How cost accounting and control runs, step by step

Cost accounting and control runs as a loop. The cost structure and standards are set. Actual costs are captured, valued and allocated during the period. The books are closed. Then costs, variances and profitability are analysed and reported, and the findings flow back into the standards and spending limits.

The steps in order

1. Set up and maintain the cost structure. The cost accountant creates and updates cost centers, profit centers, cost pools and cost objects, and closes out the ones no longer in use. The controller approves changes. Spend limits are attached to cost centers and projects here. Hands on: clean master data that every later posting depends on.

1. Build product costs and standards. The cost accountant works with operations and engineering to turn bills of material, routings, labor rates and overhead rates into a standard cost for each product. Purchasing supplies expected material prices. Hands on: approved standard costs, loaded into the system before the period opens.

1. Capture actual costs as they happen. Operations records production, receipts, issues and scrap. Payroll posts labor. Payables posts supplier invoices. The cost accountant watches for postings that land on the wrong cost center or carry no cost object. Hands on: a ledger full of actual costs, tagged to where they were incurred.

1. Account for inventory. The inventory or cost accountant values stock at standard, reconciles the inventory subledger to the general ledger, and books reserves for obsolete or slow stock. Warehouse counts feed adjustments. Hands on: a reconciled inventory balance and a list of adjustments with reasons.

1. Accumulate and allocate indirect costs. The cost accountant gathers direct and indirect costs, captures the allocation bases (machine hours, floor space, headcount or whatever drives the cost), and runs allocations from service cost centers to production cost centers and on to products. Hands on: fully loaded costs by cost object and by profit center.

1. Close the period. The general ledger team records period-end entries: accruals, overhead absorption, capitalised variances and intercompany charges. The period is closed and the next one opened. Hands on: locked actuals that analysis can rely on.

1. Analyse cost of sales. The cost accountant breaks cost of sales into material, labor, overhead and variances, and checks it against revenue by product and channel. Hands on: a cost of sales view that ties to the ledger.

1. Analyse variances. The cost accountant calculates price, usage, efficiency and volume variances. Operations and purchasing managers explain the material ones. Unexplained variances go back to step 3 or step 2 for correction. Hands on: explained variances and a list of standards that need revising.

1. Report on profitability. Financial planning and analysis combines revenue, cost of sales and allocated costs into profitability by product, customer, segment and profit center. Business leaders review the results. Hands on: profitability reports for decisions on pricing, product mix and cost reduction.

1. Act on the results. Budget owners respond to spend limit breaches. The controller approves revised standards, allocation bases or cost center changes. Cost information is passed to budgeting and to billing where prices are cost-based. Hands on: changes that feed back into steps 1 and 2 for the next cycle.

Where the handoffs usually break

Most trouble starts upstream. A new product goes live before its standard cost is approved, so it posts at zero or at a guessed value. A cost center is reorganised in the business but not in the system, and allocations keep flowing to a team that no longer exists.

Allocation bases are another weak point. Someone collects them from a spreadsheet that nobody else maintains, and when that person is away, the allocation runs on last period's figures.

Variance explanations often stall at step 8. Finance calculates them, operations is asked to explain them, and the explanation arrives after the reports have gone out. The standard is then never fixed, and the same variance reappears every period.

Questions to ask the people who run it

The documented process and the real one tend to drift apart. These questions surface the gap.

• Who actually approves a new cost center or a change to one, and does anything stop a posting to a cost center that should be closed?
• When a new product starts production, what cost does it carry until the standard is approved?
• Where do the allocation bases come from, who updates them, and what happens if they are late?
• Which manual journals are booked every close, and why can the system not do them?
• How is the inventory subledger reconciled to the ledger, and what is done with differences that cannot be explained?
• Which variances get investigated, and who decides that one is too small to bother with?
• How often are standards revised in practice, and who has to agree?
• Which profitability reports do leaders actually use, and which are produced but never opened?
• What happens when a cost center exceeds its spend limit? Is spending blocked, flagged or simply reported afterwards?
• Which spreadsheets sit outside the system, and who owns each one?
• Where do figures get corrected after the period is closed, and how are those corrections recorded?

What to check before changing anything

Trace a single product through every step, from its standard cost to its line on the profitability report. Note each person who touches it and each file it passes through. The handoffs that rely on one person, one spreadsheet or one reminder email are where a change will either help most or break first.

Confirm that the outputs still tie to the general ledger after the change. Auditors will test inventory valuation, cost of sales and capitalised variances, and they will ask for the documentation behind each allocation. Keep that trail intact.

APQC's Process Classification Framework® (PCF) is an open standard developed by APQC, a nonprofit that promotes benchmarking and best practices worldwide. To download the full PCF or to view definitions and measures, please visit www.apqc.org/pcf.