Manufacturing cost accounting encompasses several tasks that impact production operations and the valuation of inventory. These activities can significantly boost the profits of a business, as well as bring it into compliance with the applicable accounting standards.
The following are all elements of manufacturing cost accounting:
- Inventory valuation. This is the fully loaded cost of inventory at the end of an accounting period, which is required under various accounting standards to place a correct valuation on inventory. It is of little use in the day-to-day operations of the manufacturing area. There are a number of ways to assign a valuation to inventory, such as the standard cost, FIFO, and LIFO methods.
- Cost of goods sold valuation. This is closely related to inventory valuation. It is possible to track the cost of specific production jobs (job costing), or in general for all units produced (process costing). This cost tracking can be at the level of just those costs that vary with changes in revenue (direct costing), or it can include a full allocation of factory overhead costs (absorption costing).
- Constraint analysis. This involves finding the bottleneck in the manufacturing process (if any) and advising the production department regarding the impact on throughput of changes to the flow of work through that bottleneck. The analysis can include an examination of the inventory buffer in front of the constraint and the existence of any upstream sprint capacity. This can be among the most important functions of manufacturing cost accounting.
- Margin analysis. This involves the compilation of all costs associated with a product and subtracting them from product revenues to arrive at the margin of each product. Margin analysis can also be applied to distribution channels, business units, customers, and product lines. This is a traditional cost accounting role that is gradually giving way to constraint analysis, since many businesses now realize that incorporating allocated costs into margin analysis can lead to incorrect decisions to sell more or less of a product. Instead, it is better to consider that all products usually have some amount of throughput associated with them, so the real issue is to find the most profitable mix of products to produce (including the option to outsource production).
- Variance analysis. This is the comparison of actual costs incurred to standard or budgeted costs, and exploring the reasons for any variances. This aspect of manufacturing cost accounting may not be necessary, since the baseline budget or standard cost may be faulty. Thus, a favorable variance may simply mean that a standard was set to be so easy to attain that all variances from it are bound to favorable.
- Budgeting. The information derived from the preceding analyses can be used as the basis for the annual budget for the manufacturing area, though this work is ultimately the responsibility of the production manager, not the cost accountant.
The cost accountant is primarily responsible for manufacturing accounting activities.