Identifying Cost Elements
An Analysis Made for the Internal Accounting Structure

By: Emanuel Schwarz

March 8, 1999 (Pro2Net) If you had the opportunity to read my last article, I explained how to transfer external accounting's expenditure amounts to internal accounting's cost elements accounts.

The cost elements' classification of accounts is the very first structure in the internal accounting's chart of accounts.

From this first class of accounts (which will be identified with the number two), we shall begin. Consequently we must use great care to correctly identify the different amounts that will be incorporated in internal accounting, which then will help us to accurately establish the specific cost of production and the important appraisal of the cost of goods sold.

Let us start with a very basic first approach: We shall establish the code structure of our internal accounting's chart of accounts.

Class of Accounts. This is expressed by the first digit of the code. The cost elements class will be designated with the number two.

Group of Accounts. This is the identification by the next digit of the code. I recommend the use of only one digit in this position, for a total of nine groups in each class of accounts.

Main Accounts. These numbers should have only two digits, which will make it possible to create a total of roughly 90 main accounts. In my experience, I believe it is adequate to designate up to 90 main accounts within each group of accounts.

Sub Accounts. These should have a total of three digits. With a capacity of up to 900 sub accounts for each of the 90 main accounts within each group of accounts, we have created an adequate quantity of sub accounts for the code structure of the internal chart of accounts.

Sub-Sub Accounts. In case there is a need to increase the chart of accounts, we may allocate four digits for these sub-sub accounts, which would then increase the capacity of each sub account with some 9,000 accounts.

The code structure within the internal chart of accounts will be identified in following way.

   Class   Group   Main      Sub    Sub-Sub
      X       X     XX      XXX     XXXX

With this planned structure, we will now develop the following group of accounts.

2-1-00-000 Salaries and Wages
2-2-00-000 Benefits
2-3-00-000 Stores Withdrawal
2-4-00-000 Depreciation and Amortization
2-5-00-000 Adm. & Sales Costs
2-6-00-000 Utilities - Services
2-7-00-000 Financial Costs
2-8-00-000 General Costs
Let us now consider some main accounts that could be incorporated under some specific groups of accounts.
2-1-01-000 Salaries for Management and Professionals
2-1-05-000 Hourly Wages -- Direct
2-1-11-000 Hourly Wages -- Indirect
2-3-01-000 Stores Withdrawal of Direct Materials
2-3-11-000 Stores Withdrawal of Indirect Materials
2-3-41-000 Stores Withdrawal of Supplies
2-3-51-000 Stores Withdrawal of Spare-Parts
2-5-11-000 Administrative Costs of Professional Fees
2-5-12-000 Travel and Representation
2-5-13-000 Telephone and Fax
2-5-51-000 Sales Commissions
2-5-53-000 Advertising
2-6-11-000 Outside Services
2-6-15-000 Facility Services
2-8-06-000 Postage and Mailing Services
2-8-11-000 Employee Relations
2-8-21-000 Lease and Rentals
These main accounts can then be complemented with all necessary sub accounts to create an ideal information structure about all cost elements that the company may have.
All of these cost elements are accrued costs. They are accrued or "matched" costs of this accounting period and the company's functional activities. We should not approve costs that do not belong to this accounting period and to the functional activities. Instead we shall proceed with the same attention as we do when matching expenses toward revenues.
This matching procedure is very important. Since the newly developed internal chart of accounts will correctly establish the cost of goods sold and compare it with the corresponding sales revenues, there is no longer a need for accounts such as prepaid expenses in the general accounting structure. These prepaid accounts were developed for the purpose of matching the expenses toward the sales revenues. This approach of matching costs is only necessary in internal accounting.
This is a very important statement: We have created an absolutely new approach in our accounting philosophy.
Until now, there have been mixed definitions in general accounting (financial accounting) that actually correspond only to managerial accounting. We had to use these mixed definitions because there was not a separate internal accounting structure.
Therefore we had to use prepaid accounts to prevent mistakes in income statement presentations. Amounts for prepaid rent, prepaid insurance, etc. had to be included in the assets. We now have internal accounting and the philosophy of matching expenses, which solves the cost elements accounts. We no longer need any prepaid accounts in our assets.
An additional benefit to the internal accounting structure: Within the cost elements' class of accounts, we will open accounts that will register all necessary amounts regarding price, payment and efficiency variances.
These new details will be included in the stores withdrawal group of accounts to show management a clear structure of the variances that exist between actual price and standard price, actual labor hours and standard labor hours. All these variations will be referring to the job orders that we worked with.
With our new internal cost approach, we will be able to create absolutely new information that is as good as unthinkable with the old general accounting structure.
With this basic presentation of the cost element's accounts in internal accounting, you will now be able to see how the next steps must be realized.