What is Cost Formula Accounting

Cost accountants use a wide range of formulas and tools to show a company’s management various ways in which they can increase profitability and find problems. They also use financial formulas to reduce complicated financial data into an easily digestible format for review by management or third parties.

The formulas are used to simplify complicated calculations, show the costs of various production volumes, identify potential profit and loss and more.

For example, the cost volume profit formula, which calculates the company’s net operating income for a particular volume of production is:

Cost Formula

This formula is used to show how much volume of a particular product will contribute to the operating income of a facility and to its profits. You can add a third and fourth variable if there are additional costs such as depreciation.

Net Operating Income = (Unit Sales Price x The Number of Units Sold) – (Unit Variable Cost x The Number of Units Sold) – Fixed Costs

This formula includes the calculation for the contribution margin per unit sold. The contribution margin is the unit sales price minus the variable costs of production.

Once you know the contribution margin per units old (CMU), you can calculate the product’s operating income by subtracting (c), which is the fixed costs of production allocated to the unit. Fixed costs can be determined by finding out how much of the facility’s overhead and production hours are required to create one unit, and there can be several other methods used to determine fixed costs depending on the type of facility.

Once fixed costs have been determined for one unit, along with the contribution margin per unit sold, a wide range of different calculations can be performed by cost accounts to help a facility outline particular goals.

This is just one example of a common cost formula used in cost accounting.

Classifying Costs

In order for a business to properly calculate its operating costs, it must classify each of its costs as fixed or variable. Fixed costs are costs that stay at the same no matter what the volume of production is. Fixed costs include rent, insurance, annual business registration fees, property taxes, fixed salaries, etc.

Variable costs change as production levels increase or decrease. Examples of variable costs include material costs, shipping costs, sales commissions, server hosting, billable wages, credit card processing fees, etc.

The Formula for Total Costs

The formula for total costs is used to determine total production costs. This is another one of the key formulas used in cost accounting, and it shows how much revenue is required to operate the business for a period of time.

Total Production Costs = Total Fixed Costs + Total Variable Costs

This formula can be solved for varying periods such as months, quarters and years, and it can be used to compare one month’s production costs to another.

For example, if an energy drink company was found to have $50,000 of total fixed costs per month at its peak production volume of 20,000 energy drinks per month which include the company’s rent, property taxes, and insurance.

It also has $60,000 of variable costs which include the ingredients needed to create the energy drinks, employee wages, and shipping costs.

The Total Monthly Production Costs are $50,000 + $60,000 = $110,000.

Since we know these are the costs needed to produce 20,000 energy drinks, we know that it costs the company $5.50 of fixed and variable costs to produce one energy drink, or one unit of product.