What Is Cost Accounting? (Definition And Objectives)
Updated 30 September 2022
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Cost accounting provides information to business managers on the cost or profit of specific aspects of its operations. It helps provide detailed information that financial accounting may not be able to furnish. If you are interested in pursuing cost accounting professionally, understanding more about it can help you decide if you are a good fit for this line of work. In this article, we examine what is cost accounting, what its primary goals are and how it differs from other accounting disciplines.
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What Is Cost Accounting?
The answer to the question "What is cost accounting?" is that it is a part of a managerial information system that uses past, present and future financial data to help managers in decision making. According to the Institute of Cost and Works Accountants of India, cost accounting is the technique and process of ascertainment of costs. Cost accounting or accounting for costs begins with recording expenses and ends with preparing statistical data. Under cost accounting, accountants use multiple techniques like marginal costing, standardised costing and rational protocols to arrive at fixed and variable costs.
Fixed costs are static expenses that recur monthly and are not dependent on production levels. Examples of fixed costs include rental or leasing costs, equipment depreciation or interest payments on loans. Expenses that change in proportion to production expenses are variable costs. Examples include supplies, materials, labour and equipment maintenance costs. In cost accounting, a company's internal management compares the costs to output results like production or sales, while measuring the company's financial health and making decisions that can affect the future of the business.
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What Are The Objectives Of Cost Accounting?
The primary goals of cost accounting are to determine, classify and allocate expenditure that a business incurs on materials, wages and other operational costs. These are the primary objectives of cost accounting:
The primary goal of cost accounting is to ascertain the cost of production for every process, department or service of a business. Costing refers to the technique of ascertaining cost. Accountants accumulate every expense and classify and analyse them to generate costing information. They can generate the cost of a product or service at the end of production or determine its cost during the production phase.
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Controlling the cost of production is another primary goal of cost accounting. Accountants study the various operations and processes used to manufacture a product. They compare the budgets allotted for material, labour and overheads, and compare it with actual expenses. The differences and variances help management to evaluate whether costs are within control and, if not, how they can control it.
A company may want to reduce costs without impacting the quality of its products or services. They may use new technologies, improve product design, improve the production process, fix wastage or try innovative marketing strategies. Cost accounting helps management choose a cost-effective method to permanently reduce the unit cost of goods without diminishing their quality.
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Cost accounting ascertains the profitability of every product or service that a business offers. It also helps compare profits over previous years and identify which products and services are more profitable. Accountants then compare profitability predictions with actual profits. Accounting reports provide profitability predictions and the management uses this information to maximise profitability.
A producer fixes a product's price based on the total cost of production, demand, supply and margin of profit they want to make. Cost accounting gives the producer detailed and complete information about the composition of the cost that can help them determine their selling price. If there is inflation, depression or recession, cost accounting guides a producer on curtailing and reducing cost of production to decide the minimum selling price.
Providing a basis for decision-making
Cost accounting provides information about the gross-profit analysis, cost-volume-profit relationship, the break-even point for sales and differential costing. Management uses this information to take important production-related decisions. This may include introducing or discontinuing a product or service, optimising production capacity, selecting a profitable sales strategy or exporting goods at a lower price.
Statutory compliance is another goal of cost accounting. As per government guidelines, it is mandatory for companies that produce certain goods or provide certain services to include cost accounts in their book of accounts. Also, companies with an aggregate turnover above a specific income ceiling submit their cost accounts to the government for filing taxes.
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What Are The Benefits Of Cost Accounting?
Cost accounting is important for maintaining profitability. Cost accounting traces its origins to manufacturing industries, but service-based businesses also implement cost accounting to avail its benefits. The benefits of cost accounting include:
Accurate profit analysis
Cost accounting methods aim to consider every cost that a business operation incurs. The company's top-most decision-makers can see which costs contribute to the company's profits and which do not. Through the process, cost accounting helps to show whether the business can earn more than their total expenditure towards producing goods or services.
Improved business strategy
The management of a business often requires a comprehensive view of the company's financial situation to formulate effective business strategies. Knowing where profit margins are falling short helps in deciding where to trim extraneous costs and increase the efficiency of resource utilisation. Management can then effectively make decisions regarding future actions to decrease costs or increase profits.
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Previous accounting statements can look at how the inflation of costs and revenues is impacting business. This information is crucial while making estimations for future revenue and expenses. By reviewing estimations, a company's decision-makers can accurately determine whether they can alter pricing strategies and other production costs.
Systematic return on investment
The break-even point is the number of units a company requires to sell to match or exceed the total production costs. Accountants identify this by considering the total costs incurred in the business's operation. Cost accounting is an effective record-keeping practice to track costs and revenue, to identify a company's current break-even point.
Reduced overhead costs
Overhead costs are indirect expenditures that a business incurs. These costs can include insurance, utilities, contingencies, advertising, administrative expenses and any logistical expenses that indirectly contribute to the company's operating cost. Separating the direct and indirect costs makes it easier to create reduction strategies for each type of expenditure.
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What Are The Major Differences Between Cost Accounting And Management Accounting?
Cost accounting gathers and analyses information related to costs. Management accounting prepares reports using qualitative and quantitative information. Cost accounting is a subset of management accounting. Apart from these major differences, additional differences between cost accounting and management accounting are:
While the purpose of cost accounting is to ascertain cost and profitability of goods and services, management accounting aims to aid management in long-term, strategic decision making.
Cost accounting prevents businesses from spending beyond their budgeted amounts. Management accounting provides an overall picture of current and potential business positions to develop strategies and action plans.
While cost accounting considers matters related to cost and expenses, management accounting has a wider scope that can impact multiple business aspects like attrition, productivity, performance and efficiency.
Cost accounting uses historical information to aid decision-making processes, while management accounting uses historical and predictive data to aid decision-making processes.
Cost accounting may be a mandatory requirement for certain types of businesses, while there is no statutory requirement for a business to include management accounting in bookkeeping.
Accountants can measure the outcome of cost accounting quantitatively, while management accounting outcomes are qualitative.
Information from cost accounting is crucial for management, external stakeholders, investors and the government. Management accounting information and reporting primarily benefits the management of a company.
Cost accounting may not depend on management accounting, but management accounting relies heavily on cost and financial accounting.
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What Are The Differences Between Cost Accounting And Financial Accounting?
There are many important differences between cost accounting and financial reporting. The basic difference is that while cost accounting aids management decisions, financial accounting aims at providing financial information to external stakeholders like investors and government agencies. Additional differences between cost accounting and financial accounting are:
Local and global accounting bodies set standard practises and procedures for financial accounting and reporting. In contrast, a cost accountant can prepare reports in any format or include only information that the management requires.
A financial accountant may classify a cost based on the type of transaction, while a cost accountant may classify a cost based on the information required by the management.
Cost accounting accumulates and compiles the cost of material, labour and inventory, and financial accounting uses this information in its year-end reporting.
Accountants prepare financial accounting reporting during the end of the accounting period. Cost accountants can prepare reports whenever the management requires them.
Financial reporting covers information for the preceding year, while cost accounting can cover past, present and future periods.
Financial accounting focuses on reporting financial results and the overall financial position of a business entity. Cost accounting can provide information for every department, individual product, specific subsidiary or a branch in a particular part of the world.
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