Cost accounting - What is cost accounting?
Cost accounting is a way to account for your business costs by using different methods to accurately determine the cost associated with each product or service you sell.
Once you understand how much your products or services cost to produce, you should then price your products accordingly. Read more on our blog: ‘How to boost profits using pricing strategies’.
Cost accounting involves both fixed costs and variable costs. Fixed costs are recurring expenses that occur regularly and do not change due to production, for instance, a rental lease or loan interest.
Variable costs, on the other hand, are costs that fluctuate along with the changes in production, for instance, labour costs and maintenance.
Cost accounting versus financial accounting
Cost accounting and financial accounting are the main ways to keep track of your income and expenses. Cost accounting is used by managers within a company, whereas financial accounting is used by outside investors of a company.
Financial accounting provides a financial overview of the company through statements of revenue, expenses, and assets. While financial accounting provides insight into the financial health of a business, cost accounting is used more for the management team to plan and rearrange costs within a business.
The different types of cost accounting
There are a number of different methods used in cost accounting which I will explain in detail below.
Standard costing allocates ‘standard’ costs to products rather than the actual costs. Standard costs include elements such as labour, materials, and direct/indirect expenses during normal operations.
Standard costing helps a business budget and plan for future expenses by using general operational costs allocated to products. However, the actual cost may differ based on production. The difference between the standard cost and the actual cost is called the variance analysis.
If the actual costs are higher than the standard cost, the variance is negatively affecting the company. If the standard costs are higher than the actual cost, then the variance is favourable.
Activity-based costing is a method of assigning overhead to activities directly related to the products or services you sell. It uses cost pools to divide up the activities used when creating and selling a product.
A company may have cost pools such as manufacturing, customer service, and order processing. With the activity-based method, you would be able to divide up your overhead costs into these categories to determine how much each activity is costing per product.
Marginal costing is a useful method for short-term decisions. It involves calculating the difference in cost by adding one extra unit to production. It is calculated by dividing the cost difference by the quantity difference.
Marginal costing uses fixed and variable production costs to determine the break-even point and maximise profits. Management teams can use this information to price products, change production, and determine marketing strategies.
Lean accounting involves using different methods to improve financial practices within a business. These methods improve the organisation and productivity of a company.
Some methods include aligning employee strategies, accounting methods, measurements of performance, and management practices.
These methods allow management teams to align similar strategies throughout different departments to ensure maximum efficiency and productivity.