What Is Cost Accounting?
Cost accounting is a managerial accounting process that involves recording, analyzing, and reporting a company's costs. Cost accounting is an internal process used only by a company to identify ways to reduce spending.
Cost accounting is helpful because it can identify where a company is spending its money, how much it earns, and where money is being wasted or lost.
Key Takeaways
- Cost accounting is the reporting and analysis of a company's cost structure.
- Cost accounting involves assigning costs to cost objects that can include a company's products, services, and any business activities.
- Cost accounting is helpful because it can identify where a company is spending its money, how much it earns, and where money is being lost.
- Having a clear idea of the costs associated with running a business makes it easier for management to boost profitability.
- Cost accounting is distinct and separate from general financial accounting, which is designed for outside audiences and heavily regulated.
Understanding Cost Accounting
Even though cost accounting is commonly called a costing method, the scope of cost accounting is far broader than mere cost. Costing methods determine costs, while cost accounting is an analysis of the different types of costs a company incurs.
Cost accounting has elements of traditional bookkeeping, system development, creating measurable information, and input analysis. For many firms, cost accounting helps create and measure business strategy in a more organic way.
Having a clear idea of the costs associated with running a business essentially makes it easier for management to devise ways to maximize productivity and profitability. Entrepreneurs and business managers rely on actionable information before making allocation decisions. Cost accounting buoys decision-making because it can be tailored to the specific needs of each separate firm.
Modern methods of cost accountingfirst emerged in the manufacturing industries, though its advantages helped it spread quickly to other sectors.
How Cost Accounting Is Used
Cost accounting can be applied to many areas of a business. Here are some examples of how it is used.
Cost Controls
Cost accounting is used to help with cost controls. Firms want to be able to spend less on their inputs and charge more for their outputs. Cost accounting can be used to identify inefficiencies and apply the necessary improvements needed to control costs. These controls can include budgetary controls, standard costing, and inventory management.
Internal Costs
Cost accounting can help with internal costs, such as transfer prices for companies that transfer goods and services between divisions and subsidiaries. For example, a parent company overseas might be the supplier for its U.S. subsidiary, meaning the U.S. company would be charged by the parent for any purchases of materials.
Expansion Plans
Companies looking to expand their product line need to understand their cost structure. Cost accounting helps management plan for future capital expenditures, which are large plant and equipment purchases.
Preparing Financial Statements
Cost accounting can contribute to preparing required financial statements, an area otherwise reserved for financial accounting. The prices and information developed and studied through cost accounting will likely make it easier to gather information for financial accounting purposes. For example, raw material costs and inventory prices are shared between both accounting methods.
Types of Costs in Cost Accounting
Businesses can incur many types of costs depending on their industry. Here are a few of the most common costs involved in cost accounting.
Direct Costs
A direct cost is a cost directly tied to a product's production and typically includesdirect materials, labor, and distribution costs. Inventory, raw materials, and employee wages for factory workers are all examples of direct costs.
Indirect Costs
Indirect costs can't be directly tied to the production of a product and might include the electricity for a factory.
Variable Costs
Costs that increase or decrease with production volumes tend to be classified as variable costs. A company that produces cars might have the steel involved in production as a variable cost.
Fixed Costs
Fixed costs are the costs that keep a company running and don't fluctuate with sales and production volumes. A factory building or equipment lease would be classified as fixed costs.
Operating Costs
Operating costsarethe costs to run the day-to-dayoperations of the company. However, operating costs—or operating expenses—are not usually traced back to the manufactured product and can be fixed or variable.
Cost Accounting vs. Financial Accounting
Financial and cost accounting systems can be differentiated based on their target audiences. Financial accounting is designed to help those who don't have access to inside business information, such as shareholders, lenders, and regulators. For example, retail investors who analyze financial statements benefit from a company's financial accounting.
Alternatively, cost accounting is meant for those inside the organization responsible for making critical decisions. Unlike financial accounting for publicly traded firms, there is no legal requirement for cost accounting.
Cost accounting is distinct and separate from general financial accounting, which is regulated by the Securities and Exchange Commission and the Financial Industry Regulatory Authority and is criticalfor creating financial statements.
What Are the Advantages of Cost Accounting?
Cost accounting is helpful because it allows executive management of companies to understand how to use their resources more effectively by tracking and measuring them and studying their effects.
What Is the Main Difference Between Cost Accounting and Financial Accounting?
Cost accounting is for inside use. It helps company management to make decisions and is tailored to the specific needs of each separate firm. This differs from financial accounting, which must follow a set template and is used to inform people outside the company, such as investors, about its financial performance.
What Are the 4 Types of Cost Accounting?
There are various forms of cost accounting. They include:
- Standard cost accounting
- Activity-based cost accounting
- Marginal cost accounting
- Lean accounting
The Bottom Line
Keeping on top of costs is essential for businesses. The objective is to maximize profitability; achieving that goal depends greatly on managing costs.
That’s essentially what cost accounting is designed to do. It helps managers and employees keep track of the costs associated with running the business, which is information that makes it easier to boost efficiency and profitability.
