Cost accounting is a form of management accounting that records, analyzes and reports company's variable and fixed costs. It thus makes it possible to know the total cost of production of a company. Accountants in this field are specialists who determine the costs associated with providing a service or manufacturing a product and bringing it to market by analyzing spend within the supply chain and measuring actual costs such as labor, shipping, production and administration, both for a function and at the unit level.
The key points of cost accounting
Cost accounting is used internally in the company by management in order to make business decisions.
Unlike financial accounting, which provides financial information and statements to external users, cost accounting is not required to meet established standards and can be flexible to meet the needs of management.
Cost accounting takes into account all costs associated with the production and marketing of the products and services offered by the company, including variable and fixed costs.
The types of cost accounting are standard cost, cost per activity, lean accounting, and marginal cost.
How does cost accounting work?
Cost accounting first measures and records costs individually, then compares input costs to output results in order to measure financial performance and make future business decisions. There are many types of costs involved in cost accounting:
- Fixed costs are costs that do not vary regardless of the level of production. This is usually the mortgage or lease payment on a building or equipment that is amortized at a fixed monthly rate.
- Variable costs are costs related to the level of production of a business, the more seasonal the activity, the more impact it will have.
- Operating costs are the costs associated with the day-to-day operations of a business. They can be fixed or variable.
- Direct costs are costs specifically related to the production of a product that include the cost of time spent on production.
- Indirect costs are costs that cannot be directly linked to a product, such as costs linked to the company's consumption of electricity.
Cost accounting vs. Financial accounting
While cost accounting is used by the management of a business to aid in decision making, financial accounting is communicated to outside investors and creditors. Financial accounting includes the preparation of financial statements, which include information on the income, expenses, assets and liabilities of the business. Cost accounting is a budgeting management tool that helps in setting up cost control programs to improve the company's net margins in the future.
An essential difference between cost accounting and financial accounting is that in financial accounting, cost is classified according to the type of transaction while cost accounting classifies costs according to the information needs of management. Cost accounting, a company internal tool, must not meet any specific standard such as generally accepted accounting principles (GAAP). Thus, its use varies from one company to another or from one department to another.
Types of cost accounting
Standard costing assigns “standard” costs, rather than actual costs, to its cost of goods sold (COGS) and inventory. They are based on the efficient use of labor and materials to produce the good or service under standard operating conditions. They thus correspond to the budgeted amount. However, the company still has to pay the actual costs.
Evaluating the difference between the standard cost and the actual cost is called a gap analysis. If the variance analysis determines that the actual costs are higher than expected, the variance is unfavorable. Conversely, if it determines that they are lower than expected, the difference is favorable. The cost of input, the cost of labor and materials influence this gap. This is considered to be a rate variance. There is also the efficiency or the amount of input used which introduces volume variance. If, for example, a company plans to produce 400 products over a period of time but ends up producing 500 products, the material cost would be higher because of the total quantity produced.
Activity-based valuation (ABC) identifies the overhead costs of each department and assigns them to the goods or services marketed by the business. The ABC system of cost accounting is based on activities, that is, any event, unit of work or task with a specific objective, such as the installation of machines for production, product design, distribution of finished products or the use of machinery. These activities are cost drivers and are used as the basis for the allocation of overheads.
ABC therefore tends to be much more specific and useful for managers who need to consider the cost and profitability of specific services or products in their business.
The main goal of lean accounting is to improve financial management practices in a business. Lean accounting has the stated intention of minimizing waste while maximizing productivity. For example, if an accounting department is able to reduce wasted time, employees can focus more productively on value-added tasks.
In lean accounting, traditional costing methods are replaced by value-based pricing and lean-driven performance metrics. Financial decision making is based on the total profitability of the company's value chain. Value streams are the profit centers of a business.