Just like you work hard exploring all possible ways to earn more, cutting down the unwanted cost is one of way to look at. Remember,’ A penny saved is a Penny Earned’. Every time you save, it directly goes to your pocket.
Here is why cost accounting plays an important role in recording cost incurred by your business and the valuable insights in the form of reports, allows you to make accurate decisions.
As the name says, cost accounting is concerned with recording, classifying, and summarizing all the cost associated with the business. Being a key function, it helps business to determine the cost of the product or services, cost control, planning and optimizing the cost at all levels.
In this article, let’s understand the fundamentals of cost accounting. Being a business owner, knowing the fundamentals of cost accounting will help you identify the areas to optimize cost and make confident decisions.
What is Cost Accounting?
Cost accounting is a process of recording and reporting all the cost incurred by the business by of applying costing principles, methods and techniques. This is also known as cost accountancy.
We often hear about costing, cost accounting, cost control, cost audit and so on... do all of these convey the same?
No. All these are connected but they are a little different from each other.
Let’s figure it out.
Costing | Costing is the technique and process for ascertaining cost. |
Cost Accounting | Cost accounting is that branch of accounting which deals with classification, recording, allocation, summarization and reporting of current and prospective cost |
Cost control techniques | The cost control technique deals with the guidance and regulations related to cost optimization |
Budgeting | It is an overall blueprint consisting of a comprehensive plan of operations and actions of the business expressed in financial terms |
Cost Audit | It is a process of verifying the correctness of cost records and the adherence to the cost accounting plan. |
Types or Classification of Cost
The cost incurred by the business can be classified based on different nature as detailed below:
- Classification based on volume/activity
- Classification based on association with the product
- Classification based on traceability
- Classification based on time of occurrence
- Classification based on control over factors of production
- Classification based on decision making
- Classification based on functions
Further, each of these classifications consists of different types of costs. Let’s understand with an example.
Classification Based on Volume/Activity
- Fixed cost - Costs that are constant with different volumes of output. E.g., Rent, Salary etc.,
- Variable cost - Costs that vary with output and have major relationship with output. E.g., Wages, Electricity, cost of material etc.,
- Semi-variable cost - Costs that do not vary proportionately nor remain stationery. E.g., telephone charges, repairs, supervision charges etc.,
Classification Based on Association with the Product
- Product cost - Costs that can be easily associated with or becomes part of the cost of the product. E.g., Direct material, Direct labour etc.,
- Period cost - Costs that cannot be traced back to the product. E.g., Rent, Insurance, Salary etc.,
Classification Based on Traceability
- Direct cost - Costs that can be traced or mapped with the product, service, process or job.
- Indirect cost - Costs which are not traceable or mapped to the product. E.g., salaries of timekeepers, storekeepers etc.
Classification Based on Time of occurrence:
- Historical cost - These are the costs that are available for computation only after production or manufacturing activities are completed.
- Predetermined cost - These costs are computed even before a production activity is started based on the factors which influence them. E.g., Estimated costs and standard costs.
Classification Based on Control Over Factors of Production
- Controllable cost - Costs that can be managed by the specified member of an undertaking. E.g., Direct material, Direct labour etc.,
- Uncontrollable cost - Costs that cannot be controllable are termed uncontrollable costs. E.g., rent, taxes, salary etc.,
Classification Based on Decision Making
- Opportunity cost - Cost of next best alternative or the value of benefit sacrificed in favour of choosing a particular action. For example, if an owned lab building in a research Centre is proposed to be utilized for a new project, the likely revenue if rented out is the opportunity cost which should be added while evaluating the profitability of the project.
- Sunk cost - Cost that has been created due to the decision made in the past and which cannot be changed by any decision that could be made in future. E.g., amount spends on research and development activities, investment in plant and machinery etc.
- Replacement cost - It is the value of the current market cost of replacing an asset.
- Shut down cost - Costs that continue to incur even after a plant is temporarily shut down. E.g. rent, depreciation etc.
Classification based on Functions:
- Production cost - Costs that commences with operating activities involving factors of production such as a supply of labour, material, services and which ends with the packing of the product. It includes the cost of material, labour and production overheads.
- Selling and distribution cost - It is the cost associated with creating and stimulating demand for the product, securing orders from clients and making the packed product available for the logistics department for dispatching. E.g., advertisement cost, showroom expenses, warehouse cost, transportation cost, cost of samples etc.,
Business Benefits of Cost Accounting
- Cost accounting helps the management in ascertaining the cost of process, activity, by using techniques such as job costing or process costing.
- It aids the management in price fixation from the cost sheets or cost records.
- Helps in inventory control.
- Cost accounting helps in identifying unprofitable activities so that corrective actions be taken.
- Optimizing or cutting down the unwanted cost.
- Helps in checking the accuracy of financial account.
How Businesses Manage Cost Accounting?
To keep your business in operation, you spend. The spending range as big as buying machinery to as little as paying for stationeries. Irrespective of how big or small is the cost, it should be recorded, and timely reporting should be produced for you to assess and make decisions.
Traditionally, the process of recording and reporting by applying the cost accounting principles was complex by the business. However, owing to the value cost accounting brings to table, the businesses have found a smart way to account and manage cost by using accounting software.
Accounting software not only made the life easier in accounting the cost but also proved to be effective for business owners to make decisions considering the costing insights. It helped them to stay on top of spending even on the little expenses and identifying areas to optimize the cost.
Among the several techniques, the most effective way to manage ad optimize the cost is using cost centre management. It helps the business owner to be aware of all the spending’s and provide actional insights for confident decision making.
Know How Tally.ERP 9 helps you manage and optimize cost
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