Policy Cost

Policy cost refers to the expenditure incurred as a consequence of a policy determined by the management of an organization, such as insurance premiums based on policies like key-man insurance.
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Definition

Policy cost is a term used in accounting to describe an item of expenditure that an organization incurs as a result of a management-dictated policy. These costs are typically directly related to specific policies the organization has in place. One common example is the insurance premium associated with a key-man insurance policy, where the cost (premium) is directly tied to the sum assured under the policy.

Examples

  1. Key-Man Insurance Premium:

    • A company takes out insurance on key personnel whose loss would significantly impact the business. The premium paid for this insurance policy is a policy cost.

  2. Employee Health Insurance:

    • If an organization decides to provide health insurance to its employees as a part of its HR policy, the premiums paid for this insurance reflect a policy cost.

  3. Environmental Compliance Costs:

    • An organization implements a policy to minimize its carbon footprint, resulting in expenditures on renewable energy or carbon credits, which are categorized as policy costs.

Frequently Asked Questions (FAQs)

What constitutes a policy cost?

A policy cost is an expenditure directly resulting from a policy decision made by management. This could include recurring costs like insurance premiums or one-time expenditures such as implementing new environmental regulations.

How are policy costs recorded in financial statements?

Policy costs are typically recorded as operating expenses in an organization’s income statement. They are thus part of the ongoing costs of conducting business based on management’s strategic decisions.

What are the benefits of identifying policy costs?

Identifying policy costs helps in accurate accounting and financial reporting. It ensures management is aware of the financial impact of their policies and can aid in budget planning and strategic reviews.

Can policy costs be controlled?

Yes, management can control policy costs by reviewing and amending policies periodically. For instance, they may re-evaluate the terms of insurance policies or renegotiate premiums to better manage these expenses.

  • Operating Expenses: Costs that an organization incurs during its normal business operations, including policy costs.
  • Key-Man Insurance: A life insurance policy that an organization buys on an individual’s life whose absence would significantly impact the business.
  • Budgetary Control: The method of managing an organization’s finances according to its budget, which includes controlling policy costs.
  • Strategic Planning: Involves setting goals and defining policies that may lead to policy costs, like investment in new technologies.

Online References

Suggested Books for Further Studies

  1. “Management Accounting: Principles and Applications” by Hugh Coombs, Dinos D. Philoppou, Ellis Jenkins
  2. “Strategic Cost Management: The New Tool for Competitive Advantage” by Shank and Govindarajan
  3. “Financial & Managerial Accounting” by Jan Williams, Susan Haka, Mark Bettner, Joseph Carcello

Accounting Basics: “Policy Cost” Fundamentals Quiz

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