How to Use Cost Accounting to Improve Your Production Process?
Knowing how much you spend is an important aspect of accounting. If you don’t keep track of your expenditures, you’ll never know if your company is profitable. This is where cost accounting comes into play. Cost accounting focuses on the costs connected with running your firm. Before you can get into cost accounting, you must first grasp what it is, the many forms of cost accounting, and the benefits of this sort of financial monitoring.
What is cost accounting?
Cost accounting is a branch of managerial accounting that helps managers and business owners to understand the costs of running a business. Cost accounting can help to improve the efficiency, profitability, and performance of a business by providing information on how much it costs to produce a product, service, or activity, and how to allocate resources optimally.
Cost accounting is a style of accounting that focuses entirely on the fixed and variable expenditures of a business. Companies track all of their expenses and allocate them to various processes or units of production using the cost accounting approach, helping managers to better understand the financial implications of their business’s activities.
Cost accounting is especially critical for firms that manufacture and sell on a large scale and/or have different product lines, as these enterprises incur several costs in the manufacturing, packing, and distribution of their goods. Accounting for expenses is crucial for these sorts of firms in order to effectively calculate profit margins, as well as budgeting, forecasting, and detecting efficiencies.
What is the aim of cost accounting?
The purpose of cost accounting is to provide useful information for managers and business owners to plan, control, and evaluate their business activities. Cost accounting helps to:
- Determine the cost of products, services, and activities: Cost accounting can help to calculate how much it costs to produce a unit of output or perform a unit of activity. This can help to set prices, monitor costs, and improve efficiency.
- Analyze the profitability and performance of different segments: Cost accounting can help to compare the revenues and costs of different products, services, customers, markets, departments, or divisions. This can help to identify the most and least profitable segments and allocate resources accordingly.
- Make informed decisions based on relevant costs and benefits: Cost accounting can help to provide relevant information for various decisions such as make or buy, accept or reject, expand or contract, etc. Cost accounting can help to estimate the incremental costs and benefits of each alternative and choose the best option.
- Monitor and control the budget and variance: Cost accounting can help to prepare a budget that shows the expected revenues and costs for a given period. Cost accounting can also help to compare the actual results with the budgeted results and analyze the causes and effects of any deviations. This can help to take corrective actions and improve performance.
What is the types of cost?
The types of costs that cost accounting considers are:
- Fixed costs:
These are costs that remain constant regardless of production or output level. They are also called sunk costs because they are incurred regardless of the level of activity. Fixed costs can be classified into two categories: committed fixed costs and discretionary fixed costs. Committed fixed costs are long-term and unavoidable, such as rent, depreciation, and salaries. Discretionary fixed costs are short-term and flexible, such as advertising, maintenance, and research and development.
- Variable costs:
These are costs that change with a certain level of output or production. They are also called marginal costs because they represent the additional cost of producing one more unit of output. Variable costs can be classified into two categories: direct variable costs and indirect variable costs. Direct variable costs are directly traceable to a specific product, service, or activity, such as raw materials and labor. Indirect variable costs are not directly traceable to a specific product, service, or activity, but are allocated based on some criteria or method, such as utilities and commissions.
- Operating costs:
These are costs that are related to the day-to-day operations of a business. They can be either fixed or variable depending on the situation. Operating costs can be classified into two categories: manufacturing costs and non-manufacturing costs. Manufacturing costs are costs that are incurred in the production process, such as direct material, direct labor, and manufacturing overhead. Non-manufacturing costs are costs that are incurred outside the production process, such as selling, general, and administrative expenses.
- Direct costs:
These are costs that may be linked to a certain product, service, or activity. They are also called traceable costs because they can be easily identified and measured. Direct costs can be classified into two categories: direct material and direct labor. Direct material is the material that is physically incorporated into the final product or service. Direct labor is the labor that is directly involved in the production or delivery of the product or service.
- Indirect costs:
These are costs that cannot be linked to a certain product, service, or activity. They are also called common costs because they are shared by multiple products, services, or activities. Indirect costs can be classified into two categories: manufacturing overhead and non-manufacturing overhead. Manufacturing overhead is the indirect cost that is incurred in the production process, such as rent, depreciation, insurance, and quality control. Non-manufacturing overhead is the indirect cost that is incurred outside the production process, such as advertising, administration, and research and development.
These types of costs can help to measure and analyze the cost structure, profitability, and performance of a business.
The types of cost accounting?
The types of cost accounting are different methods and techniques that are used to assign and analyze costs. Some of the most prevalent kinds of cost accounting are as follows:
- Standard costing:
This is a method that uses predetermined or estimated costs for each unit of output or activity. It compares the actual costs with the standard costs to identify variances and evaluate performance. Standard costing is useful for planning, budgeting, and controlling costs. It also helps to simplify the accounting process and reduce clerical work. However, standard costing may not reflect the actual costs in a dynamic and changing environment. It may also lead to overemphasis on meeting the standards and ignoring other important factors.
- Activity-based costing:
This is a method that assigns costs to activities rather than products or services. It identifies the activities that consume resources and allocates costs based on the amount of resources used by each activity. Activity-based costing is useful for tracing the indirect costs to the products or services that cause them. It also helps to improve the accuracy of product or service costing and identify profitable and unprofitable activities. However, activity-based costing may be complex and costly to implement and maintain. It may also require a lot of data collection and analysis.
- Lean accounting:
This is a method that focuses on eliminating waste and improving value for customers. It uses simple and transparent measures and reports to support lean management practices. Lean accounting is useful for reducing non-value-added activities and costs, increasing the efficiency and quality of production, and enhancing customer satisfaction and loyalty. However, lean accounting may not be compatible with traditional accounting systems and standards. It may also require a significant change in the organizational culture and mindset.
- Marginal costing:
This is a method that considers only the variable costs for decision-making. It calculates the contribution margin (the difference between sales revenue and variable costs) and the break-even point (the level of output where total revenue equals total cost). Marginal costing is useful for short-term decisions, such as make or buy, accept or reject, expand or contract, etc. It also helps to analyze the effect of changes in sales volume, price, or cost on profit. However, marginal costing may not consider the fixed costs that are relevant for long-term decisions. It may also ignore the interdependence of products or services in a multi-product or multi-service situation.
The difference between financial accounting and cost accounting in details is as follows:
- Financial accounting is the process of documenting, summarizing, and reporting a company’s financial transactions and occurrences. It is mainly used for external reporting purposes, such as providing information to shareholders, creditors, regulators, and tax authorities. Financial accounting follows generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS) to ensure the reliability, comparability, and consistency of the financial statements. Financial accounting uses historical costs to measure and report the financial performance and position of a business for a specific period or date. Financial accounting focuses on the whole business entity and does not provide detailed information about the costs and profitability of individual products, services, or activities.
- Cost accounting is the process of identifying, measuring, analyzing, and reporting the costs of various aspects of a business. It is mainly used for internal management purposes, such as planning, controlling, evaluating, and improving the efficiency, effectiveness, and profitability of business operations. Cost accounting does not have to follow any set standards or rules and can be customized to suit the specific needs and goals of each business. Cost accounting uses both historical and predetermined costs to measure and report the cost behavior and structure of a business for various levels of output or activity. Cost accounting focuses on the individual products, services, or activities of a business and provides detailed information about the costs and profitability of each segment.
Some of the key differences between financial accounting and cost accounting are:
- Financial accounting is mandatory for all businesses, while cost accounting is optional for some businesses.
- Financial accounting reports are prepared at the end of each accounting period, while cost accounting reports are prepared frequently and as per the management’s requirements.
- Financial accounting reports are intended for external users, while cost accounting reports are intended for internal users.
- Financial accounting reports are based on historical costs, while cost accounting reports are based on both historical and predetermined costs.
- Financial accounting reports show the income, expenses, and profit of the whole business entity, while cost accounting reports show the cost, revenue, and profit of each product, service, or activity.
- Financial accounting reports are audited by external auditors, while cost accounting reports are not subject to any audit.
The benefits of cost accounting:
- Cost accounting helps to provide information on the cost of manufacturing goods and services for decision-making purposes. Cost accounting can help managers determine the optimal level of output, the best mix of products or services, the most profitable customers or markets, and the most efficient use of resources. Cost accounting can also help managers evaluate the performance of various products, services, departments, or divisions based on their costs and revenues.
- Cost accounting helps to improve the efficiency and effectiveness of the flow from production to the customer’s hands. Cost accounting can help managers to identify and eliminate waste, inefficiency, and non-value-added activities in the production process. Cost accounting can also help managers monitor and control the quality and quantity of output, reduce inventory holding costs, and minimize delivery costs. Cost accounting can also help managers to implement continuous improvement and lean management practices.
- Cost accounting helps to aid in financial planning and control. Cost accounting can help managers prepare budgets and forecasts based on the expected costs and revenues of different products, services, or activities. Cost accounting can also help managers compare the actual results with the budgeted results and analyze the causes and effects of any variances. Cost accounting can also help managers to take corrective actions and improve performance.
Overall, Cost accounting is a way of finding out how much it costs to run a business and how to make it better. It looks at different kinds of costs and uses different methods to calculate and analyze them. It is different from financial accounting, which is for external users and follows certain rules and standards. Cost accounting has many benefits for a business, such as giving information for decision-making, improving efficiency and effectiveness, and helping in financial planning and control. Cost accounting can help a business to optimize its operations and maximize its profits.