Cost Accounting – Definition

Cite this article as:"Cost Accounting – Definition," in The Business Professor, updated December 10, 2019, last accessed October 22, 2020, https://thebusinessprofessor.com/lesson/cost-accounting-definition/.

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Cost Accounting Definition

Cost accounting refers to a systematic procedure that businesses use to record and report their cost of production. To be able to measure the cost of production, they usually assess each step’s output costs involved in the production and fixed costs like capital equipment depreciation.

What cost accounting does is to first record and measure the cost as an individual entity. It uses methods such as recognition, allocating, aggregating, classifying, and reporting to do this.  What follows is a result comparison of both the input and output.

By doing this, the management of the company is able to measure its financial performance. Generally, cost accounting provides the management with comprehensive information that helps them to plan for the future as well as control the current operations.

Note that since the managers make decisions only for their firms, they don’t have to compare their information to that of other firms. What they do is to ensure that the information is relevant to a particular setting. Managers majorly use cost accounting information to make decisions for the well being of the company. However, it can also be used in financial accounting.

A Little More on What is Cost Accounting

While companies use cost accounting information to make decisions from within, financial accounting, on the other hand, reflects the actual status of the company. Financial accounting shows the status of the assets and liabilities of the company. It is what investors from the outside world will see and use the information to make investment decisions as far as that company is concerned.

There is one major difference between financial accounting and cost accounting. In financial accounting, there is a classification of cost according to the type of transaction, while in cost accounting, it is according to the management’s information needs.

Also, since cost accounting information is only meant for internal use, it has no standards requirements set by the General Accepted Accounting Principles (GAAP). For this reason, cost accounting information varies from one organization to the other or from one department to the other.

The History of Cost Accounting

All businesses, regardless of size or type, require cost accounting to be able to track their operational activities. It helps those managing the businesses to understand the costs involved in running those businesses.

The origin of modern accounting can be traced back to the industrial revolution, a period when those businesses operating on a large scale, experienced difficulties. The situation led to the development of systems, to help business owners to record and track costs, as well as make decisions based on the accounting information.

During the industrial age, businesses used to incur costs that today’s accountants call variable costs. They call it variables because they could directly vary, with the cost of production.

Costs for things such as labor, raw materials, and power to run the factory, were in direct proportion with production. Those in the management used to total the product’s variable costs and then use the rough estimates as a guide to making decisions.

Unlike variable costs that rise and fall with work volume, some costs used to be the same even during peak seasons. With time, such fixed costs became important to managers. Examples of fixed costs are things like:

  • Equipment or plant depreciation costs
  • Maintainance costs
  • Production control costs
  • Tooling costs
  • Purchasing costs
  • Storage and handling costs
  • Quality control costs
  • Plant supervision and engineering costs

In the early 19th century, the above costs were considered to be of little importance to businesses. With the advancement of things such as railroads, large scale manufacturing, and steel towards the end of the nineteenth century, their costs continued to be important than that of variables.

Such reasoning led to bad decision making that affected many businesses. So, for managers to be in a position to make sound decisions regarding their products and pricing, they must first understand the importance of fixed costs.

Cost Accounting involves the following:

  • Determining the costs of products, projects, processes, among others to be able to report the right amount on the financial statement of the company
  • Assist the management to plan and control organization
  • Prepare special analyses that help to make the best decisions

Cost Accounting Functions

Cost accounting functions are as follows:

Cost Control: Cost accounting is used to control costs related to budget management for a given product or service. It enables the management to allocate resources in an appropriate manner

Cost computation: Computing cost is the main function of cost accounting, and it is the source of other cost accounting functions

Cost reduction: Cost computation enables the company to cut down its costs on processes and projects. Reduction in cost enables the company to generate more profits since the margin increase naturally

Types of Cost Accounting

There are various types of cost accounting, and they include the following:

Standard Cost Accounting

It is a type of cost accounting where ratios are used to compare efficient uses of materials and labor to produce services or goods under standardized conditions. The process of assessing the difference is known as variance analysis.

Activity-Based Cost Accounting

It is a technique with an approach that helps the management to monitor and cost activities. It traces consumption of resources, resource assigned to activities, costing final outputs, and activities to cost objects based on consumption estimates. This type of cost accounting is accurate and, therefore, reliable.

It helps managers to understand the profitability and cost of specific products or services. For the management to know where the company spends most of its money, employees have the task of accounting for the time they spend on various tasks.

Lean Cost Accounting

Lean is a technique in cost accounting that is considered to be a lean manufacturing philosophy extension. It is a production that was developed in the 1980s by a Japanese company. Note that a good number of accounting practices that involve manufacturing works assumes that anything under production is always on a large scale. So, lean accounting is used, and it replaces the other methods by lean-focused performance measurement and value-based pricing.

Marginal Cost Accounting

It uses a cost accounting with a simplified model and marginal costing to analyze the relationship between the following:

  • The sale price of service or product
  • Amount  produced
  • Volume of sales
  • Costs
  • Expenses

The specific relationship is known as the contribution margin. The contribution margin is an analysis the management can use to understand the company’s potential profits, especially with the changes in cost. It can also use it to understand the type of sale prices to come up with for its products, and the types of marketing campaigns to engage in.

The Techniques of Cost Accounting

There are different types of cost accounting techniques that help managerial personnel to make decisions. They include the following:

Marginal Costing: Here, it is the management who decides the units to be produced. The technique only considers the variable costs incurred for any additional unit produced. There is no consideration for fixed costs in this type of technique because they do not vary with changes in production.

Standard Costing: In this kind of technique, there is comparing the cost incurred to the process, predetermined cost of the product, or project. The management does variance analysis to ensure cost-effectiveness.

Direct Costing: Here, the direct costs incurred for a given process, product, or project are charged to it. For the indirect costs, the management writes off to either loss or profit.

Historical Costing: It compares all the costs a company incurs after performing the process.

Uniform Costing: This technique follows similar costing practices across particular units related to the comparison.

Absorption Costing: This is a method that involves full costing. The costs in all this are charged to process, product, or project.

What are the Main Objectives of Cost Accounting?

Accumulate and utilize cost data to ensure control. By doing so, they are able to realize a minimum possible cost that is consistent with quality maintenance. They use the following means to achieve this:

  • Targets fixation
  • Comparison of actuals with targets
  • Ascertainment of actuals
  • Analyzing deviation’s reasons between targets and actuals and giving the report on the deviation to the management. The management uses the data to take corrective action
  • Provide useful information to management so that they can make informed decisions

References for “Cost Accounting”

https://www.investopedia.com › Investing › Financial Analysis

https://en.wikipedia.org/wiki/Cost_accounting

https://www.accountingcoach.com/blog/what-is-cost-accounting

https://www.wallstreetmojo.com › Accounting › Accounting Careers

www.businessdictionary.com/definition/cost-accounting.html

https://corporatefinanceinstitute.com › Resources › Knowledge › Accounting

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