What’s it: Cost accounting is the accounting branch that provides information to help management evaluate costs and production efficiency. It assesses each production step’s input costs and the fixed costs to calculate the cost of production.
Differences in cost accounting and financial accounting
Cost accounting measures the costs associated with individual production. The accountant then compares the results of the input with the output. Its purpose is to assist management in measuring financial performance.
Unlike financial accounting, management uses information from cost accounting to assist in making decisions. Accounting is a management tool in budgeting, especially in preparing cost control programs and determining product selling prices.
Because it is only an internal tool by management, this accounting does not have to meet the specific standards set by the accounting standards body.
Conversely, financial accounting reports financial performance for the company’s external parties, such as investors and creditors. The main output of financial accounting is financial reports.
A financial report’s main parts consist of the balance sheet, income statement, cash flow statement, changes in equity, and notes to financial statements.
Another difference between the two accounting is the cost classification. Under financial accounting, the classification of costs depends on the type of transaction. Meanwhile, under cost accounting, the classification depends on the information needs of management.
Types of cost
- Fixed costs are types of costs that do not vary with output. Examples include rental costs and depreciation costs. The firm pays a fixed rent, regardless of whether output increases or decreases.
- Variable costs are a type of cost in which the value changes with the volume of production. Variable cost examples are direct labor costs, raw material costs, and variable overhead costs. If it increases output, for example, firms have to buy more raw materials and direct labor.
- Operating costs are costs associated with day-to-day business operations. These costs can be either fixed or variable. Examples include sales costs and marketing costs.
- Direct costs are costs associated with producing a product. An example of direct costs is the cost of raw materials. Another example is the cost of labor directly involved in the production process.
Cost accounting method
The following are the types of cost accounting:
- Activity-based cost accounting
- Standard cost accounting
- Marginal costing
- Lean accounting
Activity-based cost accounting
Activity-based cost accounting tells you that each activity’s costing must match its consumption (contribution) in the production process.
The assignment of activity costs accumulates the overhead of each department. The company then assigns the amount to a specific cost object such as service, customer, or product.
The company then performs an activity analysis to identify the type of activity that the cost object consumes.
The next step is determining the overhead costs and cost drivers for each activity. Then, the company calculates the overhead rates and allocates overhead costs to each cost object.
Activity-based costing is more accurate because it is based on activities directly involved in the production process. This information is useful for management.
Management can understand how individual costs arise. They can identify key and support activities. Such information is useful in making decisions about efficiency and cost savings. If done right, it ultimately supports the profitability of their company-specific service or product.
Furthermore, in the process, accountants typically run a survey of employees to list activities (tasks) and calculate the amount of time they spent on each task. Such information certainly gives management a better idea of where their time and money is being spent.
Standard cost accounting
Standard cost accounting uses a ratio to compare actual costs to standard costs. The actual use of labor and materials will be compared with labor and materials in standard conditions. This difference was assessed using analysis of variance.
Traditional cost accounting basically allocates costs based on one measure, labor, or machine hours.
Several problems arise with cost accounting. One of them, this accounting emphasizes labor efficiency even though it makes the amount of output relatively small.
Lean accounting is basically the application of lean methods to a company’s accounting and control processes. It helps management speed up processes, eliminate errors and waste, and free up production capacity.
In the traditional method, management uses standard costing, activity-based costing, cost-plus pricing, or other management accounting systems. However, they are considered less efficient. As an alternative, management can use lean accounting.
The traditional method usually divides the production process into various departments. So, the movement of inputs to sales will go through various departments, from incoming logistics to marketing.
Meanwhile, lean accounting focuses on the value stream. Each flow covers the costs of buying, designing, producing, selling, and marketing, and collecting cash from customers. Each employee or team is then assigned to one value stream instead of being divided across departments.
Marginal costing is a simplification of the cost accounting model. Sometimes it is called a cost-volume-profit analysis.
The marginal cost determination relates to the selling price, sales volume, quantity produced, expense, and profit from the product. This particular relationship is called the contribution margin.
To calculate the contribution margin, the company must first subtract variable costs from sales revenue. Then, it divides the result of the sales revenue. The following is the contribution margin formula:
Contribution margin = (Revenue – Variable costs) / Revenue
Contribution margin analysis helps management determine potential profits when there are changes in costs, selling prices, or marketing campaigns.