What Is Cost Accounting?

A typewriter that has written the words “cost accounting.”

Cost accounting, or management accounting, is the art and science of preparing statements that will help an enterprise or small business make important financial decisions. Such preparation of statements entails collecting, analyzing, forecasting, and distributing relevant expenses. A form of managerial accounting, this process is only necessary for business-specific operations. Precisely, this is where the process differs from other forms of accounting. Whereas financial accounting involves relaying statements to an external audience, such as investors or creditors, cost accounting only relays statements internally.

With asset tracking solutions keeping track of internal costs has become effortless, accurate, and highly tailored to a given business’s exact needs. These asset tracking solutions integrate a business’s cost accounting system with its manufacturing management, in order to precisely monitor the entire supply chain. In doing so, businesses can immediately recognize disruptions, missing assets, or fluctuations in costs. This allows for the ability to make real-time decisions that can save time and money, as well as preserve operations from the front-end to the back-end.

What Is the Purpose of Cost Accounting?

Every company wants to maximize profits and minimize losses. The essence of cost accounting does just that. The purpose of cost accounting, then, can be thought of as how it is used to a business’s advantage.

The methods used within cost accounting assist in determining the true cost of goods. By knowing this, businesses can make better decisions when it comes to buying or selling products or services, as well as preparing budgets and estimating profits.

PRINCIPLES OF COST ACCOUNTING

Here are a couple of the core principle of cost accounting:

  • Identifying All Your Costs - This principle helps cost management accountants create a budget for their project, product, or activity. By creating a budget, money and resources can be effectively spent and allocated.
  • Eliminating Unnecessary Costs - Upon exploring each cost individually, cost management accountants can more easily decide which costs don’t deliver profit. Therefore, eliminating any unnecessary costs.
  • Cost Savings - Additionally, exploring each cost individually allows for the ability to make estimations about future costs. By doing so, a cost accountant can deter a business from making unprofitable decisions in the first place.

Types of Cost

To become familiar with the different types of cost, it is important to know the difference between that and cost objects. “Cost” is the amount spent in order to obtain a product or service. “Cost object” is who or what the individual cost is associated with. As noted below, some costs do not have a direct cost object.

Several types of cost are included within cost accounting, each of which holds its own purpose. Below are a few examples of the different types of cost:

DIRECT COSTS

Direct costs include everything that goes into producing a good or service that is directly traceable to a specific cost object, such as the labor costs, materials, and manufacturing supplies. For example, consider someone who builds tables. This builder’s work is a source of direct labor since it can be traced back to him. Additionally, the wood is a direct material and the nails needed for assembly are direct manufacturing supplies, as they can be traced back to a specific cost object.

INDIRECT COSTS

Since direct costs can be traced to specific cost objects, assigning a value to each is conceivable. Indirect costs, on the other hand, are not so easy to allocate as they apply to more than one business activity. To further expand on the person who builds tables, consider the lighting and HVAC expenses of his workshop. These are considered indirect costs as they do not apply to one activity. Rather, they encompass the entire production of building the table. Inventory management software, however, has largely solved this problem by integrating tracking and accounting for all your costs, whether direct or indirect. If this builder has a company with a certain number of workers, the indirect costs of lighting and HVAC can be precisely allocated using such software.

FIXED COSTS

As the amounts of goods or services produced or sold change, fixed costs stay the same. This is because fixed costs, also referred to as overhead costs, are independent of any specific business activities. Examples of fixed costs include mortgage or lease payments. A company that agrees to rent an office for $800 a month will continue to pay that fixed cost until their lease is up. Essentially, these costs stay the same in the short term.

VARIABLE COSTS

As their name suggests, variable costs fluctuate depending on the level of production. For example, consider a fireworks company that needs to buy more products before the Fourth of July in order to meet consumer demands. The fireworks company will then incur higher costs as their distributor attempts to keep up with the increased demand.

OPERATING COSTS

Operating costs are determined by a business’s day-to-day activities. These costs can be thought of as an accumulation of both direct and indirect costs. While a company’s daily operations include the indirect costs of rent and lighting, they also include the direct costs of labor and materials. By determining operating costs, businesses can compare their expenses and profitability to other companies in their industry. Such comparisons enable a business to know how well they are competing.

Types of Cost Accounting

Despite being utilized interchangeably, cost and cost accounting entail their own matters. As previously mentioned, “cost is the amount spent in order to obtain a product or service.” Whereas, cost accounting is the process of establishing budgets and standards in accordance with the total production cost. Below are a few examples of cost accounting:

ACTIVITY BASED COSTING

Activity based costing (ABC) takes into consideration the costs that cannot be directly determined, such as overhead or indirect costs. The method then assigns these costs to certain business activities, such as machine or labor hours. Essentially, these are used as cost drivers, or proxies, of non-direct costs. While this accounting method is more precise than traditional cost accounting, the amount of information needed to make the computations contributes to its difficulty in implementation.

LEAN ACCOUNTING

Lean accounting augments the process of lean manufacturing. Though the latter can be used to help a business eliminate waste and shorten the time between receiving and delivering orders, improvements in production can be hard to notice from simply observing workflow. Lean accounting quantifies such changes to operations into information that is both relevant and high-quality.

Since accounting and stock management throughout the supply chain are so interrelated, it pays to utilize software that integrates both. Such cohesion allows businesses the information they need to make the most advantageous decisions they can.

MARGINAL COSTING

Marginal costing determines how a business’s total production cost would change given they produced one additional product or sold one additional service. This accounting method assists manufacturers in optimizing for productivity by establishing the point at which they have achieved economies of scale.

Consider the cost of producing one laptop versus producing two laptops. If it costs $400 to produce one laptop, but $750 to produce two then the marginal cost is $350. In other words, producing an additional laptop costs less than what it did to produce the first one. This is determined by subtracting the cost of producing two from the cost of producing one. The marginal cost thereby informs a business that by increasing production they will decrease the average cost of laptops.

STANDARD COST ACCOUNTING

Standard cost accounting employs an expected cost in place of an actual one, and as such analyzes variances between the two. This process shows a business how productive they are being without the stress of having to gather the actual cost — though this will eventually have to be paid back. Additionally, the variance between the two can provide businesses a measure of how close or how far they are operating from the standard cost of production.

For example, consider a business that utilizes a specific material. If the standard cost of the material is much lower than the actual, management knows to investigate. Such a variance can be caused by missing or even stolen materials.

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