Why It Matters
Figure 4.1 Hallie Refinishing Furniture. Companies can generally choose from two systems—job order costing or process costing—to account for the costs involved in making a product. Job order costing is the optimal decision when costs are readily assigned to the individual product. Managers should consider their options to select the best accounting system for their company’s production and pricing. (credit: modification of “120425-staining-wood-hand-brush” by r. nial bradshaw/Flickr, CC BY 2.0)
Hallie graduated from college last year and moved to Tempe, Arizona, to begin her career. Before moving, she purchased a secondhand dresser for $35 and spent $25 on refinishing materials. After two hours of work, she posted a picture of the dresser on social media, and a friend offered her $100 to refinish another dresser exactly the same way.
Fortunately, Hallie understands cost accounting and knew she needed to calculate the cost to refinish another dresser. She found a similar dresser for $65. She knows that the refinishing materials will cost $25, and thus before adding in any cost for labor she is already at a cost of $90, without considering any overhead, such as electricity to run her sander.
Hallie estimated that her labor costs should be $20 per hour. The total cost then would be $130, and accepting less would mean accepting less for her labor. For a business in this situation, agreeing to the $100 offer would be considered a loss. If Hallie accepts the $100 price before checking her costs, she would have received only $10 for her labor (the sales price of $100 less the $90 cost of the dresser and materials).
Hallie didn’t know if she would lose a potential customer by raising the price, so she found a different style dresser costing $25. A sales price of $100 would be fair with the two hours to refinish at $20 per hour and a materials cost of $25. She offered her friend the original style dresser for $130 or the alternate style dresser for $100.
As this example illustrates, it was essential for Hallie to know the cost to complete her project. It is also essential for all types and sizes of organizations to know the costs to complete their project. Manufacturing organizations need to know the costs of production, retail organizations need to know the cost to sell their products, and service organizations need to know the cost of providing their services. Management strives to eliminate unnecessary costs and needs to know the costs associated with using large pieces of equipment as well as seemingly insignificant office supplies. Cost accounting involves measuring and reporting the cost of production or service, while also providing data to determine the cost of the individual unit produced.