Managing costs in a business is an important component of the work done by managers and accountants. Even if you, as a manager, are not directly involved in the accounting system processes, you will need to have a firm foundation in how the costs are budgeted and expended to make good planning decisions.

Costs are assigned to different “pots” in order to figure out product pricing, figure out profitability of a certain product line and to control spending. A cost object is anything that you might need cost data for, like a product, customers, jobs or an organizational subunit.  At this point, costs will be divided up by direct costs (those directly relating to the production of a product or service) and indirect costs (those costs that cannot be directly related to a particular product).

The value chain is the process of business functions that add value to the customer user of a particular product. Each of these processes involves costs, that need to be incorporated into the price of the product or service.  There are many business processes that add usefulness for the end user. Managerial accounting is a component in many of these processes.

This diagram shows how each step in the process adds value for the customer. Production in a service business would be the performance of the service. Managerial accounting is a part of each step! So in our previous unit, we discussed how managerial accounting is not a mandatory activity for a business. Can you see now how important the process is?  Without determining the costs of development and design, and incorporating them into the production, sales and distribution of the product or service, figuring out how much to charge customers would be a huge challenge.

Each department must communicate with the others in the value chain. If engineering is looking at designing a new product, marketing and manufacturing both need to be involved in the process. If the manufacturing department is unable to produce it, or there is no market for the product, why should engineering spend time and money designing it?

Let’s imagine a purchasing department that doesn’t discuss the quality of components with engineering or manufacturing departments. If they look only at the lowest priced component, without regard to quality, might the company end up with more scrap in manufacturing, or a higher number of customer complaints?

As you can clearly see, each step in the value chain is important, each works with the other, and managerial accounting ties them all together.