Cost accounting definition
/What is Cost Accounting?
Cost accounting involves the recordation, analysis, and reporting of costs to management. The intent behind this type of accounting is to provide insights into the cost structure of a business that can be used to better manage it, thereby improving profitability. It is especially useful for understanding which segments of a business are profitable, and which require improvement. As opposed to financial accounting, cost accounting is primarily intended for internal operational activities.
Cost accounting is also used to compile asset costs and expenses that are to be reported in the financial statements. For example, a cost accountant calculates the cost of ending inventory, which appears in the balance sheet. Similarly, the accountant compiles the cost of goods sold, which appears in the income statement. These are not simple calculations, since the cost accountant may need to deal with cost layering systems, overhead allocation, and byproduct costing splits.
Cost accounting systems vary by business, since there are no standards for how they are to be constructed. This differs from financial accounting systems, for which there are comprehensive sets of standards (such as GAAP and IFRS).
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Types of Cost Accounting Activities
Some of the activities associated with cost accounting are noted below:
Activity-based cost analyses. Activity-based costing calls for the accumulation of overhead costs into cost pools, from which the costs are allocated to cost objects. The intent is to gain a better understanding of what causes overhead costs. This is especially useful for determining the true cost of any type of cost object, such as a product, product line, division, or sales region. The outcome of any activity-based costing analysis may be the shifting of resources toward or away from a cost object.
Breakeven analysis. Breakeven analysis calls for the calculation of the sales level at which a business or product line breaks even. This is useful for determining business or product line viability. It can also be used to decide whether to invest in automation, which increases an organization’s fixed cost base while reducing its variable costs (in the form of labor). If a breakeven analysis determines that it requires nearly all of a company’s sales capacity just to reach the breakeven sales level, then it may be time to shut down the business.
Budgeting. Budgeting is the process of developing a model of planned revenues and expenses for future periods, which can be used to plan for financing needs and control expenditures. Budgeting is especially useful for older businesses in staid markets that need to exercise tight cost controls in order to earn a profit.
Cost control. Cost control is the analysis of expenditures to see if any can be reduced or eliminated. This is a significant driver of organizational profitability. Cost control is especially important in older markets where markets shares are relatively locked in, leaving only cost reduction as a reasonable avenue for increasing profits.
Minimum pricing analysis. Minimum pricing analysis delves into the lowest prices that can be charged, while still earning a profit. This analysis is usually conducted for large-volume special deals. In these situations, a manager needs to understand how much excess capacity is available for producing the requested items, as well as the firm’s incremental cost to do so.
Standard cost development. Standard costing requires one to develop standard costs for products. This analysis is usually conducted in conjunction with the engineering department. Standard costs establish a benchmark against which actual costs can be compared, so that managers can judge whether production processes are operating in an efficient manner. Standard costs are also used to compile estimates for quotes made to customers.
Target costing. Target costing involves setting a price at which a product can be sold for a reasonable profit, and then designing the product to have the specific cost structure needed to achieve the targeted profit. If a product cannot be designed that meets the firm’s profit criteria, then it is not manufactured at all. Instead, the firm revisits the analysis from time to time, to see if costing conditions have changed sufficiently to make a product design viable.
Throughput analysis. Throughput analysis focuses on bottleneck operations, to see if their usage is being maximized. This is a major driver of company profitability, and so is of great concern to the cost accountant. The result can be a tight focus on supporting bottleneck operations to the utmost, such as by scheduling work during all three shifts, and overmanning the operations to ensure that they generate the maximum possible amount of output.
Variance analysis. Variance analysis is the ongoing comparison of actual to budgeted revenues and expenses, as well as investigations to discern the causes of those variances. The intent is to provide management with actionable information about variances. A tight focus on variance analysis may result in gradual cost reductions in the targeted areas.
Cost Accounting vs. Financial Accounting
The essential difference between cost accounting and financial accounting is that cost accounting is inwardly focused on management decisions, while financial accounting is focused on issuing financial statements to outside parties. This means that the audience differs, since cost accounting is targeted at company managers, while financial accounting is targeted at the outside recipients of an organization’s financial statements. Also, cost accounting typically results in quite detailed financial reports, while financial accounting produces highly regimented and summarized financial statements. Further, there is no regulatory framework governing cost accounting, while there are several such frameworks that may be imposed on an entity’s financial accounting function. Finally, cost accounting is concerned with both historical information and future projections, while financial accounting is solely concerned with the reporting of historical financial information.
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