A key component of accounting is knowing how much you are spending. If you don’t have a handle on your expenses, you never know whether your business is making money. That’s where cost accounting comes in. Cost accounting is centered specifically on the costs associated with running your business. Before you can dig into cost accounting, it is important to understand what it is exactly, the different types of cost accounting and the benefits of this type of financial tracking.
Cost accounting is a method of accounting that focuses purely on a business’s costs – both fixed and variable. Using the cost accounting method, companies track all of their costs and allocate them to individual processes or units of production, allowing managers to better understand the economics of their business’s activities.
Cost accounting is especially important for businesses that manufacture and sell at scale and/or have diverse product lines, as these companies have many costs associated with manufacturing, packaging, and distributing their goods. For these types of businesses, accounting for costs is critical to accurately calculating profit margins, as well as budgeting, forecasting and identifying efficiencies. [Read related article: What are Accounting Standards?]
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More than other types of accounting, cost accounting gives companies a comprehensive view of their costs. Cost accounting tracks all of a company’s costs associated with its offerings and allocates them to specific products or activities. Whereas in financial accounting, costs appear as just one- or two-line items on a budget, cost accounting lets businesses break expenses down to see exactly what is driving costs. This can provide better insights into what the company can do to cut costs and increase profits.
After all, there are only two ways for companies to make more money: They can either increase sales (which is largely beyond their control), or they can cut costs (which they have greater control over).
Not only can you understand the total costs involved to produce your products, but it can be easier to spot instances of overcharging by vendors. Additionally, your company may be able to find efficiencies that allow you to save money.
Some of the benefits of cost accounting include the following:
Additionally, cost accounting can also help business owners make sure they capture all of their tax-deductible expenses.
When using cost accounting, it is important to understand the different types of costs.
|Rent, mortgage payments and insurance
|Raw materials, supplies, packaging
|Utilities, accounting and legal, marketing
|Labor hours for production and distribution
While these are the four most common categories for grouping costs, there are other types as well, such as semivariable. In addition, some costs fall into multiple categories, or they may fall into different categories depending on an individual company, the industry it’s in and how it operates.
Fixed costs don’t change based on a company’s level of production. These costs include items like rent, mortgage payments and salaries for administrative personnel. Fixed costs are significant, because they don’t stop if managers temporarily halt production. Some fixed costs don’t stop even if a business folds.
A company’s variable costs are those that change based on the company’s level of activity. For manufacturing companies, for example, each additional unit of production requires purchasing more raw materials.
Variable costs are significant for a company because they are marginal – each additional unit of production adds more cost to the company. These costs can often be lowered through bulk discounts or other breakpoints.
Operating costs include the expenses involved with running a facility (marketing and utilities are prime examples); it doesn’t include costs that are directly tied to production.
Operating costs can be fixed or variable, but they’re generally costs that companies need to pay to stay in business – even if they aren’t producing anything.
Direct costs are those that a company can tie directly to the production or distribution of a particular product. For example, if you run a manufacturing company, direct costs include the labor hours for manufacturing a product, along with costs for running equipment to manufacture that product.
Direct cost is significant because it is the easiest of the four types to allocate to specific activities or product lines, though it’s not usually the easiest place to find cost savings.
When using cost accounting, it is important to understand the different types of costs, including fixed, variable, operating and direct.
Within cost accounting, there are several subtypes. Each of these is used by different types of companies or for various purposes. For example, lean cost accounting is for manufacturing companies implementing other lean practices.
The four main types of cost accounting are:
Cost accounting focuses purely on a business’s costs, while financial accounting combines this information with other items, like revenue, liabilities, and shareholder equity, to provide a comprehensive look at a company’s finances.
Both cost and financial accounting are used to track elements of a business’s finances. This data helps guide company strategy, including informed decision-making. However, while cost accounting focuses on tracking costs and allocating those costs to specific offerings or activities, financial accounting tracks all aspects of a company’s finances. Financial accounting includes cost accounting, as well as other elements – such as income, liabilities, and equity – which it combines to provide comprehensive reports and insights into the company’s financial circumstances and future prospects.