Cost accounting is an accounting process that measures all costs associated with production, including fixed and variable costs. Purpose cost accounting is to assist management in decision-making processes that optimize operations based on effective cost management. The costs included in cost accounting are detailed below.

Key things

  • Cost accounting is an accounting method that takes into account a company’s total production costs by evaluating both fixed and variable costs.
  • Managers use cost accounting to help them make business decisions based on effective cost management.
  • The types of costs evaluated in cost accounting include variable costs, fixed costs, direct costs, indirect costs, operating costs, opportunity costs, sunk costs, and controllable costs.
  • Cost accounting is not in accordance with generally accepted accounting principles (GAAP) and can only be used for internal decision making.

What are the different types of costs in cost accounting?

Direct costs

Direct costs are related to the production of a good or service. AND direct costs includes raw materials, labor and costs or distribution costs associated with the production of the product. Costs can easily be traced to a product, department or project.

For example, Ford Motor Company (F) manufactures cars and trucks. A plant worker spends eight hours building a car. The direct costs associated with the car are the wages paid to the worker and the cost of the parts used to assemble the car.

Indirect costs

On the other hand, indirect costs are expenses that are not related to the production of a good or service. Indirect costs cannot be easily traced to a product, department, activity or project. For example, at Ford, the direct costs associated with each vehicle include tires and steel.

However, the electricity used to power the plant is considered an indirect cost because the electricity is used for all the products produced in the plant. No product can be traced back to an electricity bill.

Fixed costs

Fixed costs do does not vary with the number of goods or services that the company produces in a short period of time. For example, suppose a company leases a production machine for two years. The company must pay $2,000 per month to cover costs leaseno matter how many products this machine is used. The lease payment is considered a fixed cost because it remains unchanged.

Variable costs

Variable costs they fluctuate as the level of production changes, as opposed to fixed costs. This type of cost varies depending on the number of products the company produces. Variable costs increase as production volume increases and decrease as production volume decreases.

For example, a toy manufacturer must package their toys before shipping the products to stores. This is considered a type of variable cost because as a manufacturer produces more toys, its packaging costs increase, but if the toy manufacturer’s production level decreases, the variable costs associated with packaging decrease.

Operating costs

Operating costs are expenses associated with day-to-day business activities but cannot be traced back to a single product. Operating costs can be variable or fixed. Examples of operating costs that are more commonly called operating costsincluding rent and energy for the production plant.

Operating costs are day-to-day costs, but they are classified separately from indirect costs – i.e. costs linked to actual production. Investors can calculate a company’s operating expense ratio, which shows how efficiently a company is using its costs to generate revenue.

Opportunity cost

Opportunity cost is the benefit of giving up an alternative when one decision is made over another. These costs are therefore most relevant to two mutually exclusive events. In investing, it’s the difference in return between the chosen investment and the one that missed out. For companies, opportunity costs do not appear in financial statements, but are useful in management planning.

For example, a company decides to buy a new piece of manufacturing equipment instead of leasing it. The opportunity cost would be the difference between the cost of the cash outlay for the equipment and improved productivity versus how much money could be saved in interest costs if the money were used to pay off the debt.

Sunk costs

Sunk costs are historical costs that have already been incurred and will have no effect on current management decisions. Sunk costs are costs that the company has committed to that are unavoidable or sunk costs. Sunk costs are excluded from future business decisions.

Controllable costs

Controllable costs are expenses that managers have control over and have the authority to increase or decrease. Controllable costs are taken into account when one person decides to take over the costs. Common examples of controllable expenses are office supplies, advertising expenses, employee bonuses, and charitable donations. Controllable costs are categorized as short-term costs because they can be adjusted quickly.

What are the types of cost accounting?

The different types of cost accounting include standard costing, activity costing, lean accounting, and marginal costing. Standard costing uses standard costs rather than actual costs of cost of goods sold (COGS) and inventory. Activity-based costing takes overhead costs from different departments and associates them with certain cost objects. Lean accounting replaces traditional costing methods with value-based pricing. Marginal costing evaluates the cost impact of adding one more unit to production.

What is the main purpose of cost accounting?

The main purpose of cost accounting is to evaluate the costs of the business and, based on the data, make better decisions, improve efficiency, determine the best selling price, reduce costs and determine the profit of each activity involved in the operational process.

What is the difference between cost accounting and financial accounting?

Cost accounting focuses on the costs of a business and uses cost data to make better business decisions to reduce costs and improve profitability at every stage of the operational process. Financial accounting is focused on reporting financial results and the financial situation of the entire business entity.

Bottom Line

Cost accounting seeks to assess the various costs of a business and how they affect operations, costs, efficiency and profits. An individual assessment of a company’s cost structure allows management to improve the way it runs its business and thereby increase the value of the firm.

Source Link