Cost Accounting – Concept, Objectives, Types & Methods

While running a business, companies need to employ cost accounting strategies to analyse their cost structure. Under this procedure, the cost is assigned to a company's product, services, and other company activities. Check out the following sections for a complete idea of the concept and techniques of cost accounting. 

What is cost accounting?

Cost accounting refers to the computation of a company's overall expenditure. This procedure includes an assessment of a company's variable and fixed costs involved in each step of production. Cost accounting helps in taking strategic decisions to manage a company's expenses. 

Scroll down to learn more about various techniques of cost accounting!

Types of cost accounting

Cost accounting is conducted through multiple procedures based on managerial decisions. Here are the best types of cost accounting:

• Direct cost accounting

In the direct costing technique, only variable costs are considered for cost accounting. It does not include any fixed costs incurred by a company. However, this process is generally used for short-term decision-making. Using a direct cost accounting procedure for a long-term decision can be hazardous as it does not include all types of costs. 

For instance, if you are computing the direct cost accounting for a construction business, only material cost (variable cost) will be used for analysis.

• Standard cost accounting

Standard costing is an estimation of the cost that you can incur in a production process. As actual costs cannot be pre-determined, manufacturers use standard costing methods to plan their expenses accordingly. It helps in preparing a company budget in advance for streamlined financial management. 

For instance, the raw material cost, labour charges, etc., required for production is analysed through standard costing.

• Marginal cost accounting

A company determines the number of units to produce and decides a cost structure based on that. This is known as marginal cost. It is used to determine the impact on expenditure and profit if a single unit of production exceeds the estimated one. 

For instance, a company decides the marginal cost for producing 100 units of soft toys. With this technique, they can determine if the production unit exceeds 140 and whether it will be profitable or not. 

• Historical cost accounting

Under this cost accounting method, a company's financial statement records the price of an asset as per the original cost incurred in purchasing it. The company does not update the figures as per the market records. For instance, a company purchased the property 50 years ago for Rs. 10 lakhs; at present, the property valuation is Rs.50 lakhs. However, if the company maintains historical accounting, it will record the property price of Rs.10 lakhs only. 

• Uniform cost accounting

Uniform costing is the latest cost control technique that has no resemblance with any other type of cost accounting. Under this method, a large group of companies in the industry follow and accept the same costing principles as per mutual agreement. In India, coal, fertiliser, steel, etc., industries use this costing method to manage the company expenses on a mutual agreement and participation.

Importance of cost accounting

Cost accounting is essential for a business and benefits the employees, clients, stakeholders, and even the government. Here are some of the best advantages of the cost accounting technique:

• As cost accounting helps differentiate fixed and variable expenses, it helps the company make better financial decisions. Management can decide the product price as per the cost incurred in producing the item. 
• It helps efficient workers get recognition and incentives on time. This is because cost accounting help assesses the efficiency of every worker and keeps a competitive work spirit going on.
• Cost accounting helps manage and control costs by determining the various costs incurred in running a company. With this technique, a company can reduce operational costs and enhance work efficiency, thereby benefiting the company and its client.

How is cost accounting different from financial accounting?

Here is detailed information on cost accounting vs financial accounting:

• Cost accounting targets the company, its management, and its staff. It helps in critical decision-making. However, financial accounting deals with public firms and helps lenders, stakeholders, and other outsiders who have no access to business information. 
• The cost accounting technique is used by industrial enterprises only. However, every business uses financial accounting techniques to manage expenses.
• In the cost accounting technique, management uses the cost type to record predetermined and historical expenses. However, financial accounting deals only with historical costs.
• Cost accounting helps predict or forecast expenses by implementing budgeting strategies. However, it is not possible in financial accounting.

Which are the different types of costs?

So far, we have discussed cost accounting. Now let's know what is cost and its types. Generally, the expenses incurred in functioning a business are termed costs. Given below are some of the types of costs for a better understanding:

• Variable cost

Variable costs change as per the production procedure and level. For instance, the cost of raw materials varies as per the production volume. So, it is a variable cost.

• Fixed cost

Fixed costs, as the name suggests, are fixed expenses involved in production. These are just the opposite of variable costs. For instance, the salaries of employees do not vary depending on the variation in production.

• Sunk cost

Sunk costs refer to the expenses which are not recoverable in future. Thus, these costs are termed sunk. Installing machinery in production is a sunk cost as you cannot recover it further.

• Opportunity cost

Opportunity costs include the expenses you incur while choosing one production option over the other. For instance, a company with a limited production capacity needs to choose the production of toy cars over toy frogs, considering the higher profit involved in it.

Which are the various methods of costing?

Take a look at the different costing methods:

• Operating costing

It calculates the costs of services provided to clients. For instance, hospitals and consultancies use operating costing methods.

• Job costing

This method calculates the costs involved in a particular job or product. No pre-production cost is used in this method. For instance, advertising agencies use this method.

• Contract costing

It helps calculate the expenses incurred when a company takes on contractual work. For instance, construction companies use this method of costing.

• Batch costing

Batch costing involves a production process where the company keeps producing the goods in batches, irrespective of order or demand. For instance, spare parts manufacturing companies use this method.

• Process costing

Companies that conduct large-scale production use this method to calculate per unit costs involved in a production. Chemical, sugar, oil, etc. industries use this costing method.

Which are the elements of cost in general?

The elements of cost, in general, include the following:

• Expenses (Direct and indirect)
• Labour (Direct and indirect)
• Material (Direct and indirect)
• Overhead (Administration, selling, factory, distribution)

Conclusion

Companies can use cost accounting tools to manage their expenses strategically for a successful business functioning. Moreover, it helps determine the company’s profit benefiting the company and its employees.

Frequently Asked Questions

What is the cost accounting formula?

The cost accounting formula goes as follows:

(Average fixed costs + Average variable costs)x Number of units = Total cost

This formula helps in deriving the total costs incurred in production.

Why is cost accounting used?

Cost accounting identifies a company’s areas of expenditure, its earnings, profits and losses. It helps analyse the overall cost and improves the company’s cost control and efficiency.

What are some advantages of cost accounting?

Cost accounting is customisable to attain the desired company cost control. Managers use this technique and implement changes as per the business requirements. Cost accounting helps analyse the procedure of resource distribution, capital raising, etc., to benefit the company.

Who benefits from cost accounting?

Manufacturing industries are the prime users of cost accounting. It benefits the company’s internal organisation, including management, employees, workers, etc.