define cost accounting

define cost accounting

The Importance and Applications of Cost Accounting in Business

1. Introduction to Cost Accounting

Cost accounting is not a particular system of accounts and is not any specific type of record. It is the establishment of a system and of a set of practices through which costs are traced. As costs are traced, they are entered into books of account, so that the purpose of the system is to provide an accurate and timely means of accumulating economic information about the operation of the business. The accounting system is designed to measure the financial effect of executing business activities through the use of labor, services, working capital, and fixed capital committed to carrying out the plans of people in the business enterprise, and to translate those costs of cost-producing events into the production of goods and services.

Cost accounting provides valuable information to assist management, both in the day-to-day decision-making tasks and in developing long-term policies. Without this information, it would be impossible to determine vital matters such as product costs, accumulation of costs, and rate of cost increase. Since management’s job is one of defining and solving the problems affecting the enterprise, cost accounting serves management’s needs in this regard. Therefore, it is essential that students of business administration as well as those interested in the management of industrial concerns have a clear understanding of the fundamental principles and procedures involved in cost accounting.

2. Key Concepts and Principles of Cost Accounting

The basic classification of costs into direct and indirect costs serves as the foundation for all cost accumulation processes. Underlying this principle are the concepts of unity, why, and how of costs that assist in the development of efficient cost accounting systems. This in-depth study of key prerequisites furthers understanding of the system concept and management uses of cost data, as well as the need for judgment and estimation in cost accumulation. In adhering to a particular ground rule, nuances are present, such as the treatment of common costs, exceptional costs, and imputed costs. Development of information systems with these characteristics enables personnel from all levels of the organization to make the best possible use of the data they offer, thereby contributing to the management goal of efficient functioning.

The unique characteristics, scope of coverage, and functions of cost accounting entail certain basic concepts and principles to be adhered to. These include the dollar unit, which is tied to the price structure, and the concept of management uses, which envisage a multiple-product or composite accounting system. In setting up and maintaining cost accounting systems, certain fundamental principles are observed. An examination of several of them reveals that systems designed for different business organizations typically adhere to the same ground rules.

3. Methods and Techniques of Cost Accounting

This section refers mainly to the machines and some of the materials, because only 15 materials are used for the work. The staff is a very limited number; for instance, if I am going to allow 20 people to make that road, then I can’t look for a profit. This section refers mainly to the machines and some of the materials, because only 15 materials are used for the work. The staff is a very limited number; for instance, if I am going to allow 20 people to make that road, then I can’t look for a profit.

When each job is different from the other but is identical with-profit element it is called cost tracing. The work of a contractor who specializes in building referees to contract is called contract costing; here only 15 members can do the work. For instance, when I have made a road and I said my workers have done, then the cost can be easily ascertained for 1 km road. The work of a type-writer is termed job. Another point called ordnance factor, which uses job cost. Similarly, the work of a build is called contract more or construction costing. Most of the construction companies use synthesis. The contractor is interested more in the profit. He can’t look for a profit for the various work.

Definition: The method of costing where the cost is ascertained and accumulated according to something known as the job is referred to as job costing method. In other words, there are certain jobs where costing is very accurate, i.e., in which they know what are the raw materials required, the type of labor necessary, how much the overhead is going to be, and all that. And cost is determined and recorded or accumulated based on that.

This article throws light upon the three methods of costing for ascertaining cost in cost accountancy for cost determination. The methods are: 1. Job Costing Method 2. Batch Costing Method 3. Contract Costing Method.

4. Applications of Cost Accounting in Business Operations

8. Cost auditing – By means of the study of cost records, a cost auditor checks the reasonableness of the cost plus the capability of the cost accounting system to supply relevant information to management for decision making. Additional special reports may be requested.

7. Placing competitive limits on bids – The number of competitive bids will be determined by a company’s own long-range profitability criteria and the pricing in relation to its competition. Total costs are key factors in the pricing of competitive reality. With cost accounting data, management is able to project effective pricing strategies.

6. Inventoriable costs and pricing – Cost accounting provides a measure of the physical volume of inventories, units of capacity, and the cost components when determining the true cost per unit, thus assisting in how the pricing structure should be set. Also, the finest cost discipline is required where there is a risk of pirating. Careful cost controls ensure that such losses are kept at a minimum.

5. Cost-profit relationship – Cost accounting helps in determining overall costs so that the specific correlation between individual costs and sales of business units may be established. In addition to the aggregate reporting based on department or product group, the analysis of cost and sales related to products, types, and models helps in the make or buy decision within a given product group.

4. Cost analysis – Cost accounting helps in identifying and controlling the various aspects of cost. In a manufacturing process, we may determine the material costs, labour costs, or both should they be pertinent or overhead costs or even these costs together.

3. Product movement costing – In the case of industries which follow the job order method of process costing, product movement is essential. Through cost accounting, enlightened management can trace the specific cost in relation to specific jobs, cost centers, contracts.

2. Manufacturing, marketing and administration costs to cost centers – Cost accounting provides data on how manufacturing, marketing, and administrative elements (in manufacturing) are related to the execution of cost center functions. In turn, allocation of these expenses using suitable allocation keys to the cost centers becomes possible.

1. Cost allocation for service departments – Service departments are those whose services are utilized by other departments. To find out the total cost, direct expenses and service department overheads allocation is necessary. Cost accounting furnishes data to show the percentage distribution of services given by the service departments.

Cost accounting also provides data for various management decisions. The key areas are briefly discussed as follows:

5. The Role of Cost Accounting in Decision Making

Costs help managers measure and control the activities that drive costs: Different costs are affected by different events. Costs driven by a single activity can be closely tracked using activity-based costing.

Costs help managers to focus their attention on fixed and variable costs: Cost accounting information helps managers consider any alternative in terms of its fixed and variable costs; this is a major factor in making decisions concerned with break-even or cost-volume-profit analysis. Analysis of the behavior of costs, particularly fixed and variable costs, is an important part of cost management.

Costing encourages sensitivity analysis: The cost accountant is often called on to provide managers with information about the potential effects of different events on the future. Costing stimulates managers to undertake sensitivity analyses—asking, for example, what happens if a key assumption changes. It expects managers to be prepared to react to different futures.

Costing shows the behavior and relation among costs: Managerial decisions often hinge on how costs behave along a range of possible activities. The cost accountant’s task is to provide information that shows how costs change along the selected activity increments.

Costing offers a structure for analyzing costs: Cost accounting attempts to classify costs by function, by behavior, by activity level, and by responsibility. The resulting structure makes it possible to focus management attention on the factors that are influencing costs.

Cost accounting information plays an extremely important role in the decision-making process. The following are some significant ways in which the system can contribute to management decisions.