Keeping track of, analyzing, summarising, and studying the costs incurred by the firm for any procedure, service, product, or other elements of the organization is a part of the business discipline known as Cost Accounting. This supports the company’s efforts to manage costs, plan strategically, and make decisions that will increase cost-effectiveness. The management can see their cost information thanks to such financial statements and ledgers. Managers can view their spending information through these financial reports and ledgers. Managers gain insight into where they need to minimize costs and where they need to boost spending, which aids in the development of a vision and strategy.
In this article, we will discuss What is Cost Accounting, its scope, and its importance, followed by its characteristics. After that, we will see different types of cost accounting such as marginal costing, activity-based costing, standard cost accounting, and lean accounting. In the end, the advantages and disadvantages of cost accounting are also discussed.
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Cost Accounting Definition and Its Importance
According to the ICMA, London, “Cost accounting is the process by which we can record costs. It starts when an item is spent or committed and concludes when its final connection to cost centers and cost units is established. In its widest definition, it encompasses the gathering of statistical data, the use of cost-control measures, and the assessment of the profitability of current or upcoming activities.”
We need to look at more than just the definition of cost accounting to fully comprehend what Cost Accounting is. We are aware that cost accounting is typically thought of as the industry’s total costs. This is accomplished by reviewing information on the costs incurred by the management of that organization, assigning accurate costs to different goods and services, and assessing the efficiency of financial management. Gaining insight into how a firm creates and spends value, as well as contributing to potential future profit-generating activities, is the main goal of cost accounting.
The methods and procedures for determining costs are part of costing. The term “technique” refers to a set of guidelines used to estimate the price of goods, labor, and services. The daily practice of calculating expenses within the technique of costing used by a corporate company is referred to as the “process.”
The management of a business, whether it be in manufacturing or services, in the public or private sector, for-profit or not, in the military or civilian life, would see to it that cost accounting receives the proper attention.
Important terms related to Cost Accounting
- Cost – The Chartered Institute of Management Accountants (CIMA) has defined cost as “the amount of spending incurred or credited on a particular product.”It may be explained more simply as anything that is sacrificed or given in exchange for another good or service.
- Costing – Costing is the process of categorizing, documenting, and appropriately allocating expenditures to calculate the costs of goods or services and to provide data in an organized manner for management control and direction.
- Cost Accountancy – It is the use of cost accounting and expenditure accounting theories for improved corporate management while taking into consideration the concept of profitability. Moreover, it entails the presentation of information gathered for management decision-making.
- Management Accounting – In both the public and commercial sectors, management accounting refers to the application of accounting and financial management concepts to the creation, defense, preservation, and growth of value for stakeholders in for-profit and non-profit companies.
- Cost Management – The information needed to plan, manage, and control costs is provided via the application of management accounting concepts, data collection methods, data analysis, and data presentation.
Importance Of Cost Accounting
Cost accounting plays a significant role in determining and controlling the cost of services, and the use of cost accounting systems is one of the success factors for any commercial activity. It is important for all businesses, contrary to popular belief that it is only important for manufacturing firms.
These are some reasons why Cost Accounting is significant:
- By gathering and documenting all of the company’s cost components, cost control is achieved.
- We can distinguish between all forms of expenses thanks to cost accounting methods for classifying costs.
- Since cost accounting generates cost reports, the product price has a substantial impact on regulating product pricing.
- The corporation may establish budgeting using cost accounting techniques, but to do so, it must first study its actual activity costs from prior years to project what its future expenses would be.
Nature and Characteristics of Cost Accounting
Nature of Cost Accounting
- Cost Accounting is a systematic body of knowledge with unique principles, ideas, and customs. Many industries have different versions of these guidelines.
- Cost accounting is a science since it is an organized body of knowledge that covers a wide range of topics, including legislation, office practices, and procedures, data processing, production, material management, etc.
- Cost accounting is an art in that it necessitates the competence and expertise of the cost accountant to apply the concepts, procedures, and methods of cost accounting to a variety of management issues. These issues include determining expenses, controlling costs, determining profitability, etc.
- Cost accounting is a profession – It has emerged as one of the major careers that have grown increasingly difficult in recent years. These two facts make this opinion clear. First, several institutions have sprouted up in various nations, raising people’s knowledge of the pricing profession. Second, many students have enrolled in these institutions to gain memberships and cost credentials that would enable them to support themselves financially.
Characteristics of Cost Accounting
The main characteristics of Cost Accounting are as follows:
- A specialized area of Accounting – It is a specialized area of accounting that deals with the gathering, grouping, documenting, allocating, figuring out, and controlling of costs. It has its notions and customs even though it is built on a double-entry system.
- Several Overall Cost Components are Determined – By the processes of accumulation, categorization, analysis, and recording, which determine the cost of goods and services. This system’s primary purpose is to calculate overall cost and cost per unit. Moreover, if the work is left unfinished, it calculates the cost of the unfinished project or work.
- Beneficial to Management – This system offers information, control measures, and management recommendations for different levels of management.
Cost Accounting Cycle
The actions related to the creation, journalizing, posting, and control of account and subsidiary ledger adjustments of source documents are all included in the cost accounting cycle. When accounts are closed, the cycle is completed by providing the income statement, which contains the results of operations for the accounting period.
The steps included in the Cost Accounting Cycle are as follows :
- Recording Cost Data: It is the first step of cost accounting. In this step, we determine the cost of production by recording the cost of each element.
- Classification of Cost: In this step, Cost accounting categorizes the cost by its function, nature, and behavior.
- Determining the Total Cost: The cost of goods sold for a product is computed in this phase of cost accounting. The total of all expenses incurred during the manufacturing of the commodities that are sold is referred to as the cost of goods sold.
- Unit Cost: In this step, Unit Cost is calculated by dividing the cost of items sold by the overall number of units sold.
- Selling Price: Adding a profit margin to the cost of sales yields the selling price.
- Cost Control and Decision Making: It is the last/final step of the Cost Accounting Cycle. It involves controlling costs and making a choice utilizing a budget and budgetary management system.
Types of Cost Accounting
1. Standard Cost Accounting
In this type of Cost Accounting, we determine and examine the discrepancy between the cost that should have been spent to create the items and the cost that was spent. The expenditures incurred to transport the items are the standard cost. Direct labor expenses, product costs, direct material costs, and manufacturing overheads are included. It compares how effectively labor and resources are being used (or could be used) to generate products and services under typical conditions by using various ratios. Finding the deviations and examining their potential causes of them is one of the main goals of standard costing. The fact that traditional cost accounting stresses labor efficiency even though labor expenses represent a small portion of costs in contemporary businesses is one of its problems.
2. Activity-based Cost Accounting
In activity-based costing (ABC), overhead expenses from each department are identified and attributed to particular cost items, such as products or services. The ABC method of cost accounting is based on activities, which are any event, unit of labor, or activity with a particular objective, such as assembling industrial equipment, creating products, distributing completed items, or running machinery. These activities are also regarded as cost drivers, and it is based on them that overhead expenses are allocated. As activity-based costing is thought to be more precise, managers will find it more helpful in evaluating the price and profitability of the goods and services provided by their organization.
3. Lean Cost Accounting
The idea of lean manufacturing and production, which has the explicit goal of reducing waste while increasing productivity, is expanded by lean accounting. The primary objective of lean accounting is to enhance internal financial management procedures. Value-based pricing and lean-focused performance metrics are utilized in place of conventional costing techniques when implementing lean accounting. Based on the effect on the company’s overall value stream profitability, financial decisions are made. Value streams, or any branch or division that directly contributes to a company’s bottom line profitability, are its profit centers.
4. Marginal Cost Accounting
The effect of adding one more unit to the production process on a product’s cost is known as marginal costing (also known as cost-volume-profit analysis). For making short-term financial decisions, it is helpful. It can assist management in determining how different cost and volume levels affect operational profit. Management may utilize this kind of research to learn more about potentially lucrative new items, how much to charge for existing products, and the results of marketing initiatives. The break-even point is determined by dividing a company’s total fixed expenses by its contribution margin. The break-even point is the production level at which total revenue for a product equals total expense. It is possible to compute the contribution margin on a per-unit basis to establish how much a particular product contributes to the company’s total profit. The contribution margin is determined as the sales revenue less variable expenses.
Pros and Cons of Cost Accounting
- Fixation of responsibility: The establishment of a cost center entails the creation of a certain type of interaction between superiors and subordinates. As a result, everyone who is worried about cost incurrence has responsibilities.
- Measures economic performance: Standard costing and budgetary control are two cost-control methods that may be used to determine how well a corporation is performing.
- Price fixation: By supplying cost information, management is aided in setting the selling price in advance. As a result, quotes may be sent to potential clients to obtain orders.
- Making decisions is made easier: Based on cost reports, it helps management decide whether to make or buy, switch from manual labor to machines, or shut down or continue operations.
- Reduces losses and waste by helping: The use of a cost accounting system makes it possible to identify material losses, idle time, and underutilized equipment.
- Future production policy is guided by it: Management can make future production policy decisions using cost data. Future production expansion or contraction will be determined by historical cost data.
- It is expensive: Cost accounting systems require additional costs to be incurred for installation and upkeep. Before implementing it, though, caution must be exercised to make sure that the gains outweigh the cost of the accounting system.
- The system is more complex: The cost accounting system is regarded as a complex system of accounts since it requires several stages to determine costs, including the collection, categorization, and distribution of expenses.
- Not suitable for small-scale units: Only large businesses can use a cost accounting system; small businesses are not eligible. As a result, its applicability to all company types is limited.
- Social accounting is absent: Cost accounting neglects to consider the company’s social responsibility. In other words, cost accounts do not apply to social accounting.
Cost accounting is a method for tracking and evaluating product or service costs to support strategic planning and increase cost-effectiveness. It matters to a lot of people who are involved in a firm, including management, staff, and customers. Companies can use cost accounting tools to manage their expenses strategically for a successful business functioning. As you have seen in the above article Cost Accounting helps to determine the company’s profit which benefits the company as well as its employees.