Cost Accounting For Dummies
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In cost accounting it’s necessary to connect the relevant cost and relevant revenue to the capacity planning. After all, capacity is limited. Relevant, of course, refers to the cost and revenue that makes a difference when you make decisions.

Here’s an example. A pastry chef creates and delivers specialty desserts to local restaurants and had seven restaurants as clients. The type of product isn’t relevant because each client gets the same selection of desserts, but in varying quantities.

With only seven restaurants, it’s relatively easy for her to separate data about each one. If the products are identical for each client, there must be other cost and sale factors that could determine which clients are more profitable.

Research pays off. It turns out that five clients consistently placed their dessert orders a week in advance. This gave the chef time to plan ingredient purchases and production. She had two large commercial ovens at home, which allowed her to bake a large number of items at a time. Her production time was baking time, and normal production was a smooth process.

During her review, she noticed that two clients, the Blue Heron and the Lakeside Café, didn’t give her as much notice. On average, they placed orders just three days in advance. As a result, she had to scramble. Her purchasing and production had to be changed.

There’s a financial impact, and it’s relevant. The chef had to buy additional ingredients (such as flour, milk, eggs, sugar, and specialty food items) at the last minute — all the time.

Also, she had to buy less than her normal amounts. And she had to make extra trips back to her suppliers to buy for the two late-ordering customers. The chef paid relatively more for smaller amounts of ingredients, and her driving cost was the same as for a normal buy.

She should have passed those higher costs on to the Blue Heron and the Lakeside Café. Being a diplomat, she would have explained the situation to them. Before she sent any invoice with higher prices, she should have explained that ingredient costs were higher because they ordered later than other clients. “If you order a week in advance, the product cost will be lower, Mr. Customer!” Maybe this explanation would have changed the client’s behavior.

What type of restaurant would be the ideal new customer? One that orders one week in advance. Her policy would be to be clear up front about ordering, maybe saying, “If you can’t do that, Ms. New Customer, I charge a 5 percent fee. I run up more costs by ordering materials later than planned. I’m sure you can understand that.” That will sound perfectly reasonable to the client.

If you know of customer behaviors that increase your costs, you can do something about it! You can actually coach or train your clients, so you don’t have to pass on the additional cost to them. They can change their behavior and get a better price.

Managing a business requires you to make decisions. In fact, you are making a business decision when you choose to do nothing. As you gather and analyze data, focus on your relevant costs and revenue. Relevant costs and revenue will be different, depending on the decision that you make. When you consider relevant information, you can make a well-informed business decision.

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Kenneth W. Boyd has 30 years of experience in accounting and financial services. He is a four-time Dummies book author, a blogger, and a video host on accounting and finance topics.

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