What is Cost Accounting?
Cost accounting is a method of recording, concisely constructing, analyzing, and understanding a company's expenses due to some investment, capital requirements, process, etc. It is a business strategy meant to give insight into the company's expenditures, leading to greater cost efficiency, pre-planning, and finance decisions. Another advantage of cost accounting is that it provides transparency to the company regarding its financial activities. This practice makes it possible for the management to look into which areas require cost-cutting and which ones need greater investment. This technique leads to a better vision for the organization. This article will explore the meaning of cost, the meaning of costing, cost accounting, and other properties.
Features of Cost Accounting
The following are a few features of cost accounting:
It is a branch of accounting
Acts as the basis for budget-related decisions for the management
It helps to determine a standard pattern of costing
It is an excellent tool for analyzing the efficiency of a unit of the business. It discloses the level of financial wastage caused in each unit
Types of Cost Accounting
The following are the types of cost accounting:
Costing Based on Activity
Lean Accounting
Standard Accounting
Marginal Costing
Standard accounting is a costing method where the firm determines costs by comparing the actual expenditures on a certain activity compared to the desired expenditure.
Marginal costing is a technique that involves diving all costs into fixed and variable expenses. Fixed costs are those expenses of a company that are not affected by the change in profits incurred. Variable costs are directly proportional to the level of production activity in the firm.
Importance of Cost Accounting
Cost accounting is an important activity in the department of finance of any facility. This technique provides a lot of insight into the economic activity levels of the organization. Following are a list of advantages of cost accounting:
Improves financial efficiency
Identifies activities that run in losses
Helps in price reduction and fixing of prices
Keeps an account of the stock
Helps to understand and analyze losses
Aids in planning the future financial course of the firm
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Meaning of Cost
What is the meaning of cost, and how do we determine the cost of something? The cost of a good or service is essentially the valuation or the resources given in exchange for that good or service. In industrial terms, the cost is the value in the money of a commodity, the materials involved, the efforts, risks, and opportunities created altogether. Cost is also the investment made for producing a product. It is noteworthy that while the value of a commodity is a measure of its usefulness, the cost is strictly calculated in terms of money.
Cost is often an umbrella term for several classifications that it holds. These classifications are as follows:
Prime cost
Sunk cost
Factory cost
Direct cost
Indirect cost
It is important to mention the type of cost in the balance sheet for better interpretation.
Meaning of Costing
Costing is simply the method for ascertaining the cost of goods and services and other business elements.
Costing is essentially a technique, and as with any other process, it follows a certain procedure and several rules and regulations. Some of the standard principles followed in ascertaining costs are historical costs, standard costs, etc.
Some Important Points to Remember
Direct costing is the assignment of cost according to the increasing and decreasing level of activity.
On the contrary, the assignment of costs irrespective of the activity levels is known as absorption costing.
Solved Examples
Q. What is an Overhead Cost in Accounting?
Answer: Overhead costs are those expenses of a company or business which are ongoing but not directly related to the service or commodity that the business provides. For example, if a company runs a service-based enterprise such as a restaurant, then, other than the costs for providing the hospitality, there will be additional expenditures such as rent, maintenance, and insurance. The accounting of these costs is crucial for budget management and for determining the price of the company's services.
FAQs on Cost, Costing, and Cost Accounting: Key Concepts
1. What is the fundamental concept of 'cost' in accounting?
In accounting, 'cost' refers to the total monetary value of resources, such as materials, labour, and other expenses, that are sacrificed or consumed to produce a specific product or service. It represents the expenditure incurred to acquire or create an asset. It's important to distinguish cost from value, as cost is a measure of expenditure, while value relates to the utility or usefulness of the product or service.
2. What is 'costing', and what is its primary purpose?
Costing is the technique and process of ascertaining costs. Its primary purpose is to determine the cost of a product, service, or business activity. This involves following specific principles and procedures to calculate the total expenses. Essentially, while 'cost' is the expense itself, costing is the methodology used to figure out that expense.
3. What is Cost Accounting, and why is it important for a business?
Cost Accounting is a specialised branch of accounting that involves recording, classifying, analysing, and interpreting the costs incurred by a business. It is crucial because it provides management with detailed information to aid in decision-making. Its importance lies in helping to control costs, determine selling prices, measure efficiency, and plan future financial strategies, ultimately leading to improved profitability.
4. How do 'costing' and 'cost accounting' fundamentally differ?
The fundamental difference lies in their scope. Costing is a narrow concept focused on the process of 'ascertaining' or calculating costs. In contrast, Cost Accounting is a much broader concept that includes costing as one of its functions. Cost Accounting also involves analysing these costs for management control, budgeting, and strategic decision-making. Simply put, costing is about finding the cost, while cost accounting is about using that cost data to manage the business.
5. What is the key difference between Cost Accounting and Financial Accounting?
The key difference lies in their primary users and purpose. Financial Accounting is focused on preparing financial statements (like the Profit & Loss Account and Balance Sheet) for external stakeholders such as investors, creditors, and government agencies. It summarises past performance. Cost Accounting, on the other hand, provides detailed cost information for internal users—the management—to help with planning, controlling, and decision-making for the future.
6. What are the main objectives a business aims to achieve through cost accounting?
A business uses cost accounting to achieve several key objectives, including:
- Ascertainment of Cost: To accurately determine the cost per unit of different products or services.
- Cost Control: To monitor and manage expenditures by comparing actual costs with standard or budgeted costs.
- Price Determination: To provide a basis for setting competitive yet profitable selling prices.
- Decision Making: To supply relevant data for managerial decisions, such as whether to make or buy a component.
- Measuring Efficiency: To identify and analyse sources of wastage or losses and improve operational efficiency.
7. How are costs classified for managerial decision-making? Please provide examples.
For decision-making, costs are often classified based on their behaviour in relation to changes in activity levels. The two main classifications are:
- Fixed Costs: These are costs that do not change with the level of production or sales. Examples include factory rent, insurance premiums, and salaries of administrative staff.
- Variable Costs: These are costs that change in direct proportion to the level of production. Examples include the cost of raw materials, direct labour wages, and packaging expenses.
This classification is vital for techniques like marginal costing and break-even analysis.
8. Why is it important for a manager to distinguish between direct and indirect costs?
Distinguishing between direct and indirect costs is crucial for accurate product costing and control. Direct costs (like raw materials) can be easily and directly traced to a specific product, making it simple to calculate the prime cost. Indirect costs (also known as overheads, like factory rent or a supervisor's salary) cannot be traced to a single product and must be allocated on a reasonable basis. This distinction helps managers to accurately determine a product's profitability, set correct prices, and identify areas where overhead expenses can be controlled or reduced.
