Chapter 11. Cost Concepts and Conundrums

In This Chapter

• Determining costs: The second most important thing accountants do

• Appreciating the different needs for cost information

• Contrasting costs for understanding them better

• Determining product cost for manufacturers

• Padding profit by manufacturing too many products

Measuring costs is the second most important thing accountants do, right after measuring profit. (Well, the Internal Revenue Service might think that measuring taxable income is the most important.) But really, can measuring a cost be very complicated? You just take numbers off a purchase invoice and call it a day, right? Not if your business manufactures the products you sell — that's for sure! In this chapter, I demonstrate that a cost, any cost, is not as obvious and clear-cut as you may think. Yet, obviously, costs are extremely important to businesses and other organizations.

Consider an example close to home: Suppose you just returned from the grocery store with several items in the bag. What's the cost of the loaf of bread you bought? Should you include the sales tax? Should you include the cost of gas you used driving to the store? Should you include some amount of depreciation expense on your car? Suppose you returned some aluminum cans for recycling while you were at the grocery store, and you were paid a small amount for the cans. Should you subtract this amount against the total cost of your purchases? Or should you subtract the amount directly against the cost of only the sodas in aluminum cans that you bought? And, is cost the before-tax cost? In other words, is your cost equal to the amount of income you had to earn before income tax so that you had enough after-tax income to buy the items?

These questions about the cost of your groceries are interesting (well, to me at least). But you don't really have to come up with definite answers for such questions in managing your personal financial affairs. Individuals don't have to keep cost records of their personal expenditures, other than what's needed for their annual income tax returns. In contrast, businesses must carefully record all their costs correctly so that profit can be determined each period, and so that managers have the information they need to make decisions and to make a profit.