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Cost Accounting

Recording, analyzing, and summarizing costs associated with a production process, and allocating the costs to specific products and services

What is Cost Accounting?

Cost accounting is the process of recording, analyzing, and summarizing costs related to a production process and allocating the costs to specific products and services. The costs are first recorded individually, and then input and output costs are matched and analyzed to determine the financial performance of the company.

Cost Accounting

The cost information obtained is then shared with management to help them optimize business processes and plan for the future.

Cost Accounting vs. Financial Accounting

One key difference between cost accounting and financial accounting is where the information obtained is used. Cost accounting is an internal tool that is used by the management team to make decisions and set up cost control programs to boost the organization’s profits. Financial accounting, on the other hand, reports the company’s financial information to external stakeholders such as the government, creditors, investors, and other parties.

The other distinction is in how costs are classified. In financial accounting, costs are classified depending on the type of transaction. On the other hand, in cost accounting, costs are categorized based on the functions, processes, and specific informational needs of the management team.

Unlike financial accounting, cost accounting is not guided by rules dictated by the Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). The only “requirement” is that the information is presented in a way that makes it useful for the purposes of analyzing costs and improving operational efficiency.

Types of Cost Accounting

The following are the main types of cost accounting:

1. Activity-based costing

Activity-based cost accounting assigns the cost of each activity performed in an organization to specific products and services, according to their consumption. It assigns more indirect costs to direct costs, as compared to the traditional costing method. The indirect costs in each department are identified and assigned to specific cost objects like customers and products, and the method of allocating the costs is first decided in the activity analysis.

This means that the cost information is more accurate, and it can help managers understand the inputs and outputs of the organization’s products. Companies are motivated to adopt activity-based costing due to the need to improve the costing accuracy of their products and services.

2. Marginal costing

Marginal costing also referred to as cost-volume-profit analysis, is the analysis of the relationship between production volume, sales, selling prices, costs, expenses, and profits related to a product or service. The relationship is referred to as the contribution margin, and it gives insights into the amount of profit that the business can generate.

The contribution margin is obtained by dividing revenues minus variable costs by revenue. Marginal costing provides management with useful cost information that is used in the decision-making process.

3. Lean accounting

Lean accounting involves simplifying accounting methods to speed them up and make them more functional. Applying lean accounting methods to a company’s accounting and control process can help management speed up processes, eliminate errors and wastes, and increase production capacity.

Lean accounting works without other accounting methods such as activity-based costing and standard costing. Instead, the latter methods are replaced by simple, visual, and lean-focused performance measurements.

4. Standard accounting

The standard type of cost accounting uses ratios to compare the labor and materials used in the production process of a good with the labor and materials that the same good would’ve required to produce under standard conditions.

However, the standard cost accounting methods introduced over a century ago used labor as the only cost measurement because it was the most important cost of producing manufactured goods. Since then, overhead costs have increased in proportion to labor. It means that allocating overhead cost as the overall cost can mislead management.

Cost Accounting - Types

Types of Costs

The following are the main types of cost involved in the production of goods and services:

1. Variable costs

Variable costs refer to costs that change with changes in the level of production. One example is the cost of raw materials used in the production process. If the level of production increases, the cost of raw materials will increase, whereas a reduction in the level of production will result in a similar decline in the cost of raw materials.

2. Fixed costs

Fixed costs are costs that remain constant regardless of any decrease or increase in the level of production. An example of a fixed cost is rent for the business premises.

3. Direct Costs

Direct costs are costs that are directly related to the production of a product and can be directly associated with that product. Direct labor is an example of a direct cost.

4. Indirect Costs

Indirect costs are costs that cannot be easily associated with a specific product or activity because they are involved in multiple activities. For example, the rental cost incurred by a business may not be directly identified to a specific activity carried out on the premises since there could be multiple activities taking place within the business premises.

Additional Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)® certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

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