Cost accounting is an internal process. The reports of a cost accountant are used by management executives to make important strategic decisions regarding the shaping of business.
Cost accounting is defined as a systematic set of procedures for recording and reporting measurements of the cost of manufacturing goods and performing services in the aggregate and in detail.
Cost accountants do not need to adhere to legal statutes or laws and are more of an internal management requirement. The major components of cost accounting include standard costing, activity-wise costing, lean, and marginal costing.
Scope of Cost Accounting
In order to understand the concept of cost accounting better, you first need to familiarize yourself with basic terms associated with this type of accounting.
Types of Cost
A cost accountant deals with various types of costs in his daily work. It is important to make note of the important types:
- Fixed Costs: Costs that do not vary with varying levels of production are considered fixed. Examples of fixed costs include loans or lease payment on fixed assets such as buildings or some specific equipment, that depreciate at a fixed cost over a fixed period of time.
- Variable Costs: Such costs depend on production levels. An example could be that of a flower shop. It will incur a spike in costs of its main product, flower when it purchases more quantities on special occasions like local festivals or Valentine's Day.
- Operating Costs: The costs incurred in the daily operations of a company are clubbed under this head. Note that these costs can either be fixed or variable, depending on the nature of the expense.
- Direct Costs: As the name suggests, it includes all costs that directly go into producing a product. For example, in a jute bag manufacturing business, the labor costs and equipment costs fall under the direct costs of the company.
- Indirect Costs: Everything apart from direct costs, constitute indirect costs. In the same example of the jute bag manufacturing unit, the energy consumed by the factory to produce all types of bags are indirect costs. Note that such costs are indirect since they cannot be traced to one single product manufacturing.
Take an accounting course on Superprof.
Types of Cost Accounting
Just like costs handled by the accountant vary, so does the type of accountant and their role. Let us take a look at the various types of cost accounting:
- Standard Costing: The process of assigning standard, as against actual costs to products and inventories. Such costs are calculated based on the efficient use of labor and materials used to produce the final good or service. Note that standard costing is a method of financial estimation and companies still need to pay actual costs. Cost accountants use variance analysis to determine if the difference between standard and actual costs are favorable to business or not.
- Activity-Based Costing: Popularly known as the ABC system of cost, this method helps to identify overhead costs across all departments and assigns them to specific cost objects, like goods and services. This system is what drives costs in a business, and helps assign overhead costs.
- Lean Costing: This type of costing concerns itself with improving the financial management processes of an organization. This helps managers to cut down on unnecessary costs and improve the profit margins in the long-run.
- Marginal Costing: Also called cost volume profit analysis, it analyzes the impact on the cost of a product by adding an additional unit to its production.
Find out more about what cost accounting entails from the Institute of Cost Accountants of India (ICAI).
What Does a Cost Accountant Do?
The primary job of a cost accountant is to identify irrelevant and unnecessary costs, help managers in financial decision-making, and increase company profits.
A day in the life of a cost accountant includes myriad tasks. These can range from data entry to report the formulation and presentation of recommendations and findings to top bosses in a company. A closer look at the job profile of a cost accountant would reveal the following important tasks:
- Preparation of monthly financial journals and presenting them to an internal committee.
- Review financial data thoroughly to identify discrepancies or anomalies, if any.
- Preparation of monthly, quarterly, half-yearly, and annual company financial statements and reports.
- Conduct regular inventory checks and present data analysis to company management.
- Support the financial accountant to make recommendations for financial policies that can potentially increase the company's cash flows.
- Suggest policy changes through research and analysis of depreciation rates, labor, and overhead costs.
- Ensure costs are classified accurately.
- Prepare Purchase Price Variance reports and analyze findings.
- Establish standard costs for accounting and forecasting purposes, and update them across a set period of time.
- Maintain and review the general ledger and ensure alignment with balance sheets.
- Support business with cost-benefit analyses and securing the best vendors.
Advantages of Cost Accounting
Financial accounting in any business, big or small, depends a great deal on cost accounting. It is a general practice nowadays to hire cost accountants to supplement the work of a financial accountant. It is thus noteworthy to understand the advantages of cost accounting in a changing business environment:
- Measuring Efficiency: Cost accounting provides information that allows a business to capture data on efficiency. This in turn helps make strategic course corrections to improve the same.
- Identifying Ineffective Activities: The data gathered from cost accounting helps a company understand its sales performance, and eliminate unprofitable activities.
- Tackling Adversities: During difficult economic times, like a recession, cost accounting allows a business to reduce prices below the total cost of the product. This, in the short-run, helps to keep the business afloat.
- Stock Control: Cost accounting helps a company with restocking and control over materials, thus avoiding over or understocking.
- Analyzes Expenses: The methods of cost accounting help a company identify the reasons behind its profit and loss dynamics.
- Planning and Forecasting: By controlling and steering company finance, the cost accountants help the business plan for all sorts of future economic scenarios.
Difference Between Cost and Management Accounting
While it is true that the various types of accountants follow the same accounting principles, the Generally Accepted Accounting Principle (GAAP), India, there some significant differences between each type. In the context of cost accounting, it is important to mention how it is different from management accounting.
- Purpose: Cost accountants generally look after cost control and decision making in a company by supporting the management with necessary financial data and analysis. Management accountants, on the other hand, provide recommendations on performance management, planning, and controlling decisions.
- Type of Data: The nature of the role of a cost accountant requires dealing with quantitative data, specifically in monetary terms. Management accountants, however, use both quantitative and qualitative data to present their findings and recommendations. Usually, such data cannot be quantified in monetary terms.
- Primary Role: A cost accountant has the important job of determining costs and cost controls. A managerial accountant, on the other hand, mainly concerns herself with performance control and management decisions.
- Interdependent Nature: The success of a cost accountant is independent of the work of a management accountant. While on the other hand, this is not true. Management accountants depend heavily on the data and findings provided by cost accountants, as well as financial accountants.
- Nature of Findings: Cost accountants use historical financial and cost information to recommend future financial processes and policies. Management accounting data, on the other hand, is derived from past records, and are used to make predictions about future decision-making in a company.
- The objective of Reporting: The reports prepared by cost accountants are meant for a larger audience. This includes company management, shareholders, investors, and creditors. Management accounting reports, on the other hand, are prepared exclusively for company management.
- Accounting Principles: Cost accounting is derived primarily from principles of cost accounting. Management accounting is based on principles of both cost and financial accounting.
- Compliances: Unlike cost accounting, management accounting does not fall under any legal statute. Hence the question of compliance does not arise. Cost accounting reports, however, have to abide by laws and statutory compliances, as applicable in a country.
Cost accounting thus offers a very wide range of opportunities in terms of both career growth and following your passion for accounting and numbers. You can go on to become the next Chief Financial Officer of your dream company with a certification or diploma in cost accounting. So wait no further, and jump right into the journey of following your dream.