what is cost accounting

what is cost accounting

The Importance and Principles of Cost Accounting in Business Operations

1. Introduction to Cost Accounting

Cost accounting refers to the branch of accounting responsible for the classification, recording, and appropriate allocation of expenditure as the means for determining the costs of products or services, as well as for presenting the details of costs with respect to time periods or geographic areas. Production and sale decisions of the business are based mainly on data revealed from cost accounting. With the help of these data, comparisons between expected costs and the cost realized can be made, making it easier to control costs and to develop new strategies to reduce or control production costs. Victory in the competitive world of business through profit making will become possible if the cost of products and/or services could be controlled. Overall, cost accounting will therefore play an important role in business operations.

2. Key Principles and Concepts of Cost Accounting

Cost accounting has principles that guide in classifying, recording, and allocating costs. The key principles are the classification and allocation to costs assumption. Each and every item of cost of the product must be identifiable with the unit of goods. The best principles involve the classification of different elements of costs and the allocation of expenses for cost control by department, function, or operation. It is used for internal regulation of use and consumption of expenses. The two functions performed are planning and cost control, while classification and allocation are used to organize and coordinate action. These principles apply to productive and unproductive costs. The identification principle states that each expense incurred by a unit of the enterprise must be identifiable with that unit. Some expenses cannot be directly allocated to the production, firm, or department. These common expenses are allocated to a particular department, cost center, or operation by an arbitrary criterion. In brief, the principles of expenses are cost allocation, openness, management, and feedback.

Cost accounting imparts knowledge about costs. It is a dynamic process that involves the ascertainment, classification, accumulation, and control of costs. It helps in cost control and cost reduction, and is concerned with the cost of producing goods or rendering services in order to maximize income or revenue. Cost accounting processes information about the results with the help of financial accounting data. Cost data is correlated with every aspect of the organization, dealing with organizing objectives, business strategies, planning, directing, and controlling the activities of the organization. Cost accounting is generally performed during the manufacturing process and is an important part of management accounting. Cost accounting establishes budgets and standard rates for various items of costs and revenues. The cost accounting system helps the management and the financial analyst, providing a reliable basis for contracts and quotations. In price fixing, cost accounting data and studies are invaluable.

3. Cost Types and Cost Behavior

In terms of function, costs can generally be divided into production, sales, and management costs. Production costs include all costs incurred in the production of goods, while sales costs cover marketing activities to ensure sales. Office support and administration costs are included within the framework of management costs. Beyond these, fixed and total costs can be considered in terms of cost behavior. Total costs include both fixed and variable costs. Fixed costs remain constant in total over a wide range of the activity in which the company engages, while the variable costs are the costs that change with activity, such as production amount or sales. Be aware that the cost classification mentioned may change by industry and business, and thus it is highly contingent, and requires close attention to detail.

In general, the term ‘cost’ means an expense related to a product, process, or department. In other words, it is the value of some factors consumed in a business entity which can be used for a period, service, or commodity. Each business entity bears its own costs related to the production, sale, and management activities. Besides, each item contains component costs that sum to the aggregate cost of the aggregate. Cost types, as considered in the production process, can generally be listed as direct or indirect costs according to the judgment criterion. If the resource is allocated directly to the production process, it is direct; if a resource is directly related to the resource used in the production process, then it is classified as an indirect cost. Product development costs, materials used, and labor expended can be considered direct costs, while water, light, and facilitator salary can be considered as indirect costs.

4. Costing Methods and Techniques

Modern cost accounting systems attempt to minimize costs and maximize efficiencies and effectiveness by employing a variety of techniques and methods. In the final analysis, the essence of any cost accounting system is that it allows for the discovery of the costs of products and services, and to measure the use of resources. Prior to this, certain basic principles have to be adhered to by most costing systems. The more common of these principles and such of the techniques and methods in vogue are treated here below.

Like in financial accounting, in cost accounting too, methods and techniques used for recording business transactions, such as depreciation, valuation of stock, and evaluation of finished goods, are based on certain principles. Costing methods and techniques have evolved over a period of time from the elementary principles and vary from industry to industry. The multiplicity of costing methods and techniques in vogue is a testimony to the dynamism displayed by the industry in this regard.

5. Role of Cost Accounting in Decision Making

The management can lose interest in controlling costs based on the behavior of elements within the component of cost. It uses an understanding of the behavior of the component to evaluate the relative performance of its function and teamwork. The management can then thus assign appropriate management attention on effort to firm phosphorescence. These, in turn, represent the firm’s actual weight of added value of its production capacity. The general realization is that – as the firm’s weight of added value is transparent through intelligent component of cost behavior management and staff pay attention to managing their functions within that firm.

The cost accounting principle of appropriate costing and cost ascertainment applies to the entire gamut of business operations. The manufacturing concern does not afford the unique opportunity for understanding costs and costs behavior. The concepts prove to be very relevant in the service sector too. In the modern business environment, it is a question of choosing whether to provide, make the product, or buy the product or service. The performance audit indicates the relative performance, and a realized performance credit permits the establishment to spend less time managing itself and its assets and more in building performance. The commercial or the competitive cost and management accounting profession positively says that it is selling a commercial insurance for corporate governance and enhancing shareholder value.