What is cost accounting?
Cost accounting refers to a form of managerial accounting that considers all expenses within a supply chain and determines the actual cost associated with manufacturing a product or providing a service. By assessing the variable and fixed costs at every step of production, managers can decide which products and services are most profitable and which need improvement. Measuring financial performance helps internal management make future business decisions.
Accounting software helps companies streamline the financial management process to make sure all costs are accounted for and there are no surprises along the way. From accounts receivable to invoicing, these tools can do it all.
Types of cost accounting
Cost accounting compares input costs with output results to measure financial performance and inform future business decisions. These are the four primary methods of cost accounting:
- Standard cost is an estimated cost the company determines for the production of goods and services when operating under normal circumstances. Even though standard costs exist, the company still has to pay actual costs. Variance analysis is the difference between the standard and actual costs incurred.
- Activity-based cost (ABC) assigns overhead and indirect costs such as salaries and utilities to products and services. Once the cost of an activity is determined, it can be assigned to the cost objects that use them. ABC works best in complex environments. It is used to reduce overhead costs.
- Lean accounting focuses on minimizing waste while optimizing productivity. A lean organization considers time and employees as its most important assets and aims to train employees to make the most of their time on the clock.
- Marginal costing, also referred to as cost-volume-profit analysis, is the increase or decrease in the total cost of production when an additional unit is added to production. Marginal costing helps management make short-term economic decisions, gain insight into potentially profitable new products, and establish sales prices for existing products.
Additionally, the types of costs used in cost accounting include:
- Fixed costs are business expenses that aren’t dependent on the amount of goods or services produced by the business.
- Variable costs are expenses that change as the quantity of the goods or services a business produces changes. Some examples include packaging, shipping, and processing costs.
- Direct costs are expenses that a business can directly tie to a specific “cost object,” which may be a particular project, facility, or project.
- Operating costs refer to all expenses associated with the day-to-day operation of a business such as supplies, wages, advertising expenses, rent, and administration fees. Operating costs can be either fixed or variable.
- Indirect costs aren’t directly accountable to a cost object but are necessary for the general operation of the business. These include administration, personnel, and security costs.
Use of cost accounting
Cost accounting is concerned with understanding where a company earns and loses money and provides input for future decisions related to profit. It’s also crucial for reporting, analyzing, and helping improve internal cost controls and efficiency.
Cost accounting vs. financial accounting
As mentioned above, the main purpose of cost accounting is for internal purposes, such as helping management determine how to run a business. It’s also beneficial as a tool for management in budgeting and monitoring cost control programs, which can increase a company’s future net margins. Due to its internal nature, cost accounting doesn’t have to meet specific standards and typically varies from company to company.
One of the significant differences between cost accounting and financial accounting is that financial accounting information reveals a company’s financial position (including revenues, expenses, liabilities, and assets) to outside investors or creditors. In contrast, cost accounting is an internal tool used by management. Further, in financial accounting, the cost is found using accounting software and is classified depending on the type of transaction.
Amanda Hahn-Peters
Amanda Hahn-Peters is a freelance copywriter for G2. Born and raised in Florida, she graduated from Florida State University with a concentration in Mass Media Studies. When she’s not writing, you’ll find Amanda coaching triathletes, cuddling up with a good book, or at the theater catching the latest musical.
