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Cost accounting: Meaning and types explained

[] Cost accounting is a management accounting technique that is used to determine the amount of money spent on a product’s production by a company.

Cost accounting is a management accounting technique that is used to determine the amount of money spent on a product’s production by a company. Cost accounting aims to capture all production costs, including variable and fixed costs.

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It is believed that cost accounting was first introduced during the industrial revolution, when producers started monitoring their variable and fixed costs, to automate their production operations with the new global supply and demand economies.

The costs of labour, materials and other direct expenses are variable, which means that they are subject to changes in production levels. Direct costs are treated as product costs and not overhead costs in profit-volume-cost analysis. Indirect costs, such as depreciation and amortisation, which do not vary with changes in production levels, are treated as overhead costs.

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Types of costs

Fixed costs

These are charges that are fixed, regardless of the quantity of work completed, like the rent payment for a building.

Variable costs

These are charges that vary, based on the amount of work completed. For example, these include costs of packaging, shipping and processing.

Operating costs

Operating costs are expenses related to the day-to-day operations of the company and might be fixed or variable in nature.

Direct costs

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These are the costs directly associated with the company’s products’ production, acquisition and sale. They include expenses such as labour and electricity.

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Difference between cost accounting and financial accounting

Cost accounting

Cost accounting is a managerial accounting that allows businesses to identify, describe, and examine different costs, in order to exert control, minimise costs and make better decisions.

Cost accounting arranges, documents, and identifies appropriate investment allocation for determining the costs of goods and services. It aids in the presentation of pertinent data to management, regarding service, contract and cost of shipment.

It also includes information on production costs, distribution, and sales.

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Financial accounting

Financial accounting is a discipline of accounting that deals with the summarising, documenting, and reporting of financial transactions that occur in a firm.

Financial accounting means preparing numerous financial statements that firms can use to present their financial performance to various users of financial data such as creditors, investors, customers and suppliers.

Cost accounting vs financial accounting

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While costs in financial accounting are categorized, based on the kind of transaction, costs in cost accounting are classified, based on the management’s information needs.

Cost accounting, being an internal approach employed by management, is not bound by any universal requirements, such as GAAP (generally accepted accounting principles), and varies in application from firm to firm, or department to department.

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Types of cost accounting

There are four main types of cost accounting:

1. Standard cost accounting

This method of cost accounting compares the efficiency with which labour and materials are used (or can be used) to generate goods and services under normal conditions. One of the problems with traditional cost accounting is that it prioritises labour efficiency, despite the fact that labour costs account for a small percentage of total costs in modern businesses.

2. Activity-based cost accounting

A method to the costing and monitoring of activities that involve tracing consumption of resources and costing final outputs, resources assigned to activities, and activities to cost objects, based on estimates for consumption, is known as activity-based cost accounting. It collects each department’s overheads and allocates them to other cost objects like products, services, and customers. Activity-based costing is thought to be more precise and more valuable to managers in determining the cost and profitability of the products and services offered by the company.

3. Lean accounting

Lean accounting is an extension of the Japanese manufacturing and production philosophy that stresses value-based pricing and lean-focused performance measurements.

4. Marginal costing

This method of cost accounting is also known as cost-volume-profit analysis. Marginal costing examines the link between the company’s products’ production amount, sales volume, costs, expenses and profits. The contribution margin is calculated by deducting variable costs from revenue, and dividing the result by revenue. It provides helpful information to management about future revenues, profitable sales price, and the type of promotion required.

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Category: Must Knows

Debora Berti

Università degli Studi di Firenze, IT

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