The Importance of Knowing the Full Cost of Goods and Services Production

According to Chen et al. (2014), financial managers in organizations need to know the full cost of producing goods and services to help the organization budget its services, reimburse external and internal providers, manage the costs of its programs internally, and calculate the fees a user should be charged when a program is funded based on cost recovery. Financial managers also need to determine the actual costs in the organization by isolating them and assigning them to specific accounts, products, or markets for effective cost management. Average costing results in financial management error because it ignores the most important differences between products and the fact that different markets, products, and customers incur various overhead costs (Boyd, 2022). Average costing also increases the likelihood of creating a broad product line and cost averaging, leading to average price decreases and increases. Average pricing may negatively impact an organization’s profitability because some customers are subsidized, and others are overcharged, leading to reduced sales volume, profit loss, and decreased market share.

Financial managers also need to know the full cost of producing goods and services to determine the fully allocated and directly attributable costs of the products and services from purchase to customer delivery. Therefore, the organization can effectively determine the cost of production and whether they are spending more than they are making. Knowing the full cost of producing goods and services also helps determine an organization’s break-even point and its relation to capacity and increase in volume. Financial managers can also use the full cost of producing goods and services to determine the incremental profit and costs on every product or service produced and sold over a specific break-even point. The full cost of production also indicates the organization’s cost structure, utilization of its capacity, and cost trends to predict profitability and performance.