4 Cost Accounting Basics You Should Know About

Sep 2, 2020Accounting, Business

What is Cost Accounting?

Cost accounting aims to capture a company’s total production cost by assessing the variable costs of each step of production. It is a process of gathering, examining, summarizing, and evaluating various alternative courses of action. The goal is to provide management with improvements based on efficiency and capability.   

Below are four things you should know about cost accounting to help make better management decisions.

1. It is an Internal Thing

Financial accounting presents a company’s fiscal position and performance to outside parties through statements, including information about its revenues, expenses, assets, and liabilities. Cost accounting is most beneficial as a tool for management in budgeting and creating cost control programs, which improve the company’s net margins.  

2. Consider All Costs

Knowing the difference between the types of costs is important because it helps to understand the product or service better, which may lead to more competitive pricing. Also, it allows to better plan for the future of your business.

  • Fixed costs are costs that do not vary depending on the level of production. Some examples included mortgage or lease payment on a building or a piece of equipment. An increase or decrease in production levels would not affect these costs.
  • Variable costs are costs tied to the level of production. For example, the cost of raw materials can vary depending on the level of production.  
  • Operating costs are costs associated with the day-to-day of a business. These costs may be variable or fixed, depending on the situation. Some examples would be a subscription for a software, office supplies, lease or rent payment, professional fees, and bank charges.
  • Direct costs are costs related to producing a product. This may include equipment used to make the product or labor that is specific to the product.

Indirect costs cannot be directly associated with a product. This may be a variety of items such as office supplies, advertising, accounting services, or insurance.

3. Categories of Cost Accounting

There are different types of cost accounting. Therefore, you may choose the one that is most applicable to your situation.

  • Standard costing designates “standard” costs, rather than actual expenses, to its cost of goods sold and inventory. Assessing the difference between the standard cost and actual cost incurred is called variance analysis.
  • Activity-based costing identifies overhead costs from each department and assigns them to specific cost objects, such as goods or services. This is based on activities such as any event, unit of work, or task with a particular goal. Examples include setting up machines for production, designing products, distributing finished goods, or operating machines. These activities are considered cost drivers and are the measures used as the basis for allocating overhead costs.
  • Lean accounting bases decisions on the impact on the company’s total value stream profitability. Traditional methods are replaced by value-based pricing and lean-focused performance measurements. 
  • Marginal costing is the impact on the cost of a product by adding one additional unit into production. It is useful for short-term economic decisions. Marginal costing may help business owners identify the impact of varying levels of costs and volume on operating profit.

4. It is your Way

Since cost accounting is an internal tool, it does not have to meet any specific standard, such as generally accepted accounting principles. As a result, it varies in use from company to company or department to department. You can tailor the system to fit your needs.

Consider implementing a cost accounting system to better understand your business. The process will help you determine more accurately the real cost of each component to a customer, the cost of future expansion, and your business’s potential profits. With these measurements, you can prepare better budgets, adjust pricing, keep inventory at appropriate levels, and efficiently manage production and operating costs.

A cost accounting analysis can provide a better understanding of your products’ actual cost. An accurate overview of your business will help guide you toward improved profit margins and efficiency. If you would like to learn more about cost accounting and how your business might benefit from this process, contact a Smith Schafer professional.


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