◄Previous: 4.1 Direct/indirect and fixed/variable costs

# 5 Why organisations need to know the costs of products, processes and services

Figure 11

Ascertaining the cost of something is an essential part of effective management in an organisation. This applies to the commercial, not-for-profit and public sectors of the economy. In fact, it applies to all organisations, whatever their nature and form. An organisation without the necessary understanding of its cost structure and cost control is rather like a rudderless ship, lacking clear direction and at risk of breaking up when it meets the shore.

Costs are shown in external financial statements (such as the income statement) but what is disclosed about them is determined by the needs of reporting to shareholders or other stakeholders. Such information may provide a useful insight into overall performance, but it is insufficiently detailed to be an in-depth analysis of specific activities, such as the labour cost of an individual product or how much a particular service costs. It is important to make clear therefore that such aggregate information is not adequate for day-to-day management of the organisation, which requires details about, for example, the cost of individual products or services for pricing decisions, and so on. In this context, costing comes into its own. It provides a powerful management tool to monitor and plan activities.

In any organisation, it is necessary to define clearly the nature of the product or services provided. This, in turn, will be the basis for defining the cost structure. The cost unit is defined as the unit of product or service for which cost is computed. Hence, a cost unit for a fruit juice factory might be a carton of fruit juice, while the cost unit for a firm of professional accountants could take the form of a given year’s tax computation for a particular client (depending on the type of work undertaken). Normally, the management of an organisation in the commercial and not-for-profit sectors, or the funding agencies in the public sector, decide what is a convenient cost unit.

◄Contents►Next: 6 Why organisations need costing systems

OpenLearn - Fundamentals of cost accounting and environmental management accounting
Except for third party materials and otherwise, this content is made available under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 Licence, full copyright detail can be found in the acknowledgements section. Please see full copyright statement for details.