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The Important Task of Measuring Costs


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

Any business that sells products needs to know its product costs and, depending on what is being manufactured and/or sold, it can get somewhat complicated. Every step in indirect costsmanufacturing costs, has to be tracked carefully from start to finish. Many manufacturing costs cannot be directly matched with particular products; these are called indirect costs.

To calculate the full cost of each product manufactured, accountants devise methods for allocating indirect production costs to specific products. Generally accepted accounting principles (GAAP) provide few guidelines for measuring product cost.

Accountants need to determine many other costs, in addition to product costs, such as costs of the departments and other organizational units of the business, the cost of a 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 is 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 extremely important. The total cost of goods or products sold is the first and usually largest expense deducted from sales revenue in measuring profit.

A Brief Insight Into GAAP

While many businesses assume that accountants are bound by generally accepted accounting practices and that these are inviolate, nothing could be further from the truth. Everything is subject to interpretation, and GAAP (Generally Accepted Accounting Principles) is no different. For one thing, GAAP permit alternative accounting methods to be used for certain expenses and for revenue in certain specialized types of businesses.

For another, GAAP methods require that decisions be made about the timing for recording revenue and expenses, or they require that key factors be quantified. Deciding on the timing of revenue and expenses and putting definite values on these factors require judgments, estimates and interpretations which, when arrived at in a forthright and responsible manner are acceptable to GAAP, despite the method used.

The mission of GAAP over the years has been to standardize accounting methods in order to bring about uniformity across all businesses. But alternative methods are still permitted for certain basic business expenses. No tests are required to determine whether one method is more preferable than another. A business is free to select whichever method it wants.

However, if a business is to use an alternative accounting method, it must choose which cost of goods sold expense method to use and which depreciation expense method to use. For other expenses and for sales revenue, one general accounting method has been established, which is GAAP, a set of accounting rules used to standardize the reporting of financial statements in the United States; there are no alternative methods.

Notwithstanding, a business has a fair amount of latitude in actually implementing the methods. One business applies the accounting methods in a conservative manner, and another business may apply the methods in a more liberal manner. The end result is more diversity between businesses in their profit measure and financial statements than one might expect, considering that GAAP have been evolving since 1930.

The pronouncement on GAAP prepared by the Financial Accounting Standards Board (FASB) is now more than 1000 pages long. And that doesn’t even include the rules and regulations issued by the federal regulatory agency that has jurisdiction over the financial reporting and accounting methods of publicly owned businesses – the Securities and Exchange Commission (SEC).