Cost is not just one number; it varies with its intended purpose. Costs are generally used for four main purposes The first one is to decide. Every time managers face a decision, they should apply the concept of relevant costs and revenues since they reflect expectations about the future cash flows of different alternatives. Relevant costs and opportunity costs go together. The cash flow of the second best alternative is an opportunity cost.
The second purpose of cost information is to evaluate the long-term profitability of product and services. This requires the use of a cost system because it estimates the value of the resources used to do something like performing a task, running a department, manufacturing and distributing products, or serving a customer. With cost information, managers are in a better position to make sure that the selling price of products and services pay for the variable (usually the only short term relevant costs) and fixed costs.
The third purpose is to plan for the future and evaluate how events are unfolding. Once the management team has decided on a course of action, periodic evaluations should be conducted to assess the situation against the plan and change the course of action if needed. In fast moving markets evaluation has also become crucial for encouraging learning.
The fourth purpose is to provide input to financial accounting. Companies have to value inventories and cost of goods sold in their financial statements. This requires the estimation of costs following financial accounting principles (rules). Actually, this purpose was very important during most of the twentieth century, and decision-making and profitability evaluation were basically ignored in managerial accounting training.
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