Cost accounting is an integral part of the _______

Cost management in accounting is a form of management accounting that is designed to help business owners predict how much business expenses. The purpose of this form of accounting is to avoid going over budget so that businesses can hold onto as much of their revenues as possible. If you would like to work in management accounting and you are trying to learn more about cost management and planning budgets, read on and find out what you need to know about cost management plans within the over-all business model.

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What is Involved in Cost Accounting?

Cost accounting will help businesses determine the costs of products, projects, processes to ensure that financial reports and statements are as accurate as possible. It also helps executives and authorized members of management make the most informed decisions when they are financial planning or deciding on the best long-term moves for the organization.

To see the big picture, the accounting professionals will record the cost of inventory, manufacturing, goods sold, and overhead operations. After this is reported, the expert in cost accounting and management will then analyze the cost behavior so that they are able to see the cost-volume-profit relationships and how it relates to the existing budget, according to Accounting Coach.

How Does Cost Accounting Help Businesses Thrive?

Cost accounting was originally created to help manufacturing businesses assess the cost to manufacture products, store them, ship them, and stay profitable. While it was first involved in the manufacturing sector, it now has become an integral part of budget planning within the service industry. The main reason why this approach to accounting helps businesses thrive is because it shows the company where it is earning and losing money.

After evaluating how efficient the company is in using their budget, they can decide if pricing needs to be adjusted to account for high expenditures. In the end, cost management accountants will give data and analysis reports to management that will be used by managers to make decisions that will lead to long-term profits. This is done by using job costing, process costing, direct costing, and activity costing techniques to interpret costs.

How to Become a Cost Accountant

The very first step to becoming a cost accountant in charge of budget management is to earn a formal degree in accounting from a program that is accredited by the Association to Advance Collegiate Schools of Business. While some smaller employers will hire those with an associate’s degree, a majoring would prefer to hire a professional who possesses a bachelor’s degree in the discipline.

After you earn your bachelor’s, you will then be eligible for most junior accountant roles where you can gain experience. Once you have experience, you can pursue your certification and become a Certified Management Accountant (CMA). A CMA through the Institute of Management Accountants have proven that they have experience and have mastered financial management skills needed to succeed in the industry.

Related Resource: Acquisition and Mergers Specializations

More and more service companies are concerned with analyzing costs and finding a way to reduce expenditures. If you are studying accounting and want to benefit from the high demand for professionals in this role, you should consider specializing in financial management subjects. Once you focus on taking courses emphasizing the importance of cost management in accounting, you can then be considered a skilled candidate.

What Is Cost Accounting?

Cost accounting is a form of managerial accounting that aims to capture a company's total cost of production by assessing the variable costs of each step of production as well as fixed costs, such as a lease expense.

Cost accounting is not GAAP-compliant, and can only be used for internal purposes.

Key Takeaways

Cost accounting is used internally by management in order to make fully informed business decisions.
Unlike financial accounting, which provides information to external financial statement users, cost accounting is not required to adhere to set standards and can be flexible to meet the particular needs of management.
As such, cost accounting cannot be used on official financial statements and is not GAAP-compliant.
Cost accounting considers all input costs associated with production, including both variable and fixed costs.
Types of cost accounting include standard costing, activity-based costing, lean accounting, and marginal costing.

Cost Accounting

Understanding Cost Accounting

Cost accounting is used by a company's internal management team to identify all variable and fixed costs associated with the production process. It will first measure and record these costs individually, then compare input costs to output results to aid in measuring financial performance and making future business decisions. There are many types of costs involved in cost accounting, which are defined below.

Types of Costs

Fixed costs are costs that don't vary depending on the level of production. These are usually things like the mortgage or lease payment on a building or a piece of equipment that is depreciated at a fixed monthly rate. An increase or decrease in production levels would cause no change in these costs.
Variable costs are costs tied to a company's level of production. For example, a floral shop ramping up its floral arrangement inventory for Valentine's Day will incur higher costs when it purchases an increased number of flowers from the local nursery or garden center.
Operating costs are costs associated with the day-to-day operations of a business. These costs can be either fixed or variable depending on the unique situation.
Direct costs are costs specifically related to producing a product. If a coffee roaster spends five hours roasting coffee, the direct costs of the finished product include the labor hours of the roaster and the cost of the coffee beans.
Indirect costs are costs that cannot be directly linked to a product. In the coffee roaster example, the energy cost to heat the roaster would be indirect because it is inexact and difficult to trace to individual products.

Cost Accounting vs. Financial Accounting

While cost accounting is often used by management within a company to aid in decision-making, financial accounting is what outside investors or creditors typically see. Financial accounting presents a company's financial position and performance to external sources through financial statements, which include information about its revenues, expenses, assets, and liabilities. Cost accounting can be most beneficial as a tool for management in budgeting and in setting up cost-control programs, which can improve net margins for the company in the future.

One key difference between cost accounting and financial accounting is that, while in financial accounting the cost is classified depending on the type of transaction, cost accounting classifies costs according to the information needs of the management. Cost accounting, because it is used as an internal tool by management, does not have to meet any specific standard such as generally accepted accounting principles (GAAP) and, as a result, varies in use from company to company or department to department.

Cost-accounting methods are typically not useful for figuring out tax liabilities, which means that cost accounting cannot provide a complete analysis of a company's true costs.

Types of Cost Accounting

Standard Costing

Standard costing assigns "standard" costs, rather than actual costs, to its cost of goods sold (COGS) and inventory. The standard costs are based on the efficient use of labor and materials to produce the good or service under standard operating conditions, and they are essentially the budgeted amount. Even though standard costs are assigned to the goods, the company still has to pay actual costs. Assessing the difference between the standard (efficient) cost and the actual cost incurred is called variance analysis.

If the variance analysis determines that actual costs are higher than expected, the variance is unfavorable. If it determines the actual costs are lower than expected, the variance is favorable. Two factors can contribute to a favorable or unfavorable variance. There is the cost of the input, such as the cost of labor and materials. This is considered to be a rate variance.

Additionally, there is the efficiency or quantity of the input used. This is considered to be a volume variance. If, for example, XYZ company expected to produce 400 widgets in a period but ended up producing 500 widgets, the cost of materials would be higher due to the total quantity produced.

Activity-Based Costing

Activity-based costing (ABC) identifies overhead costs from each department and assigns them to specific cost objects, such as goods or services. The ABC system of cost accounting is based on activities, which refer to any event, unit of work, or task with a specific goal, such as setting up machines for production, designing products, distributing finished goods, or operating machines. These activities are also considered to be cost drivers, and they are the measures used as the basis for allocating overhead costs.

Traditionally, overhead costs are assigned based on one generic measure, such as machine hours. Under ABC, an activity analysis is performed where appropriate measures are identified as the cost drivers. As a result, ABC tends to be much more accurate and helpful when it comes to managers reviewing the cost and profitability of their company's specific services or products.

For example, cost accountants using ABC might pass out a survey to production-line employees who will then account for the amount of time they spend on different tasks. The costs of these specific activities are only assigned to the goods or services that used the activity. This gives management a better idea of where exactly the time and money are being spent.

To illustrate this, assume a company produces both trinkets and widgets. The trinkets are very labor-intensive and require quite a bit of hands-on effort from the production staff. The production of widgets is automated, and it mostly consists of putting the raw material in a machine and waiting many hours for the finished good. It would not make sense to use machine hours to allocate overhead to both items because the trinkets hardly used any machine hours. Under ABC, the trinkets are assigned more overhead related to labor and the widgets are assigned more overhead related to machine use.

Lean Accounting

The main goal of lean accounting is to improve financial management practices within an organization. Lean accounting is an extension of the philosophy of lean manufacturing and production, which has the stated intention of minimizing waste while optimizing productivity. For example, if an accounting department is able to cut down on wasted time, employees can focus that saved time more productively on value-added tasks.

When using lean accounting, traditional costing methods are replaced by value-based pricing and lean-focused performance measurements. Financial decision-making is based on the impact on the company's total value stream profitability. Value streams are the profit centers of a company, which is any branch or division that directly adds to its bottom-line profitability.

Marginal Costing

Marginal costing (sometimes called cost-volume-profit analysis) is the impact on the cost of a product by adding one additional unit into production. It is useful for short-term economic decisions. Marginal costing can help management identify the impact of varying levels of costs and volume on operating profit. This type of analysis can be used by management to gain insight into potentially profitable new products, sales prices to establish for existing products, and the impact of marketing campaigns.

The break-even point—which is the production level where total revenue for a product equals total expense—is calculated as the total fixed costs of a company divided by its contribution margin. The contribution margin, calculated as the sales revenue minus variable costs, can also be calculated on a per-unit basis in order to determine the extent to which a specific product contributes to the overall profit of the company.

History of Cost Accounting

Scholars believe that cost accounting was first developed during the industrial revolution when the emerging economics of industrial supply and demand forced manufacturers to start tracking their fixed and variable expenses in order to optimize their production processes.

Cost accounting allowed railroad and steel companies to control costs and become more efficient. By the beginning of the 20th century, cost accounting had become a widely covered topic in the literature on business management.

How Does Cost Accounting Differ From Traditional Accounting Methods?

In contrast to general accounting or financial accounting, the cost-accounting method is an internally focused, firm-specific system used to implement cost controls. Cost accounting can be much more flexible and specific, particularly when it comes to the subdivision of costs and inventory valuation. Cost-accounting methods and techniques will vary from firm to firm and can become quite complex.

Why Is Cost Accounting Used?

Cost accounting is helpful because it can identify where a company is spending its money, how much it earns, and where money is being lost. Cost accounting aims to report, analyze, and lead to the improvement of internal cost controls and efficiency. Even though companies cannot use cost-accounting figures in their financial statements or for tax purposes, they are crucial for internal controls.

Which Types of Costs Go Into Cost Accounting?

These will vary from industry to industry and firm to firm, however certain cost categories will typically be included (some of which may overlap), such as direct costs, indirect costs, variable costs, fixed costs, and operating costs.

What Are Some Advantages of Cost Accounting?

Since cost-accounting methods are developed by and tailored to a specific firm, they are highly customizable and adaptable. Managers appreciate cost accounting because it can be adapted, tinkered with, and implemented according to the changing needs of the business. Unlike the Financial Accounting Standards Board (FASB)-driven financial accounting, cost accounting need only concern itself with insider eyes and internal purposes. Management can analyze information based on criteria that it specifically values, which guides how prices are set, resources are distributed, capital is raised, and risks are assumed.

What Are Some Drawbacks of Cost Accounting?

Cost-accounting systems ,and the techniques that are used with them, can have a high start-up cost to develop and implement. Training accounting staff and managers on esoteric and often complex systems takes time and effort, and mistakes may be made early on. Higher-skilled accountants and auditors are likely to charge more for their services when evaluating a cost-accounting system than a standardized one like GAAP.

The Bottom Line

Cost accounting is an informal set of flexible tools that a company's managers can use to estimate how well the business is running. Cost accounting looks to assess the different costs of a business and how they impact operations, costs, efficiency, and profits. Individually assessing a company's cost structure allows management to improve the way it runs its business and therefore improve the value of the firm. These are meant to be internal metrics and figures only. Since they are not GAAP-compliant, cost accounting cannot be used for a company's audited financial statements released to the public.

Is cost accounting an integral part of financial accounting?

Cost accounting is an indirect part of financial accounting and a direct part of management accounting. Both cost accounting vs financial accounting can be used together to reduce costs and increase the profitability of a firm.

What is the main function of cost accounting?

What is the role of cost accounting in an Organisation?

Cost accounting helps zero in on your expenses and how they apply to each aspect of your business. Cost accounting focuses on the expenses involved with running your business. It is a common form of accounting for manufacturing businesses, as it allows them to break out costs for each product they produce.

What are the three integral components of a cost?

The three general categories of costs included in manufacturing processes are direct materials, direct labor, and overhead. Note that there are a few exceptions, since some service industries do not have direct material costs, and some automated manufacturing companies do not have direct labor costs.