Cost accounting is concerned with the collection, processing, and evaluation of operating data in order to achieve goals relating to internal planning, control, and external reporting.
In this definition, examples of “operating data” include the cost of products, operations, processes, jobs, quantities of materials consumed, and labor time used.
Role of Cost Accounting in Cost Control
Cost accounting helps to achieve cost control through the use of various techniques, including budgetary control, standard costing, and inventory control.
Each item of cost (namely, materials, labor, and expenses) is budgeted at the beginning of the period and actual expenses incurred are compared with the budget.
Any variance between the targets and the actual results are analyzed and, where necessary, corrective actions are taken. This increases the efficiency of the enterprise.
Cost Accounting: Explanation
Cost accounting calculates costs by considering all factors that contribute to the production of the output, including both manufacturing and administrative factors.
The objective of cost accounting is to help a company’s management fix prices and control production costs. In essence, cost accounting is used for internal management purposes, but it also provides information for external reporting.
Production planning and scheduling, inventory planning and management, and labor time and labor cost budgets are some of the areas in which a company’s management team benefits from the application of a cost accounting system.
Cost accounting also provides information to management regarding actual results (e.g., departmental outputs, actual labor costs, and the cost of materials in process).
It is also worth noting that cost accounting collects data both in monetary and non-monetary terms. In turn, these data are compared to pre-established standards and budgets to exercise management control over the company’s operations.
Scope of Cost Accounting
1. Determination and Analysis of Cost
The main objective of cost accounting is to determine the cost of products or services rendered. This involves:
- The collection and analysis of expenses
- The measurement of the production of different products at different manufacturing stages
- Linking up production with expenses
Cost accounting records cost and income information for each department, process, job, and sales territory, where the aim is to ascertain the cost and evaluate the operating efficiency of each division of the business.
2. Cost Control
In the age of competition, the objective of a business is to maintain costs at the lowest point with efficient operating conditions.
This requires an examination of each individual item of cost in the light of the services or benefits obtained, which ensures the maximum utilization of money expended or its recovery.
To achieve this, planning and use of the standard for each item of cost is needed, which ensures that deviations can be identified and, accordingly, and corrected.
3. Aligning Cost With Revenue
Cost accountants prepare monthly or quarterly statements to reflect the cost and income data associated with the period’s sales.
4. Assisting Management
Cost accounting enables a business not only to ascertain what various jobs, products, and services have cost but also what they should have cost. It locates losses and wastages, thereby helping to avoid them in the future.
Another way in which cost accounting assists management is that special cost studies and investigations play a role in setting policies and formulating plans for profitable operations.
Principles of Cost Accounting
The principles of cost accounting are as follows:
1. Cost accounting systems aim to work out the cost of producing goods and services soon on completion and not long after production.
2. Cost accounting also aims to attribute all costs to individual products that are manufactured and sold (or with services generated and sold). This process consists of two features:
- Classifying costs as direct and indirect in relation to specific products
- The remaining costs are classified as direct and indirect to departments and, from there, costs are charged to products
3. Cost accounting utilizes several cost classification approaches to suit different managerial needs.
4. A number of costing methods and techniques are used for costing products, cost control, and managerial decisions.
5. Only normal costs form part of the cost of production. Abnormal costs are regarded as losses.
6. Although cost accounting—particularly the integrated system of accounting—can ultimately produce financial statements (i.e., profit and loss account and balance sheet), its emphasis is on managerial accounting.
7. Cost accounting becomes a vehicle for producing accounting data that can help management execute its functions, and it also enforces accountability. Thus, cost accounting must be built around the company’s organizational structure.
Costing vs. Cost Accounting
It is clear that cost accounting provides the basis on which costing is made possible. Cost accounting provides the necessary cost data that can be used for the purpose of costing. Without cost accounting, therefore, costing is not possible.
A small manufacturer may be in a position to perform costing without the help of cost accounting, but large manufacturers will generally be unable to do this effectively without the help of a cost accounting system.
Cost accounting is a broader term compared to costing. It assimilates in itself the functions of costing, which certainly is a narrower term. In a broader sense, however, the terms are used interchangeably.
Cost accounting makes a provision for the analysis and classification of expenditure. It then enables the management to ascertain the total, as well as the per-unit cost, of a particular unit of production. It also discloses the constituents of the total cost.
The ascertainment of cost and the provision of knowledge about its constituents are the two broad objectives of costing. Therefore, both terms can be used—and often are used—in the same sense.
Importance of Cost Accounting
Cost accounting assists a company’s management team in carrying out its day-to-day functions of control and formulating business policies.
Through cost accounting, the management learns about the causes of losses and wastages. As such, cost accounting is, as a matter of fact, a valuable aid to managerial control.
The importance of cost accounting is a function of the seven points discussed below.
Costs are classified and sub-divided to provide management with all the details relating to the expenditures incurred to produce a product or render a service.
These details enable the management team to eliminate or to pull back on any activities that do not generate a sufficient amount of profit.
2. Cost Control
The perpetual inventory system, setting up labor efficiency standards, and classifying overheads (as fixed, variable, or uncontrollable) are a few of the methods that help management to exercise control over costs and take suitable control measures.
3. Setting Up Standards to Measure Efficiency
Standards are established and used to measure the efficiency not only of labor but also every other production factor. Estimates and plans are provided, which are compared with the actual results and deviations to develop corrective measures.
4. Provision For Budgets, Plans, and Other Aids
Estimates, plans, budgets, and other aids are provided to management to compare the desired results and the actual results. Certainly, this not only helps in coordinating efforts but also in setting targets and achieving organizational goals.
5. Price Determination
Unit-wise details of costs, their components, and the accuracy of calculations and cost data, which are made available by the costing department, go a long way in helping to determine product and service prices.
6. Special Factors
These factors are specially taken care of and management is kept posted with all developments, including any factors that have arisen and their causes. This enables the company’s management team to guard the enterprise against any eventuality.
Either the management is able to take effective measures to save itself from disaster or it can keep those factors away from its own establishment.
Depressions, seasonal fluctuations, and idle time (for labor and machines) are a few of the special factors that must be guarded against. Cost accounting keeps the management team well informed about these factors.
7. Policies: Business and Others
Cost accounting is not only an aid to the whole business and its various activities; it is also helpful in arriving at a fruitful business policy, as well as other policies that the business and its future depend on.
Cost accounting seldom fails a company’s management team and, consequently, the enterprise. It is certainly a very important aid since it has become an essential tool used by management.
Specifically, cost accounting serves management in executing policies and offers scope to make policies flexible, ensuring that the desired results can be achieved without any significant difficulties or disruptions.
Why Is Cost Accounting Necessary?
The above discussion leads us to the conclusion that cost accounting is a systematic procedure for determining per-unit costs. It serves, therefore, the purposes of both ascertaining costs and controlling costs.
Cost accounting is necessary for businesses due to the advantages it offers, which include:
- It ascertains the costs of each product, process cost center, and department
- It assists in cost classification and analysis
- It provides details about all the factors influencing product or service costs
- It provides a system for cost control
- It provides sufficient cost data for management to make vital decisions in the best interest of the enterprise as a whole
- It provides information to all interested parties (e.g., trade customers, banks, shareholders, associations, unions, governments, insurance companies, etc.)
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True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.