6.1 Cost Accounting
Cost accounting aims to assign costs to services and categories in a manner that supports effective cost analysis. This process relies on various data sources, including past budgets, operational reports, and contracts or billing statements. A key aspect of cost accounting is the determination of mission or service centers, which involves categorizing the primary services provided to the public. For example, in a Department of Transportation, road maintenance could be identified as a key service center. This categorization helps to accurately track and analyz costs associated with specific functions or services.
In cost accounting, direct costs refer to expenses that can be directly and accurately assigned to a specific service or project. For example, the cost of asphalt used to repave Meridian Street in Indianapolis is a direct cost because it is clearly linked to that specific project. On the other hand, indirect costs are those that cannot be precisely assigned to a specific service due to the lack of a direct causal link between the expense and the service provided. An example of an indirect cost would be the salary of a manager overseeing road maintenance in Indianapolis, as their work supports multiple projects rather than a single, specific service. One of the goals of cost accounting is to convert as many indirect costs as possible into direct costs by creating more precise links between costs and the services provided, improving the accuracy of cost allocation.
Cost concepts in accounting help distinguish how expenses behave in relation to the level of output or services provided:
Fixed cost: This type of cost remains constant and does not vary with the level of output. An example is office space rent, which remains the same regardless of how much work or service is being performed.
Variable cost: These costs fluctuate based on the level of goods or services provided. For instance, the cost of paving roads using asphalt increases as more roads are paved.
Semi-variable cost: These costs contain both fixed and variable components. An example is a copy machine, where there is a fixed rental fee but additional costs accrue based on the number of copies made.
Step cost: These costs change with output but in discrete jumps rather than continuously. For example, a school may need to hire one additional teacher for every 20 students, resulting in a step-like increase in costs as student numbers grow.
Other key cost concepts include the full (total) cost which includes all resources utilized to produce a service. The unit cost is the total cost divided by total quantity. In economics, this is called the average total cost. For a government agency (but also for industry and nonprofits) it is important to know the average total cost. If the price per unit sold (or service provided) is below the average total cost, the service provision is not sustainable in the long run. Finally, we have marginal cost which is the change in total cost if one more unit of service is provided or one more unit of output is produced.