Cost accounting is a method of accounting that helps to calculate the cost of different functions of a company, such as production, fixed price, and depreciation on capital equipment.

In cost accounting, costs are measured and recorded individually. In turn, they are compared with the actual result to assist the management of a company in the task of measuring financial performance.

Cost accounting emerged during the Industrial Revolution when the economics of industrial supply and demand forced manufacturers to begin keeping track of their business functions.

Since then, cost accounting has helped organizations make critical decisions about matters such as whether or not to decrease the price of overstocked goods or reduce the scale of production.

Goals of Cost Accounting

The main goals of cost accounting are:

  • To determine the costs for each object
  • To fix selling prices
  • To control costs by checking the company’s expenses against budgets and standard costs
  • To reduce the cost of production without compromising on quality
  • To determine the closing inventory
  • To assist the company’s management regarding employee inefficiencies and to optimize the organization’s resource utilization

Different Types of Cost Accounting

Before examining different costs, it is necessary to understand the different types of expenses.

Fixed Costs

Fixed costs are costs that remain the same despite changes in production, processes, or projects. For example, in the manufacturing industry, even if there are changes in production, employee salaries will remain the same.

Variable Costs

Costs that vary with every change in process, production, and project are known as variable costs.

For example, in a company that manufactures cars and other automobile parts, the materials and labor costs will change according to the production of different vehicles and different components.

Sunk Cost

Some costs that are sustained and cannot be improved are referred to as sunk costs. For example, in a car manufacturing unit, any machinery costs that cannot be recovered are known as sunk costs.

Opportunity Cost

The cost incurred when selecting one option over another is known as an opportunity cost. It means that managers must always consider the profit of products they could have—but, in reality, did not—produce, which almost all companies overlook.

Different Techniques of Cost Accounting

Now that you know the types of cost accounting, you will be able to understand the various cost accounting techniques that managers use for decision-making.

Marginal Costing

In this technique, the management decides on the number of units to be produced. This technique only includes the costs of additional units and excludes all fixed fees because they do not differ with changes in production.

Standard Costing

Standard costing is a costing technique that compares the quotes of the costs gained from the cost of products, processes, and projects that are determined from before.

Direct Costing

This technique refers to all the costs that are charged for a particular product or project, where the indirect damage is shown as profit and loss.

Historical Costing

Historical costing compares all the costs incurred before the accomplishment of the process.

Absorption Costing

Absorption costing is also referred to as a full costing method. In this technique, all costs are charged to products, projects, and processes.

Cost Accounting Systems

Most companies use two main cost accounting systems: job order costing or process costing.

Job Order Costing

In this costing system, collaborated manufacturing costs are listed separately for every single task. It is suitable for companies that produce unique products and services.

Process Costing

Process costing is an accounting system that combines the cost of manufacturing individually for each process. It is suitable for organizations engaged in production that involves different departments and cost flow within various departments.

How Can Organizations Establish Effective Cost Accounting Systems?

Listed below are some of the steps that organizations use to establish robust cost accounting systems.

Appraisal and Selection

It is important to determine the scope of costs within an organization in order to select a suitable accounting system for tracking, processing, and understanding them.

If a company is operating in a specialized industry, then job order costing is appropriate because it facilitates the control of costs related to jobs performed by a firm. This helps companies to stick to their estimated values.

By contrast, if a company’s business function is repetitive, then process costing and standard costing are suitable approaches.

Testing and Confirmation

It is mandatory to perform testing before a system is implemented. This helps to check its ability to perform an allotted reporting task, along with detecting and eliminating all flaws that may influence the accuracy of the cost accounting system.

Also, scrutinizing the software applications and hardware components of the accounting system will help to determine all the features of an accounting system.

Training and Changeover

Training employees to use an accounting system is essential to ensure they are familiar with the functions and techniques of the system. Moreover, it helps to build confidence and minimizes the probability of errors arising during the use of an accounting system.

Costing Methods Used in Different Types of Businesses

Cost accounting is a process that helps to determine the costs of goods and services. It records, classifies, and allocates different expenditures, and it is also an excellent basis for preparing financial statements.

Cost accounting deals with various components of business costs such as jobs, services, processes, and orders wherever required, and it considers the cost of production, cost of selling, and cost of distribution.

In the real world, systems of cost accounting are valuable for helping to keep track of all costs of the business functions. Furthermore, companies choose the most suitable cost accounting system for them depending on their company’s functions.

For example:

By using an appropriate job accounting system, almost every organization can control cash flows across the business functions.

Hence, it is necessary for every organization to choose a suitable method for cost accounting and to train their employees to use it effectively.

Frequently Asked Questions

What is the main purpose of cost accounting?

The main purpose of cost accounting is to identify, measure, and analyze the costs of producing and delivering goods and services. This information can be used to improve business performance and make more informed decisions about pricing, product lines, and operations.

What is the definition of cost accounting?

The definition of cost accounting is a process that records and classifies all expenses during production and distribution of goods, and it can be used to prepare financial statements.

What are the types of cost accounting systems?

There are two main types of cost accounting systems: job order costing and process costing. Job order costing is used for businesses with specialized products or services, while process costing is used for repetitive businesses.

What is the importance of testing a cost accounting system?

Testing a cost accounting system is important to ensure that it can meet the reporting needs of the business and that it is accurate and reliable. The testing process should include the review of software applications and hardware components, as well as the performance of tests to detect and eliminate any flaws.

What is the importance of training employees in the use of a cost accounting system?

Training employees in how to use a cost accounting system is important for two reasons. First, it ensures that everyone is familiar with the functions and techniques of the system. Second, it builds confidence and minimizes the probability of errors arising during the use of an accounting system.

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.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.