what do you mean by cost accounting? explain the nature of cost accounting

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Cost accounting : Objectives & Importance

Cost accounting helps you understand how to manage the costs of products and services. Learn more about the techniques used for cost accounting.

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What Is Cost Accounting?

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Cost accounting is a business practice in which you record, examine, summarize, and understand the money that a business spent on a process, product, or service. It can help an organization control costs and engage in strategic planning to improve cost efficiency. Cost accounting helps management decide where they need to cut back and where they need to increase costs.

Importance of cost accounting

Cost accounting has many advantages. Here are some of the ways it can help a business:

1. Controlling costs: Cost accounting helps the management foresee the cost price and selling price of a product or a service, which helps them formulate business policies. With cost value as a reference, the management can come up with techniques to control costs with an aim to achieve maximum profitability.

2. Determining the total per-unit cost: Cost accounting techniques help in determining the total per-unit cost of a product or a service, so that the business can fix the selling price for it.

3. Showing profitable and non-profitable activities: This information helps the management put an end to non-profitable activities while developing and expanding the profitable ones.

4. Comparing costs over time: The data in the cost sheets prepared for various time periods helps in comparing the cost for the same product or a service over a period of time.

Difference between cost accounting and financial accounting

Cost accounting and financial accounting use the same information from the business’ records and work around the same principles. The difference between the two is that financial accounting gives the value of profit and loss of the business as a whole, while cost accounting tells you about the cost per item and the profit or loss associated with individual products.

Let us look at a few points of distinction between the two:

Elements of cost in cost accounting

The elements of cost are broadly classified into material, labor, and expenses. Each of them is further divided into direct and indirect costs. The indirect material, labor and expenses can be categorized as overhead costs.

Let’s take a detailed look at these elements.

Material cost: This is the cost of the basic substances that are used to produce an item. It can be further classified into direct material and indirect material.

Direct material: Materials which are directly involved in the manufacturing of a product and are present in the finished product constitute direct material. For example, wood used to make furniture, or cloth used to make a shirt.

Indirect material: Materials which are instrumental in the production of finished goods but cannot be assigned to specific physical units. For example, a pair of scissors to cut the cloth for the shirt, or a saw to cut the wood for furniture.

Labor cost: These are the human resources required to convert materials into finished goods. They can be further classified into direct and indirect labor.

Direct labor: People who are involved actively during the manufacturing of products. For example, production or manufacturing labor.

Indirect labor: Employees who are not directly involved in the manufacturing process and whose labor cannot be assigned to one particular product. For example, sales representatives and directors.

Expenses: Costs incurred by a business, other than material and labor costs, generally fall under this category. They are further divided into direct and indirect expenses.

Direct expenses: These are also called chargeable expenses and are usually associated with specific cost units. For example, direct labor, cost of raw materials, utilities, and rent.

Indirect expenses: All expenses that do not fall under direct expenses are considered indirect expenses. For example, printing costs, utility bills, and legal consultation.

Overhead costs: The general understanding is that overhead costs are similar to indirect expenses. But overhead actually has a wider meaning, which includes indirect labor, indirect material, and indirect expenses.

Overhead costs can be classified into the following three categories:

Factory overhead: This includes overhead cost incurred due to manufacturing, production, or any other type of cost that is responsible for the smooth functioning of a factory. For example, factory rent, insurance, and utilities.

Office and administrative overhead: These are expenses connected to the management and administration of a business. For example, office rent, printers, and stationery.

Selling and distribution overhead: These are expenses related to marketing a product, acquiring orders, and dispatching goods and services.

Methods of cost accounting

There are four main types of cost accounting techniques.

1. Standard cost accounting: This type of cost accounting uses ratios to check the utilization of labor and goods to produce goods in a standard environment. This assessment is called a variance analysis. However, this method is somewhat dated. When it was introduced a century ago, it made sense to use labor as the only cost measurement, as it was an important cost driver. With time, overhead costs have increased compared to labor.

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NATURE OF COST ACCOUNTING

Nature of Cost Accounting is that it depends on financial accounting, is an art & inexact science, has its own body of knowledge and tools & techniques,

NATURE OF COST ACCOUNTING

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on NATURE OF COST ACCOUNTING

Table of Contents

NATURE OF COST ACCOUNTING

Cost Accounting is an art or process of recording, analyzing and classifying of expenditure for the purpose of product costing or service costing, ascertainment of profitability, operational planning and cost control. It is a forward looking approach which is related to the recording, analyzing and classifying of expenditure with the objective of ascertaining the total and per unit cost of product or service.

The following points are the nature of cost accounting:

NATURE OF COST ACCOUNTING

A BRANCH OF ACCOUNTING

Cost Accounting is a branch of accounting that deals specifically with the determination of costs of the products and services being manufactured. It deals with those techniques, tools, processes and methods which are associated with the determination of costs, their classification and analysis. It is an accounting which is done internally to the organization and is optional.

BRANCH OF KNOWLEDGE

It is an important branch of knowledge and emerges as a discipline in itself. It is an organize body of knowledge which has its own tools and techniques like

Job costing Process costing Standard costing Marginal costing Variance analysis Unit costing Batch costing

Activity based costing

Budgetary control

Contract costing etc.

COST ACCOUNTING IS SCIENCE AND AN ART

Cost accounting is both science and an art but not a perfect science.

It is science as it is a body of systematic knowledge relating to not only accounting but also to a wide variety of subjects such as law, office practices, data processing, production and material control etc.It is an art as it involves the use of the skills and experience of cost accountant in collection, classification and analysis of the costs of the products.COST ACCOUNTING IS A PROFESSION

Cost accounting is not a pure profession by nature but it is emerging as a profession. The set up of various specialized institutions like

Institute of Cost and Management Accountants in UK

Institute of Cost and Work Accountants in India

Is a way long to make cost accounting as a profession.

BASED ON DOUBLE ENTRY SYSTEM

Cost accounting is based on the double entry system. It is follows the rule of ‘every debit has equal credit.’ All transactions that are recorded in the cost accounting records have two fold aspect.

A PROCESS IN NATURE

Cost accounting is a process in nature. It is a process that involves the following steps:

Identification of costs

Recording of costs

Classification of costs

Analyzing the costs

Interpreting the results

Communicating the results to the management.

It is a forward looking approach that aims at improving the efficiency of the manufacturing activities.

TOOLS AND TECHNIQUES

Cost accounting has its own tools and techniques of standard costing and variance analysis, contract costing, process costing, job costing, unit costing, batch costing, marginal costing etc. cost accounting make use of such techniques in preparing the accounting records with full accuracy and also fix the standards of performance for future.

INTERNAL ACCOUNTING

Costing accounting is an internal accounting. There is no compulsion on the organization to prepare the cost accounting records and publish them. It is totally option to prepare the cost accounting records. These are prepared to provide for the internal use by the management and manufacturing departments.

Also Study Also Study Also Study Also Study

Cost Accounting Scope of cost accounting Elements of cost Types of cost

Material control Perpetual inventory system Pricing of materials Bin Card

Stores Ledger Incentive plans Overheads Idle time

System of wage payment in cost accounting Time rate vs piece rate wage system Cost Center Labour Turnover

Difference between management accounting and cost accounting Allocation and apportionment of overheads Allocation vs Apportionment of overheads Absorption of overheads

Over absorption and under absorption of overheads Activity based costing Traditional costing vs ABC system Reconciliation of accounts

Unit costing Cost sheet format Cost sheet vs production sheet Job costing

Batch Costing job costing vs batch costing Contract costing Job Costing vs Contract costing

Process Costing Process costing vs job costing Joint products By Product

Equivalent production Marginal costing Application of marginal costing Cost volume profit analysis

Tools and techniques of marginal costing Budget Break even point Process of budgetary control

Advantages and limitations of budgetary control Budgetary Control Zero base budgeting Standard Costing

Variance Analysis Standard costing vs budgetary control Management accounting vs cost accounting Cost accounting vs financial accounting

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Cost Accounting: Definition and Types With Examples

Cost accounting is a form of managerial accounting that aims to capture a company's total cost of production by assessing its variable and fixed costs.

CORPORATE FINANCE ACCOUNTING

Cost Accounting: Definition and Types With Examples

By ALICIA TUOVILA Updated March 09, 2023

Reviewed by ANDY SMITH

Fact checked by YARILET PEREZ

Investopedia / Theresa Chiechi

What Is Cost Accounting?

Cost accounting is a form of managerial accounting that aims to capture a company's total cost of production by assessing the variable costs of each step of production as well as fixed costs, such as a lease expense.

Cost accounting is not GAAP-compliant, and can only be used for internal purposes.

KEY TAKEAWAYS

Cost accounting is used internally by management in order to make fully informed business decisions.

Unlike financial accounting, which provides information to external financial statement users, cost accounting is not required to adhere to set standards and can be flexible to meet the particular needs of management.

As such, cost accounting cannot be used on official financial statements and is not GAAP-compliant.

Cost accounting considers all input costs associated with production, including both variable and fixed costs.

Types of cost accounting include standard costing, activity-based costing, lean accounting, and marginal costing.

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Cost Accounting

Understanding Cost Accounting

Cost accounting is used by a company's internal management team to identify all variable and fixed costs associated with the production process. It will first measure and record these costs individually, then compare input costs to output results to aid in measuring financial performance and making future business decisions. There are many types of costs involved in cost accounting, which are defined below.

Types of Costs

Fixed costs are costs that don't vary depending on the level of production. These are usually things like the mortgage or lease payment on a building or a piece of equipment that is depreciated at a fixed monthly rate. An increase or decrease in production levels would cause no change in these costs.

Variable costs are costs tied to a company's level of production. For example, a floral shop ramping up its floral arrangement inventory for Valentine's Day will incur higher costs when it purchases an increased number of flowers from the local nursery or garden center.

Operating costs are costs associated with the day-to-day operations of a business. These costs can be either fixed or variable depending on the unique situation.

Direct costs are costs specifically related to producing a product. If a coffee roaster spends five hours roasting coffee, the direct costs of the finished product include the labor hours of the roaster and the cost of the coffee beans.

Indirect costs are costs that cannot be directly linked to a product. In the coffee roaster example, the energy cost to heat the roaster would be indirect because it is inexact and difficult to trace to individual products.

Cost Accounting vs. Financial Accounting

While cost accounting is often used by management within a company to aid in decision-making, financial accounting is what outside investors or creditors typically see. Financial accounting presents a company's financial position and performance to external sources through financial statements, which include information about its revenues, expenses, assets, and liabilities. Cost accounting can be most beneficial as a tool for management in budgeting and in setting up cost-control programs, which can improve net margins for the company in the future.

One key difference between cost accounting and financial accounting is that, while in financial accounting the cost is classified depending on the type of transaction, cost accounting classifies costs according to the information needs of the management. Cost accounting, because it is used as an internal tool by management, does not have to meet any specific standard such as generally accepted accounting principles (GAAP) and, as a result, varies in use from company to company or department to department.

Cost-accounting methods are typically not useful for figuring out tax liabilities, which means that cost accounting cannot provide a complete analysis of a company's true costs.

Types of Cost Accounting

Standard Costing

Standard costing assigns "standard" costs, rather than actual costs, to its cost of goods sold (COGS) and inventory. The standard costs are based on the efficient use of labor and materials to produce the good or service under standard operating conditions, and they are essentially the budgeted amount. Even though standard costs are assigned to the goods, the company still has to pay actual costs. Assessing the difference between the standard (efficient) cost and the actual cost incurred is called variance analysis.

If the variance analysis determines that actual costs are higher than expected, the variance is unfavorable. If it determines the actual costs are lower than expected, the variance is favorable. Two factors can contribute to a favorable or unfavorable variance. There is the cost of the input, such as the cost of labor and materials. This is considered to be a rate variance.

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