Essay Sample on Effective Cost Analysis and Cost Structure

Introduction

A cost analysis also commonly known as a cost-benefit analysis refers to an approach that is used to compute and compare the costs and benefits of a particular option while making decisions in an organization. The method is often used by manufacturing entities where the management evaluates the expenses incurred to acquire and implement the inputs and comparing it to the expected benefits (Horngren, Datar, & Rajan, 2012). The approach is essential as it allows the firm to rearrange the cost of inputs in cash a manner that aims at increasing the output or rather the productivity of the particular organization. As a way to conduct the cost analysis, the personnel involved are bound to develop a cost structure.

Is your time best spent reading someone else’s essay? Get a 100% original essay FROM A CERTIFIED WRITER!

Order now

A cost structure illustrates the various types of costs and expenses the firms incur including the fixed and variable costs. Further, a cost structure shows the relative proportions of the types of costs identified above. A cost structure can be regrouped to represent smaller units within the entity. For instance, a cost structure can be developed to represent a specific product, service, customer segment, organizational division, and a product line depending on the objective that the management creates the structure (Park, Lee, Doo & Yoon, 2016). In this case, therefore, the paper aims at giving an in-depth analysis of the concepts of effective cost analysis and cost structure.

Effective Cost Analysis

Gean & Gean, (2016), suggest that as a way to conduct an effective cost analysis, it is essential to classify the organization costs based on three aspects. They include classifying by function, by behavior, and by relevance to the decision making process.

Classification by function regroups the types of cost according to various activities present within the organization. For instance, organizational activities are grouped into production, manufacturing, administration, finance, selling and distribution, and research and development. All these departments incur some individual costs that are not exhibited in their departments. While determining the total costs incurred by the organization, sometimes the accountants can ascertain the direct costs incurred by each of the departments. Nevertheless, sometimes it is not easy to ascertain some costs for particular activities. As a result, the accountants create an overhead cost structure that allocates the indirect costs across the various departments within the organization (Gean & Gean, 2016). In this case, it is easy to identify for instance the factory overheads or manufacturing overheads and differentiate the costs from other costs of the entity such as selling, distribution, and administration expenses. This classification is significant as it allows the management to identify the various costs incurred in each stage of the production and distribution process.

Classification by behavior regroups the costs into fixed costs, variable costs, and mixed cots. Fixed costs refer to the expenses that the firm incurs at a constant level regardless of the level of production. Variable costs are the expenses that change with the level of production while mixed costs contain an element of the fixed costs and variable costs. Here, the management utilizes the CVP analysis to evaluate the relation between the cost structure (C), the volume of output of output (V), and the profit (P). Through adopting the CVP analysis, it is easy to determine the breakeven point, the contribution margin, and the margin of safety (Park, Lee, Doo & Yoon, 2016). These aspects help in determining the course of action that maximizes the output. The CVP analysis operates with the formula that total costs are given by summing up the fixed costs and the variable costs. Further, the profit is given by finding the difference between the total revenue and the total costs (Gean & Gean, 2016).

Classification by the relevance to decision making groups the costs to the influence it creates to the overall decisions made in the firm. The primary aspect of this approach is whether the costs derive maximum benefits to the organization or not. It is based on several decision criteria. For instance, a company may strive to decide to either produce or buy a particular input material. In such a case, the management evaluates the costs of purchasing and the expected profits and compares this to the expected costs and benefits of producing the same product (Gean & Gean, 2016). The management then selects the option that creates the maximum benefits and minimizes costs. Another decision criterion is the option to either accept or reject the production of any special order. Here, the management evaluates the expected costs and benefits of the order. If it creates additional profits for the firm, then the company can opt to accept the request. Also, a firm may be faced with a scenario where they need to determine whether to continue producing a particular product to discontinue the operations. The decision is made by evaluating the costs incurred in producing the product and the expected revenues. If the project is not profitable, then, they discard the production of the items (Gean & Gean, 2016).

Conclusion

In conclusion, conducting a cost analysis by developing a cost structure is essential as it allows a company to determine the most effective course of action that maximizes the benefits and minimizes the costs. More importantly, conducting an effective cost analysis is necessitated by classifying the organizational costs based on their function, behaviors, and their relevance to the decision making.

References

Gean, F., & Gean, V. (2016). A three-way cost classification model for understanding the supply side of the firm. Journal Of Business And Educational Leadership, 6(1).

Horngren, C. T., Datar, S. M., & Rajan, M. V. (2012). Cost accounting: A managerial emphasis. Upper Saddle River, N.J: Pearson/Prentice Hall.

Park, W., Lee, K., Doo, S. Y., & Yoon, S. (2016). Investments for new product development: a break-even time analysis. Engineering Management Journal, 28(3), 158-167. doi: 10.1080/10429247.2016.1199747