The Basics of Cost Accounting

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If you don't understand accounting and how to handle your money, the business world can be a difficult place to work in. Understanding the expenses of a product or service, whether you make it or deliver it, is critical to your corporate strategy and sales, growth, and development goals.

Cost accounting is a business activity that involves recording, examining, summarizing, and comprehending the money spent by a company on a process, product, or service. It may assist a business in cost control and strategic planning to increase cost efficiency. Cost accounting assists management in determining where to minimize expenses and where to raise costs.

Cost accounting involves the study and classification of expenditures in such a way that the entire cost of any given unit of product or service may be determined with a fair degree of accuracy while also disclosing how that total cost is made up. For example, knowing the cost of a product is $25 isn't enough; management wants to know the cost of the materials used, the quantity of labor, and other expenses involved in order to keep costs under control and lower them.

It creates budgets and standard costs, as well as the actual cost of operations, processes, departments, or goods, as well as variance analysis, profitability, and social use of money.

Why Is Cost Accounting Important?

There are several advantages to cost accounting. Below are a few cost accounting examples of how it might benefit a company:

1. Cost control

Cost accounting aids management in anticipating the cost and selling price of a product or service, which aids in the formulation of company strategies. With the cost value as a guide, management may devise cost-control measures with the goal of maximizing profitability.

2. Calculating the per-unit cost:

Cost accounting techniques assist in calculating the overall per-unit cost of a product or service so that the firm may set the selling price.

3. Displaying profitable and non-successful operations:

This data aids management in eliminating non-profitable activities while growing and increasing profitable ones.

4. Cost comparison over time:

The data in the cost sheets created for various time periods aids in cost comparison over time for the same product or service.

Cost Accounting Vs Financial Accounting

Cost accounting and financial accounting both operate with the same data from the company's records and follow the same concepts. The distinction between the two is that financial accounting calculates the profit and loss of the company as a whole, whereas cost accounting calculates the cost per item and the profit or loss of specific goods.

Let's go through some of the differences between the two:

  • Cost accounting definition states that it is a business activity that tracks and controls the cost per line item for a business. Financial accounting, on the other hand, captures financial information for an entire firm and shows profitability and financial status at a certain point in time.

  • Historical (cost of acquiring asset) and projected expenses are recorded in cost accounting. Financial accounting, on the other hand, merely keeps track of past costs (accrued during specified time).

  • Employees, directors, and managers, among others, utilize cost accounting to examine and manage their internal operations. External stakeholders in the market, including shareholders, creditors, and prospective investors, as well as credit rating agencies, adopt financial accounting.

  • Cost accounting records monetary as well as non-monetary transactions such as units. Financial accounting, on the contrary, records only monetary transactions.

  • There is no fixed reporting time for the reports prepared in cost accounting. Reports are prepared whenever they are required and presented to the management. In financial accounting, reports are prepared at the end of the accounting period, usually one year.

  • Any statement in cost accounting is not mandatory to be prepared for the public. On the other hand, it is mandatory for public companies to announce results prepared as part of financial accounting.

  • Profit is calculated for a specific product or batch of products in cost accounting. This allows management to focus on profitable products while eliminating the less profitable ones. In financial accounting, income, costs, and profits are assessed as a whole for the company.

  • In cost accounting, there are no predefined formats for capturing or reporting information. The goal is to keep track of everything vital. This is not the case, however, with financial accounting accounts. Independent authorities have created and controlled predefined concepts like GAAP and IFRS.

Elements of Cost in Cost Accounting

Cost is divided into three categories: material, labor, and expenditures. Each one is broken down further into two categories; direct costs and indirect costs. Overhead costs are made up of indirect materials, labor, and expenses.

Material Costs

This is the cost of the raw materials utilized to make a product. It is further subdivided into direct and indirect material.

  • Direct material is defined as materials that are directly engaged in the manufacturing of a product and are included in the completed product. For instance, wood is used to produce furniture, while the fabric is used to manufacture shirts.

  • Materials that are used in the manufacturing of completed items but cannot be attributed to particular physical units are referred to as indirect materials. A pair of scissors, for example, may be used to cut the cloth for a shirt or a saw to cut the wood for furniture.

Labor Costs:

The costs associated with the human resources necessary to transform raw materials into finished items are referred to as labor costs. They can be divided into two types: direct labor and indirect labor.

  • People who are directly involved in the production of goods are referred to as direct labor. For instance, manufacturing or production workers.

  • Personnel not directly involved in the production process and whose labor cannot be ascribed to a specific product are considered indirect labor. Sales reps and directors, for example.

Expenses:

This category includes all costs incurred by a firm other than material and labor costs. They're further broken down into direct and indirect costs.

  • Direct expenses, also known as chargeable expenses, are expenses that are connected with specific cost units. Direct labor, raw material costs, utilities, and rent are just a few examples.

  • Indirect expenses are any expenses that do not come under the category of direct expenses. Printing charges, electricity bills, and legal advice are just a few examples.

Overhead costs:

Generally, overhead costs are seen to be identical to indirect expenses. Overhead, on the other hand, include indirect labor, indirect materials, and indirect costs.

There are 3 categories of overhead costs namely: Factory overhead, Office and admin, Selling & distribution overhead.

  • Overhead costs incurred as a result of manufacturing, production, or any other form of expense that is essential for a factory's smooth operation are known as factory overhead. For instance, rent, insurance, and utilities at the factory.

  • Office and administrative overhead are costs associated with a company's management and administration. Rent of office, printers, and stationery are a few examples.

  • Selling and distribution overhead refers to the costs of marketing a product, taking orders, and delivering products and services.

Methods of Cost Accounting

Cost accounting is classified into various cost accounting systems including but not limited to:

  1. Marginal Costing

The additional cost of producing an additional unit of production is known as marginal cost. The cost-profit-volume analysis is another name for this method. The link between production volume, selling price, costs, expenses, and profits is studied using marginal cost analysis. It's worked out by removing variable costs from revenue and then dividing by revenue.

  1. Activity-based Costing

This technique allocates the cost of each activity done in an organization to a specific product or service. First, activity analysis is used to determine how these expenses are attributed to cost objects. This increases the accuracy of the cost of products and services.

  1. Standard Cost Accounting

In a standard setting, this sort of cost accounting utilizes ratios to assess the usage of labor and materials to generate goods. Variance analysis is the term for this type of analysis. This strategy, however, is a little out of date. Labor was a key cost driver when it was first introduced a century ago, so it seemed reasonable to use it as the only cost measurement. In comparison to labor, overhead expenses have risen over time.

  1. Lean Accounting

Lean accounting is a set of ideas and procedures that gives numerical feedback to manufacturers who use lean manufacturing and inventory management techniques. Management may use lean manufacturing to speed up processes, eliminate inefficiencies, and frees production capacity. It gives you the financial and non-financial data you need to implement the lean approach and achieve financial success.

Cost Accounting Standards

The Cost Accounting Standards (CAS) are a collection of guidelines aimed at achieving "cost accounting uniformity and consistency." They are a collection of 19 standards and guidelines established by the United States government to be utilized in determining costs on negotiated contracts. The Cost Accounting Standards Board (CASB) established those comprehensive principles for the financial management of funded projects.

Cost accounting is a method of tracking and assessing the costs of goods and services in order to aid in strategic planning and cost reduction. It is critical for many stakeholders in a company, including management, employees, and customers. Despite their similarities, cost accounting and financial accounting provide distinct outcomes. Financial accounting shows you the profit and loss for the firm as a whole, whereas cost accounting shows you the cost of manufacturing specific things. While employing a specialized cost accounting system has its advantages, a firm that is efficient enough to keep track of its own expenses can handle all of its data without one.