Cost accounting is a type of managerial accounting with the objective to apprehend the company’s overall cost of production, done by assessing the variable cost of each stage of production, as well as its fixed costs like lease expenses. Categorization of cost accounting includes standard costing, lean accounting, activity-based costing and marginal costing.
UNDERSTANDING COST ACCOUNTING:
Cost Accounting takes into consideration all of the input costs that are associated with production processes, which includes both variable and fixed costs. Usually, cost accounting is used internally by the management of the company. The purpose of it is to have complete informed business decisions.
The motive of cost accounting is done internally by the company’s management for the identification of all variable and fixed costs that are associated with the process of production. Initially, costs will be first measured and recorded individually. Further, a comparison is made of input costs with the output results in order to measure accurate financial performance and make appropriate business decisions.
There are certain types of costs in cost accounting as described below:
- FIXED COSTS: Fixed cost is the type of cost that does not vary or depend upon the levels of production. Change in the levels of production, be it increasing or decreasing, would not cause any effect on these costs.
- VARIABLE COSTS: Variable costs are the kind of costs that are dependent on the levels of production.
- OPERATING COSTS: In the case of operating costs, the costs are associated with the day-to-day operations of the business. The operating costs might be fixed or variable. It usually depends on the circumstances.
- DIRECT COSTS: These costs are directly related to manufacturing or producing a product. Examples of direct costs include direct labour, direct material, wages and commissions.
- INDIRECT COSTS: Indirect costs are those costs that cannot be directly related to manufacturing or producing a product. Examples of indirect costs include production supervisor salary, depreciation, insurance and quality control costs.
COST ACCOUNTING VERSUS FINANCIAL ACCOUNTING:
A layperson might substitute cost accounting for financial accounting. Financial accounting provides information to external stakeholders or financial statement users. Typically, financial accounting is for investors or creditors. Financial accounting represents the financial position of the business via the use of financial statements, which consist of the necessary information for the external stakeholders such as its revenue, expenses, liabilities and assets.
Unlike financial accounting, it is not necessary for cost accounting to comply with any set standards and is flexible for the internal management requirements of the business. Cost accounting is also a very essential tool for the smooth running of the management and, also, in the setting up of the cost control programs, which also assist in better scope for net margins for the business in the future.
Another remarkable difference between financial accounting and cost accounting is that in financial accounting, the type of cost is categorized based on the kind of transactions occurring. But, on the contrary, cost accounting categorizes cost according to the information requirements of the management. Cost accounting, unlike financial accounting, also does not have to comply with any set standards, such as Generally Accepted Accounting Principles (GAAP). Thus, cost accounting differs in every company and, at times, also from one department to another.
TYPES OF COST ACCOUNTING:
Since organizations follow their own methods of cost accounting, as suitable to the circumstances, cost accounting has been classified as follows:
1. STANDARD COSTING
In the case of standard costing under cost accounting, ‘standard’ costs are assigned instead of actual costs to the Costs of Goods Sold (COGS) as well as to inventory. These standard costs are based on the efficient use of labour and materials to produce goods or services under certain standard operating conditions and they are generally the budgeted amount. Also, even though the company has assigned standard costs, it still has to pay the full expense of the actual costs incurred. The difference between the standard (efficient) and the actual cost is assessed and is known as variance analysis.
In case the variance analysis assesses that the actual costs are higher than the company expected with the standard, the resultant variance is unfavourable. Also, the vice-versa, if the variance analysis assesses that the actual costs are lower than the company expected with the standard costs, the resultant variance is favourable. There are two outputs generally, that contribute to a favourable or unfavourable variance. One is the cost of inputs, such as the cost of labour or the cost of materials. This is known to be a rate variance. Besides, there is also the efficiency or quantity of an input used. This is known as volume variance. As an example, if a company has expected to produce 500 products but ended up producing 600, the resulting cost of materials is higher due to the total quantity produced.
2. ACTIVITY-BASED COSTING (ABC)
In this kind of cost accounting, overhead costs from each department are assessed and assigned to specific cost objects, such as goods and services. The system of ABC is based on activities, which include unit or work or task or with a specific goal, for example, setting up machines for production, designing of goods, distribution of finished goods or even operating machines. Such activities are also considered to be cost drivers and are the measures used for the allocation of overhead costs.
Traditionally, the overhead costs were assigned to one generic measure, such as machine hours. But under ABC, analysis is done to find out an appropriate measure which is the cost drivers. This results in ABC being more accurate and insightful for the managers, while they review the costs and profitability of their specific products or services of the company.
3. LEAN ACCOUNTING
The main objective of lean accounting is the improvement of financial management practices within organizations. It is an extension of the philosophy of lean manufacturing and production. It has the objective of minimizing waste while productivity is optimized. An example of this is if the HR department is able to cut the downtime they waste, employees can optimize the same time on their goals.
Meanwhile, when we use lean accounting, the traditional costing methods have been replaced by value-based pricing and also lean-focussing performance measurements. Financial decisions are based on the impact of a business’ total stream value profitability. Value streams are essentially the profit centres of the company, which can be any branch or division that adds directly to the bottom line of profitability.
4. MARGINAL COSTING
This kind of cost accounting is also known as cost volume profit analysis. It is the impact of the cost of a product by adding another additional unit. It has high significance in making short term economic decisions. It helps the management identify the impacts of varying levels of costs, and volumes on the operating profit. Such analysis also helps management gain an insight into the potentially profitable products, sales prices to establish the existing products as well as the impact marketing campaigns have.
Cost accounting helps the management of companies ascertain cost, as well as gives them scope for identification as to where and how costs can also be controlled in companies to gain efficiency and increase profit margins. A lot of internal management decisions, as discussed, can be taken with the help of cost accounting. A very big advantage cost accounting also offers is how it is flexible and the management can ascertain it through various types and no standards need to be maintained for the same.