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Tuesday, March 22, 2011

What is cost accounting?

Cost accounting identifies, documents, implements and resolves business costs for both managerial decision making and financial reporting. Without cost accounting, businesses may have out of control expenses, inefficient business practices, excessive liabilities and no effective cost management systems and solutions. Just as financial accounting is regulated by General Accepted Accounting Principles (GAAP), cost accounting is also regulated by Cost Accounting Standards Cost Accounting Standards (CAS)

Cost accounting that encompasses a process of utilizing cost accounting information for improved business functioning is a helpful if not essential aspect of running a business competitively and efficiently. This article will discuss cost accounting in terms of types of business costs,  cost accounting records,  cost management systems and solutions for cost management.


Types of business costs


Business costs in cost accounting vary from industry to industry and the ideal business has no expenses, which is rare. The different types of costs incurred by a business reflect the management's decision making, the business products and services, and aspects of how a business is operated. Properly identifying business costs is helpful and necessary in preparing and analyzing corporate fundamentals. Some of the business costs handled by cost accounting are listed below:

• Manufacturing costs ex: Nuts and bolts
• Overhead costs ex: Lighting
• Variable and fixed costs ex: Nuts and bolts and salaries
• Direct and indirect costs ex: Paper used for invoices
• Sunk and opportunity costs ex: Investment in equipment

Cost statements and documents


What cost accounting also helps with is the recording and documenting of business costs. This process helps track costs every step of the way from origination, through completion of a product manufacturing, sale and service. Cost accounting statements and documents also provide regulators, investors and auditors with necessary financial information with which to analyze the profitability, accounting methods, accuracy and effectiveness of cost accounting systems. A few of the documents, reports and statements used in cost accounting are:

• Schedule of cost of goods manufactured ex: cost of completed product
• Schedule of cost of goods sold ex: costs of sold inventory
• Income statement ex: COG raw materials
• Job cost record ex: costs of work in progress
• Balance sheet ex: product and period costs

Different cost management systems


Cost accounting also uses what is referred to as 'cost management systems'. Cost management systems 1. define how costs are identified, 2. organize the method by which costs are recorded and 3. assist in reviewing and improving business costs. These cost management systems are used in various aspects of business operations to properly account for, record and identify business costs. Some of these cost management systems are cataloged hereafter:

• Actual and normal costing: ex. Average and exact water used cleaning lettuce
• Activity based costing: ex: cost of electricity used shredding
• Product costing systems ex: average cost of boys and girls bicycles
• Job order costing: ex: manufacturing cost for custom furniture
• Cost allocation and cost classification: Cost per apple vs apple picker cost

Solutions for management


Without solutions for cost management, cost accounting hasn't completely fulfilled its task. In other words, identifying, methodologically assessing costs and recording costs do not necessarily help a business improve.  Rather, solutions to cost management problems may be needed frequently or occasionally depending on how much a market and business environment change. With changes in prices, equipment capacity, training, know how and product manufacturing, also come possible changes to the cost accounting that studies these things.

• Restructuring of capital management
• Identification of redundant costs
• Redesign of cost systems
• Improved day to day operations techniques
• Enhanced sourcing and implementation of cost items

Sources: 

1. Hilton, Ronald 'Managerial Accounting: Creating value in a dynamic business environment' 5th ed,  McGraw-Hill, 2002 Chapters 1-6.
2. http://www.fasab.gov/ (Federal Accounting Standards Advisory Board)
3. http://fast.faa.gov/archive/v1198/pguide/98-30C14.htm (Federal Aviation Administration)