Advantages of Cost Accounting
Cost Accounting is a tool used by the management of the company that helps in identifying, recording and assessing an entity’s cost of production in order to measure the performance of various products and divisions, thus aiding in decision making.
As opposed to financial accounting, cost accounting is used internally by the management for budgeting and decision-making, and not for external financial reporting. Implemented effectively, a sound cost accounting system would help improve product and divisional profitability, thereby enhancing the overall organizational profitability. Below is a summary of the advantages of cost accounting.
Top 8 Advantages of Cost Accounting
#1 – Various Items of Costs
A) Material Costs
- A cost accounting system, when implemented effectively, ensures timely order fulfillment by providing uninterrupted production.
- Reduction of inventory holding costs by synchronizing the frequency of material order placement with the production schedule.
- Identification and avoidance of abnormal/ unnecessary losses and wastages during storage or production.
- It helps achieve economies of scale by identifying optimum re-order quantity to reduce inventory purchase costs—appropriate valuation of inventory as well as scrap.
B) Labor Costs
- An effective labor cost control system helps to:
- Recognize and eliminate situations of overstaffing or understaffing by determination of manpower requirements in different divisions across product lines.
- Control idle time and overtime by assessment of time consumed in different processes and departments;
- Institute wage systems, incentive schemes and a bonus plan commensurate with productivity;
C) Overhead Costs
Cost accounting helps ensure better monitoring of the consumption of resources by various cost centers and ensures better departmental control.
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#2 – Aids Cost Control and Cost Reduction
A good cost accounting system helps management decrease the entity’s production cost by employing cost control and cost reduction.
- Cost control is the process of ensuring that the actual cost incurred is in line with the planned amounts.
- Cost reduction aims to lower the per-unit cost of production without compromising on the quality of the product.
A comparison of costs across periods in respect of the same product or with competitors or industry standards helps to determine avenues for cost control and reduction.
#3 – Elimination of Wasteful Activities
Cost accounting systems help identify redundant activities, inefficiencies, abnormal and avoidable losses. Thus, cost accounting is useful for identifying the cause of fluctuations in the profitability of the business. Additionally, the cost of idle capacity can be estimated in case divisions or plants are not working to their full capacity. It would help identify the unprofitable product or product lines and wasteful activities, so that they may be better managed or eliminated. Cost analysis also helps management decide if it is economically better off making a product in-house or sourcing the same from external vendors.
#4 – Aids in Fixing Appropriate Price to Improve Product Profitability
- Cost accounting enables the management to find the ideal range of prices that would be most profitable to the company, given the level of output produced and the prevailing market scenario.
- Cost accounting enables fixation of appropriate prices by making a distinction between fixed and variable costs that are not otherwise made in financial accounting systems.
- For example, in periods of a global recession, an entity may be required to lower prices to keep up the demand for its products. In such a situation, the management may decide to sell at a price that does not cover its total cost.
- The company would then sell the product at a price over its variable cost of production. Since the fixed costs are to be incurred whether or not the entity manufactures the product, the management would price the products in such a manner that at least the incremental cost of producing each additional unit is covered.
#5 – Improvement of Division & Organizational Profitability by Fixing Appropriate Prices for Inter-Departmental Transfers
Cost accounting also helps determine a suitable price for the interdepartmental transfer of semi-finished products or materials in a production chain. This system would push department managers to improve individual division profitability by holding them accountable for the same. The divisions would then be encouraged to make optimum utilization of capacity, which would, in turn, boost the overall profitability of the organization as a whole.
#6 – Helps Management by Exception Leading to Timely and More Informed Decisions
Cost accounting systems help identify deviations from planned amounts. For example, excessive use of materials compared to the standard requirement, extra time taken to complete a particular activity/product than that estimated, additional services consumed by a division of the entity than normal, etc. will be brought to light by a good cost accounting system. Management can then focus their efforts on such material variances that are identified. Cost accounting aids the management in making informed decisions in a timely manner, with some degree of foresight.
#7 – Allows Fixation of Accountability and Responsibility
Budgeting costs and revenues define clear targets for various product lines and divisions within the entity. This helps create division-level accountability within the company, making it easier to fix responsibility for inefficiencies or the award of performance-based incentives.
#8 – Cost Accounting Benefits Economy as Whole
Various government departments use cost records maintained by the entity, that is shared with government agencies as part of statutory requirements, in their efforts to regulate the sector by means of price control, price fixation, tariff protection, fixation of minimum wage levels, etc. ensuring equitable allocation of resources and compensation.
Cost accounting supplements financial accounting to provide management with insights on how the various product lines and activities involved in the production process affect the movements of costs, thereby impacting overall company profitability. A good cost accounting system provides inputs for timely management decisions to be taken for cost control and cost reduction by reducing inefficiencies, redundant activities, and avoidable losses.
This has been a guide to the Advantages of Cost Accounting. Here we discuss its advantages, including Cost Control and Cost Reduction, Elimination of Wasteful Activities and etc. You can learn more about financing from the following articles –