate we can make and sell 90 cakes a week or 360 in a month.

We are using a basic cost accounting method that uses both fixed and variable costs to determine our unit cost.

Quick accounting definitions refresher:

• Variable Costs: These are expenses that are associated with producing your product. They are directly proportioned to the production of your product. For example, if you owned a bakery, your variable cost would be your flour, sugar, etc.
• Fixed Costs: These are expenses that would be the same even if you did not sell any of your product such as rent, insurance, etc.

Our unit cost is:

• Building rent = $900 per month / 360 cakes = $2.50 per cake
• Utilities = $300 per month / 360 cakes = $.83 per cake
• Our helper =$1600 per month / 360 cakes = $4.44 per cake
• Ingredients = $10 per cake

So the actual cost to produce a single cake is $17.77.

Now to analyze these costs and determine how we can increase our profit...let’s organize our costs. We do this by putting them into three cost accounting basic categories:

• Direct Material Cost: The actual cost of all the materials or ingredients we need to produce our product
• Direct Labor Cost: The actual wages associated with producing our product
• Burden Cost: Overhead

Now we will organize our bakery unit costs:

• Direct Material cost = $10
• Direct Labor cost = $4.44
• Burden cost = $3.33

Analyzing these three categories, we decide we cannot for the time being change or improve the burden and labor cost, but we have shopped around and found a wholesale store where we can purchase bigger quantities and different brands of our ingredients and cut our direct material cost down to $7.50 per cake. This will affect our break-even-point and our profitability in a positive way.

We could also use this cost accounting basic method to see if hiring an additional baker would be a wise decision assuming demand was there.

Cost accounting basics can help you grow your small business and make those imperative decisions regarding your product(s).

AccountingCoach Pro can help small business owners, accountants wanting to brush up on their accounting skills, and students needing help with their accounting course.

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