Purpose of Cost Classification in Managerial Accounting

Managerial accounting focuses solely on a company’s internal processes. Proprietary in nature, accounting and other data collection systems pull in production and service data; accountants classify this information where it belongs. Reports from this data allow a manager to control the production process, define production goals as well as analyze the data to make informed decisions.

One of the first purposes of cost classification in managerial accounting, used in financial reporting as well, is the classification of production costs. Used also to determine the gross revenue margin of a company, raw materials and supplies; wholesale product and direct labor calculate directly into the cost of production. Capturing these values through cost classification allows the manager to know how much it’s costing the company to manufacture its product.

Proper cost classification, handled by a company’s accounting system and accounting department, allows a manager to know what data makes up the product cost as opposed to material costs for repairing the production line, or how much time a maintenance man spent on a specific repair. In manufacturing, every nut and bolt is accounted for and applied to its use. Cost classification allows a manager to make evaluations based on accurate classification of data.

Managers also use accounting reports to determine areas ripe for cost-cutting measures. Reports that show an increase in expenses in one area may also reveal problems in reporting. Perhaps data was entered into the wrong account and needs to be corrected. Cost classification allows the manager to control processes and cut costs where needed, and perhaps send more resources to an area of the process that is lacking. It also allows him to review reports and advise accounting of needed adjustments in cost classification.

Cost accounting, a subset of both managerial and financial accounting, ascribes a value to the costs used in creating a product or service. By using reports that show these cost classifications, a manager may determine where production costs are higher than anticipated, which might raise the price of a product. Inversely, this may indicate that he needs to look at other suppliers for his raw materials or consider reallocating labor to reduce the costs associated with the product. He could not do this without knowing what these costs are, and cost classification provides him with this information.