Cost accounting is a method used by companies to classify, monitor, and record costs associated with the production of goods and services. It helps in determining the total production cost, forecasting financial necessities, and making informed decisions.
This article explains several types of costs, including fixed, variable, direct, indirect, and operational, and how they play into cost accounting. It also dives into the differences between cost accounting and traditional accounting methods, presenting the unique role cost accounting plays in making a company more efficient and cost-effective. Through this accounting system, companies can control expenses, increase productivity, and make better production decisions, thereby ensuring profitable business operations.
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What is cost accounting?
It is defined as the process of classifying, tracking and recording expenses related to the total production of goods and services in order to aid forecasting, planning, budgeting and decision-making.
This accounting procedure is used by management to estimate the cost of manufacturing products or services by accessing and analysing each step of production. In other words, cost accounting is a process used to ascertain a company’s total production and cost value.
Return on equity: Highlights
- Cost accounting is used to understand the total cost incurred by a company for manufacturing a product or service.
- The objective of cost accounting is to determine the efficiency of a company’s production process.
- Cost accounting is further classified into four types – Standard costing, marginal costing, activity-based costing and lean costing.
- Cost accounting is not the same as financial or traditional accounting.
Types of costs
- Fixed costs
It is also called indirect or overhead costs, which can be defined as those costs that are incurred, irrespective of other variables, i.e., these costs are independent of the output or production levels. Rent, salary, equipment depreciation etc., can be classified under fixed costs.
- Variable costs
These are those that are dependent on output or production levels in a company. Raw material costs can be a primary example here, where the value constantly fluctuates based on several factors. Shipping costs, delivery fees, supplies costs etc., can also be classified as variable costs.
- Direct costs
Any expense or production costs that a company incurs directly to make a product or service are called direct costs. Labour, manufacturing supplies etc., come under direct costs. For instance, to manufacture a shoe, the direct costs can be the price of leather, rubber, shoe laces etc. Direct costs are also a type of variable cost where the value constantly fluctuates.
- Indirect costs
These are those that cannot be directly traced back to a product or a service. In the same example as above, electricity charges, shipping costs etc., will all be classified as indirect costs.
- Operational costs
Any expense a company incurs for its day-to-day activities can be classified as operating costs. Now, these costs can be variable or fixed, depending on the industry, the nature of the product or service and more.
Cost accounting Vs financial accounting
In the world of accounting, many use cost accounting interchangeably with financial accounting. But, both cost and financial accounting are different concepts.
Let’s read about the difference between cost accounting and financial accounting.
| Differences on the basis of | Cost accounting | Financial accounting |
| Meaning | Cost accounting is a system of accounting used by businesses and organisations to track various costs incurred over time. | Financial accounting is a system of accounting that records financial data, depicting the financial position of a company. |
| Use | Cost accounting is generally used by the management of companies. | Financial accounting finds its employment among creditors, shareholders, investors, and more. |
| Time | Cost accounting may be prepared as and when required by the management. | Financial accounting helps prepare financial statements, which are released quarterly or annually. |
| Data | Cost accounting makes use of both historic and predetermined costs. | Financial accounting uses only historical data. |
| Analysis | Cost accounting is used to study the overall cost structure of the company, like direct costs, production costs and more. | Financial accounting analysis of the profit and loss, revenue and expenditure over a period of time. |
| Purpose | Cost accounting can help a company understand its costs, how to control them and how to bring in higher productivity. | Financial accounting can help understand the overall financial health of a company. |
| Format | No set format is used for presenting the information. | Financial statements need to be prepared in a set format. |
| Forecast | It may be possible to employ forecasting techniques. | There is no scope for forecasting or estimation. |
Types of cost accounting
Cost accounting can further be classified into four types –
- Standard costing – This costing process predetermines the cost of production based on production efficiency and standards.
- Activity-based costing (ABC) – Activity-based costing is based on the process of identifying fixed/overhead costs from each manufacturing activity to determine efficiency and manpower allocation
- Marginal costing – Marginal costing is the additional cost that a company will need to incur to manufacture one additional unit of goods.
- Lean costing – Lean accounting uses the philosophy of lean manufacturing and production to save time and cost by focusing on value-adding activities and eliminating the rest.
Why is cost accounting used?
Cost accounting is used by business organisations and manufacturing companies to understand their cost structure and measure efficiency in terms of cost and time. It can help the management understand if its resources are being employed productively and where production gaps exist, if any.
Another advantage of cost accounting is that it can help a business make better production decisions. For instance, assume XYZ Ltd is a juice company. Using cost accounting, XYZ Ltd can determine profitable and non-profitable activities and raw material prices, manage stock, oversee labour productivity per unit, forecast supply and demand, plan for loss aversion, and more.
How does cost accounting differ from traditional accounting methods?
Traditional accounting typically allocates manufacturing overhead costs against units, labour hours and more. This allocation could be more efficient because it is based on a single factor. Though simpler to understand, this may give the internal management an inaccurate picture of the production cost.
In comparison, cost accounting provides better flexibility and visibility and can be moulded depending on specific requirements.
Conclusion
Companies use many accounting procedures to analyse their costs, expenses, and financial standing. Cost accounting is a procedure used to specifically read the total cost incurred by a company for producing a good or service. This accounting method classifies expenses into various categories based on their type and occurrence. It helps a company closely understand its production value and output, aiding decision-making.
