What is Cost Accounting?
Cost accounting is the art and science of recording, classifying, summarizing, and analyzing costs with the objective of cost control, cost calculations and projections, and cost reduction, thereby helping management make prudent business decisions.
Objectives of Cost Accounting
- Cost control: The first function is to control the cost within the budgetary constraints management has set for a particular product or service. It is essential since management allocates limited resources to specific projects or production processes.
- Cost computation: It is the source of all other functions of cost accounting as we can calculate the cost of sales per unit for a particular product.
- Cost reduction: Cost computation helps the company reduce costs on projects and processes. Reduction in costs means more profits since the margin will naturally increase.
Direct Costs & Indirect Costs in Cost Accounting
Direct costs are directly involved in producing goods. That means direct costs can be directly identified as being used in the production of goods. For example, we can talk about direct materialDirect MaterialDirect materials are raw materials that are directly used in the manufacturing process of a company's goods and/or services and are an essential component of the finished goods manufactured. and direct labor that is used in producing goods. These costs we can identify as direct costs.
Indirect costsIndirect CostsIndirect cost is the cost that cannot be directly attributed to the production. These are the necessary expenditures and can be fixed or variable in nature like the office expenses, administration, sales promotion expense, etc., on the other hand, are costs that can’t be identified easily. The reason these costs can’t be determined separately because these costs assist in functioning multiple activities. For example, the rent business pays for running a production operation would be called indirect costs, since we can’t identify how much portion of the rent is used for the production of goods, how much is used for preparing the raw material,and how much is used to install the simulation systems that can train the workers.
Understanding these two types of costs is crucial since we would be using these costs in the calculation of the cost of sales per unit for a particular product.
Fixed Costs, Variable Costs, & Semi-variable Costs
Fixed costs are costs that don’t change with the increase or decrease of production units. That means these costs remain similar within a broad range of the spectrum. Plus, the per-unit fixed cost changes as the production increases or decreases. For example, rent is a fixed cost. Even if the production increases or decreases, the business needs to pay the same rent month in and month out.
Variable cost is the exact opposite of fixed cost. Variable cost changes as per the increase or decrease of production units. But even if the total variable costTotal Variable CostTotal variable cost is the total of all variable costs that would change in proportion to the output or the production of units and helps analyze the company's overall costing and profitability. Total variable cost formula = number of units produced x variable cost per unit. changes, per unit cost per unit, remain the same irrespective of changes in production units. For example, the cost of raw material is variable. The total cost of raw material changes if the production increases or decreases. But the per-unit cost of raw material remains the same even if the production increases or decreases.
In semi-variable costs, both components are present. Semi-variable costs are a combination of fixed costsFixed CostsFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity. and variable costs. Let’s say that you pay $1000 per month as a fixed salary to all your workers and the workers who produce more than 50 units of toys every month. They get an additional $5 for every additional unit produced. This sort of wages will be called semi-variable wages.
Cost Accounting Examples and Format
Cost accounting is much more than a cost statement, and this example will give us an idea about how to calculate the cost of sales per unit for a particular product –
MNC Factory has the following information, and from the below-furnished information, you need to calculate per unit cost of sales.
- Raw Materials – Opening Stock:Opening Stock:Opening Stock is the initial quantity of goods held by an organization during the start of any financial year or accounting period. It is equal to the previous accounting period's closing stock, valued in accordance with appropriate accounting standards based on the nature of the business. $50,000; Closing Stock: $40,000.
- Purchases during the period: $145,000.
- Direct labour – $100,000
- Works overheads – $40,000
- Administration overheads – $20,000
- Selling & distribution overheads – $30,000
- Finished units – 100,000;
Find out the cost of sales per unit.
In this example, every input is given. We just need to put the figures in the right place.
Statement of Cost of ABC Factory
|Particulars||Amount (In US $)|
|Raw Materials – Opening Stock||50,000|
|Add: Purchases during the period||145,000|
|Less: Raw Materials – Closing StockClosing StockClosing stock or inventory is the amount that a company still has on its hand at the end of a financial period. It may include products getting processed or are produced but not sold. Raw materials, work in progress, and final goods are all included on a broad level.||(40,000)|
|Cost of material consumed||155,000|
|Add: Direct Labour||100,000|
|Add: Works overheads||40,000|
|Add: Administration overheads||20,000|
|Cost of Production||315,000|
|Add: Selling & Distribution overheads||30,000|
|Total Cost of Sales||345,000|
|Finished Units||100,000 units|
|Cost of Sales per unit||$3.45 per unit|
Cost Accounting Video
This article has been a guide to what is Cost Accounting & its definition. Here we discuss the purpose of the cost accounting statement and its example along with its types and formats. You may learn more about accounting from the following recommended articles