Basic principles of cost accounting

In times of digitalization and other economic upheavals, cost accounting is one of the most essential tools of entrepreneurial action, as it provides the foundation for numerous operational decisions and calculations. Typically, cost accounting is crucial for pricing, calculating the calculated results, optimizing the operational performance program, and controlling profitability within the company or the group. The overall increasing complexity of the economy and the increased dynamism of the environment contribute to the continuous increase in the requirements for cost accounting systems within companies (and the need for continuous adjustments of the systems). Therefore, the increasing complexity of economic relationships and the creation of business performance requires a correspondingly increased ability and accuracy of cost accounting, so that the economic facts in the company can be adequately accurately represented.

Closely related to cost accounting is the concept of cost and revenue management (also referred to as cost policy). This refers to measures to influence and shape costs in order to improve the profitability of the performance creation within the company. Specifically, these measures aim to influence costs in terms of cost level, cost structure, and cost evolution in a timely manner. The cost level can be controlled, for example, through supplier policies, outsourcing, quality management, or rationalization. In the case of the cost structure, on the other hand, the relative amount of variable and fixed costs, or individual and shared costs, is crucial and can be controlled by terms such as capacity utilization or external sourcing. Finally, in the topic of cost evolution, it is essential to avoid progressive cost trends as much as possible. This can be achieved, for example, by reducing complexity or by using standardized components. As part of proactive cost management, efforts should be made to identify the root cause of costs as early as possible, with the starting points for cost management found in the company’s products, processes, and resources.

The concept of cost

Costs arise from the valued use of production factors (e.g., materials, personnel, etc.) to produce goods and services. They generally result from the product’s cost based on the amount used and the price of a production factor. The cost (billing) concept can also be differentiated by time period and scope of work. The time period includes cost of consumption, standard cost, and fixed cost systems, and therefore refers either to the actual costs of the current period, average costs of the past period, or fixed costs of the future period. The scope of work later described further distinguishes between the types and magnitude of allocation of costs to the cost categories, thus between full cost accounting and partial cost accounting. Both full cost accounting and partial cost accounting can be based on cost of consumption, standard cost, or fixed cost accounting.

The system of operational cost and performance accounting is described in more detail below. Important terms include, in addition to cost types accounting and cost allocation accounting, the cost allocation accounting, full cost accounting, and partial cost accounting.

Cost-of-service calculation, cost-center calculation and cost-bearer calculation

The cost types calculation divides the cost types according to accounting requirements. It focuses on the question of which costs have been incurred in total and at what amount. It is the starting point of the cost calculation and aims to record and categorize the cost types incurred during the billing period. One possible way of categorization is to summarize typical cost groups such as personnel costs, material costs, etc., or by the occurrence of the costs. Another possible way of categorization is to separate the costs into variable and fixed cost components, i.e. according to their dependence on and independence from the employment level. The cost types calculation aims to record and evaluate the relevant costs incurred in the business as accurately and completely as possible - technically this is done using the operating transfer form (BÜB).

A cost center is a unit within an organization that collects costs and services. The purpose is to show where costs were incurred and what services were provided for them. The main idea of cost center accounting is cost control. By comparing the planned and actual costs, the profitability of the cost center’s management can be checked, and in the case of deviations from profitability, necessary measures can be taken. The central task of cost center accounting lies in preparing the indirect transfer of common costs to the cost-bearing entities. To do this, allocation and reimbursement rates must be established for each cost center (they show the ratio of the total common cost of a cost center to the corresponding reference value) in order to express the cost center’s utilization for a cost-bearing entity. The operational accounting sheet (BAB) ensures that a cost provider is only charged a share of the common costs of those cost items that were involved in the creation of the respective cost item.

The cost-allocation account is of particular relevance for the pricing calculation. By cost-allocation account, we mean the services (products and services) that are paid by the market and which can be used to cover the incurred costs. Individual costs (also called direct costs) include those costs that are directly related to the service creation, such as production wages and production materials. Common costs are costs that can only be allocated proportionally to the individual cost-allocators, such as energy costs, repair costs, rental fees, etc. The allocation of these costs takes place in the form of surcharge or allocation rates, the so-called common cost surcharge. Finally, it is possible to differentiate between real and non-real common costs within the framework of the common costs. True overhead costs – as already mentioned – can only be indirectly attributed to the individual cost-bearers because they were incurred for several or all of the cost-bearers (accounting for costs under the average principle). False overhead costs regularly include auxiliary and operating materials (e.g., screws, paints, glue, or nails). Although they could (in theory) be directly attributed to a cost-bearer as individual costs, this is not done for economic and simplification reasons – these auxiliary materials usually represent no significant value, so a separate recording is not required.

The full cost accounting and partial cost accounting are described in more detail below. The essential difference between full and partial cost accounting lies in the fact that either the entire or only a part of the costs recorded in a billing period are attributed to the cost provider.

Full cost accounting

The full cost accounting places all costs caused by it (fixed and variable costs) on the individual cost bearers. Specifically, the goal is to distribute all costs incurred within the company as accurately as possible—using cost centers and allocation keys—to the cost bearers (for example, a product group). As the name suggests, the full cost accounting includes both individual costs and common costs. Typically, individual costs include those costs that can be directly attributed to the product (e.g., material costs and production wages). Common costs, such as the wages of the in-house administration, cannot be directly attributed to the individual cost bearer; they can only be indirectly attributed via a cost center.

The full cost accounting serves primarily for long-term cost calculation. It is based on the basic idea that all costs incurred in an operation must be covered by the revenue generated. Only when all costs are allocated to the cost-bearing entities and the prices of the products are at least cost-covering, is the long-term existence of the company guaranteed. Thus, through full cost accounting, the long-term price threshold for orders or products can also be determined. Finally, the calculated full costs must be below the market price so that a company does not incur losses in the long term.

Both in literature and in practice, full cost accounting is not without controversy and is subject to the following criticisms:

• Changes in the employment rate lead to incorrect cost rates;
• short-term price thresholds cannot be determined;
• the determination of the break-even point is not possible;
• the full cost accounting only provides insufficient control of cost-effectiveness.

Regarding the last point of criticism, a problem with full cost accounting is that the allocation of common costs is not made according to the causes of the costs, but is made in a lump-sum manner. This can, for example, lead to certain cost categories being overcharged with common costs and, in extreme cases, becoming unprofitable as a result. Furthermore, the full cost accounting system is often considered too cumbersome (sometimes due to the extensive locking of fixed costs) for supporting business decisions regarding changes in the scope of services or the compilation of product and sales portfolio.

Cost accounting

Under cost accounting, costs are calculated based on performance – they are characterized by the fact that only individual costs are attributed to the respective cost drivers. The cost accounting is more short-term than the full cost accounting, although this characteristic can be both an advantage and a disadvantage. The cost accounting is more sensitive to fluctuations in employment and provides decision support in short-term issues such as calculating the short-term price floor. The starting point for the cost accounting is the breakdown of costs into employment-independent fixed costs on the one hand and employment-dependent variable costs on the other. The employment-independent fixed costs comprise that part of the total costs that is independent of the production of the service and the scope of the service. These costs are determined by maintaining the operational and The company's performance is characterized and does not change with fluctuations in employment (for example, insurance, rent, leasing costs, etc.). By contrast, for example, material consumption or manufacturing wages change as variable costs in the event of fluctuations in employment - they are charged only when services are actually provided.

The cost breakdown statement is fundamentally much more informative than the full cost statement. The advantages of the cost breakdown statement are, among other things, as follows:

• Determination of the coverage contributions to cover the fixed costs (see the other article in this issue for more details);
• Determination of opportunity costs;
• Improvement of control over those responsible;
• Facilitation of the comparison between the desired and actual situation by separately recording fixed costs.

Image: © Adobe Stock - Andrey Popov