COST REPORTING VERSUS COST CONTROL

Cost reporting is where the accounting system provides management with the accounting data after the opportunity has passed for management to respond to and correct the problems indicated by the data. When companies wait to enter the cost of their purchases until the bills are received, management does not know if they are under or over budget until the bills are entered, at which time the materials purchased have been delivered to the project and may have been consumed. The extreme case of cost reporting is where companies only look at the costs and profit for each project after the project is finished. Cost reporting is typified by the accounting reports showing where a company has been financially without giving management an opportunity to proactively respond to the data.

Cost control is where the accounting system provides management with the accounting data in time for management to analyze the data and make corrections in a timely manner. Companies that enter material purchase orders and subcontracts, along with their associated costs, into their accounting system as committed costs before issuing the purchase order or subcontract allow management time to address cost overruns before ordering the materials or work. Committed costs are those costs that the company has committed to pay and can be identified before a bill is received for the costs. For example, when a contractor signs a fixed-price subcontract he or she has committed to pay the subcontractor a fixed price once the work has been completed and, short of any change orders, knows what the work is going to cost. Accounting systems that track committed costs give management time to identify the cause of the overrun early on, identify possible solutions, and take corrective action. Cost control is typified by identifying problems early and giving management a chance to proactively address the problem. A lot of money can be saved by addressing pervasive problems—such as excessive waste—early in the project.

If a company’s accounting system is going to allow management to control costs rather than just report costs, the accounting system must have the following key components:

First, the accounting system must have a strong job cost and equipment tracking system. The accounting system should update and report costs, including committed costs and estimated cost at completion on a weekly basis. Having timely, up-to-date costs for the project and the equipment is a must if management is going to manage costs and identify problems early.

Second, the accounting system must utilize the principle of management by exception. It can be easy for managers to get lost in the volumes of data generated by the accounting system. The accounting system should provide reports that allow management to quickly identify problem areas and address the problems. For example, as soon as bills are entered into the accounting system, management should get a report detailing all bills that exceed the amount of their purchase order or subcontract. Problems that are buried in volumes of accounting data are often never addressed because management seldom has time to pour through all of the data to find the problems or if they are found they are often found too late for management to address the problem. Providing reports that flag transactions that fall outside the acceptable limits is a necessity if management is going to control costs. By having reports that flag items that fall outside acceptable limits, management can make addressing these items a priority.

Third, accounting procedures need to be established to ensure that things do not fall through the cracks. These procedures should include things such as who can issue purchase orders and what to do when a bill is received for a purchase order that has not been issued. The procedures should also identify the acceptable limits for different types of transactions. Procedures ensure that the accounting is handled in a
consistent manner and give management confidence in the data that it is using to manage the company.

Finally, the data must be easily and quickly available to management and other employees who are directly responsible for controlling costs. It does little good to collect cost data for use in controlling costs if the data cannot be accessed. Where possible the reports should be automatically prepared by the accounting software. This eliminates the time and effort needed to prepare the reports manually. Additionally, frontline supervisors who are responsible for control costs should readily have access to their costs. Holding supervisors responsible for costs at the end of a job while not giving them access to their costs throughout the project denies them the opportunity to proactively control costs.

The accounting system for many construction companies consists of three different ledgers: the general ledger, the job cost ledger, and the equipment ledger. The general ledger tracks financial data for the entire company and is used to prepare the company’s financial statements and income taxes. The job cost ledger is used to track the financial data for each of the construction projects. The equipment ledger is used to track financial data for heavy equipment and vehicles. All construction companies should have a general ledger and a job cost ledger. Companies with lots of heavy equipment or vehicles should have an equipment ledger.

Managing Costs and Profits

Financial managers are responsible for managing the company’s costs and earning a profit for the company’s owners. Financial managers rely heavily on the reports from the accounting system in their management of costs. Managing the company’s costs and profits includes the following duties:

■ Controlling project costs.
■ Monitoring project and company profitability.
■ Setting labor burden markups.
■ Developing and tracking general overhead budgets.
■ Setting the minimum profit margin for use in bidding.
■ Analyzing the profitability of different parts of the company and making the necessary changes to improve profitability.
■ Monitoring the profitability of different customers and making the necessary marketing changes to improve profitability.

ENGINEERING DECISION MAKING FOR CURRENT COSTS AND EXAMPLES.

Some of the easiest forms of engineering decision making deal with problems of alternate designs, methods, or materials. If results of the decision occur in a very short period of time, one can quickly add up the costs and benefits for each alternative. Then, using the suitable economic criterion, the best alternative can be identified. Three example problems illustrate these situations.

EXAMPLE 1

A concrete aggregatemix is required to contain at least 31% sand by volume for proper batching.

One source of material, which has 25% sand and 75% coarse aggregate, sells for $3 per cubic meter (m3).Another source, which has 40% sand and 60% coarse aggregate, sells for $4.4O/m3.

Determine the least cost per cubic meter of blended aggregates.

SOLUTION

The least cost of blended aggregates will result from maximum use of the lower-cost material.

The higher-cost material will be used to increase the proportion of sand up to the minimum level (31%) specified.

Let x = Portion of blended aggregates from $3.00/m3.source
1 - x =Portion of blended aggregates from $4.40/m3 source

Sand Balance

Thus the blended aggregates will contain

60% of $3.00/m3 material
40% of $4.40/m3 material

The least cost per cubic meter of blended.aggregates is

EXAMPLE 2

A machine part is manufactured at a unit cost of 40 C for material and 15C for direct labor. An investment of $500,000 in tooling is required. The order calls for 3 million pieces. Halfway throughthe order, a new method of manufacturecan.be put into.effect that wi11 reduce the until costs to 34 C for material and 10 C for direct labor but it: will require $10000 for additional tooling. This tooling will not be useful for future orders. Other cost are allocated at 2.5 times the direct labor  cost. What, if anything , should be done?

SOLUTION

Since there is only one way to handle first 1.5 million pieces, our problem concerns only the second half of the order

Before making a final decision, one should closely examine the Other costs to see that they do, in fact, vary as theDirect labor cost varies.Assuming they do, the decisionwould be to change the manufacturingmethod.

EXAMPLE 3

In the design of a cold-storage warehouse, the specifications call for a maximum heat transfer through the warehouse walls of 30,000 joules per hour per square meter of wallwhen there is a 30°C temperature difference between the inside surface and the outside surface of the insulation.

The two insulation materials being considered are as follows:

SOLUTION

There are two steps required to solve the problem. :First, the required thickness of each of the alternate materials must be calculated. Then, since the problem is one of providing a fixed.output (heat transfer through the wall limited to a fixedmaximum amount), the criterion is to minimize the input (cost).

The foamed insulation is the lesser cost alternative.However, there is an intangible constrain that  must be considered.How thick is the available wall space? Engineering economy and the time  value of money are needed to decide what the maximum heat transfer should be.What is the cost of more insulation versus the cost of cooling the warehouse over its life?