The general objectives of a cost system

Profitability

Higher PROFITABILITY through refined management.

As we have discussed, a company's behavior, attitudes, and operating methods are reflected in either the reduction or increase of its costs. The more automated, standardized, structured, sequenced, and reliable your cost information is, the better your management—and consequently, your profitability—will be.  

You need to structure your costing system to obtain solid information, as the complexity lies in data processing. The basic objectives of a costing system are to manage costs for both managerial and accounting purposes. However, it is possible to go further, driving cost reduction and higher profitability. This will become a major competitive advantage for your industry.  

Let's dive deeper into this topic!

Cost Concepts and Structuring

Terms like expenditures, costs, expenses, and investments are widely used in accounting, so let's define them to ensure a better understanding.  

Expenditures: amounts spent to acquire goods and services intended for the transformation process that generates other goods and services.  ‍

Cost: expenditures dedicated to production, specifically in the transformation of materials to generate other goods and services.  ‍

Expense: expenditures generated directly or indirectly to obtain revenue, occurring as a result of the company's internal operations, such as administration, marketing, sales, and others.

‍Investment: amounts resulting from the acquisition of goods and services that become part of the company's fixed assets (machinery, equipment, and materials acquired and held in stock).  

Understanding these terms will allow us to clearly grasp the costing criteria we will cover next.

Industrial Costs and Expenses

Industrial and commercial activities incur a series of expenses to carry out their resource management, purchasing, production, and marketing processes. These expenses are not always considered Costs.

Let's look at a simplified structure of the Income Statement (DRE):

As can be seen in this simple Income Statement model, Costs and Expenses are treated separately.

Costs arise from the transformation of raw materials into finished products, whereas Expenses arise from the administration of the company and the marketing of products. Below, we group a company's departments according to their types of expenses.

Factory and Production

Factory: covers the cost centers where Costs occur, such as the warehouse, maintenance, laboratory, production planning, etc.  

Production: cost centers that effectively produce, such as spinning, warping, weaving, dyeing, cutting, and sewing, among others.

Administration and Sales

Administration: includes all cost centers, such as human resources, accounting, and information technology, for example.

Sales: consists of cost centers related to the marketing of products, such as sales, customer service, marketing, etc.

Classification of Costs and Expenses

To determine the cost of products within a transformation process, we classify them as:

• Direct: these are costs that can be conveniently identified with the production of goods and services, such as direct materials and direct labor.
• Indirect: all other production costs, such as rent, depreciation, and salaries.

Classification by behavior in relation to volume variations:

• Variable Costs and Expenses: these are directly related to the volume of production or sales.
• Fixed Costs and Expenses: these represent the company's installed capacity to produce or sell and are independent of the volume of production or sales.  
• Semi-variable Costs and Expenses: these vary according to the volume of production or sales, but not in exact proportion. These costs and expenses have a fixed portion, but become variable beyond that.
• Semi-fixed Costs and Expenses: expenses that remain constant within certain ranges, changing in steps once a new level of activity is reached.

Identification: the rule is to consider as Direct Cost any cost element whose quantity applied to the product can be perfectly identified. Conversely, a cost element whose quantity applied to the product cannot be perfectly identified is an Indirect Cost.

Other classifications worth mentioning, as they facilitate the understanding of the costing system:

• Prime Costs: direct labor, raw materials, and inputs applied to production.
• Transformation Costs: process costs, costs generated by general manufacturing overhead allocated to the process to transform raw materials into finished products. Also known as Conversion Costs.
• Production Costs: these are all costs related to the production of finished items, raw materials and inputs, direct labor, and Indirect Costs.

Conclusion

As we mentioned, the complexity lies in data processing, and let's face it, there is a lot of data to handle. The good news is that in a specialized computerized system, all these variables and information are considered right from the product and process engineering stage. This establishes the company's operating mode regarding costs, where all variables are handled, leaving nothing to be defined during turbulent times prone to errors or distractions.  

Furthermore, the information will be in a single, standardized, structured, sequenced, and reliable tool.  ‍‍

See you later!