Measuring Costs – What Your Accountant Knows and You Don’t

Measuring profits or net income is the essential thing accountants do. The second most important task is measuring costs. Costs are significant to running a business, and managing them effectively can make a substantial difference in its bottom line.

Any business that sells products or services needs to know its costs, and depending on what is being sold, it can get complicated. Every step in the process has to be tracked carefully from start to finish. The company cannot directly match many costs with particular products; these are indirect costs. To calculate the total cost of each product or service, accountants devise methods for allocating indirect production costs to specific activities. Generally accepted accounting principles (GAAP) provide few guidelines for measuring these costs.

Accountants need to determine many other costs, in addition to product and services costs, such as the costs of the departments and other organizational units of the business; the cost of the retirement plan for the company’s employees; the cost of marketing and advertising; the cost of restructuring the business or the cost of a major recall of products sold by the company, should that ever become necessary.

Cost accounting serves two broad purposes: measuring profit and furnishing relevant information to managers. What makes it confusing is that there’s no one set method for measuring and reporting costs, although accuracy is paramount.

Cost accounting can fall anywhere on a continuum between conservative or expansive. The phrase actual cost depends entirely on the particular methods used to measure cost. These can often be as subjective and nebulous as some systems for judging sports. Again accuracy is essential. The total cost of goods or products sold is the first and usually largest expense deducted from sales revenue in measuring profit.