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What is Cost Accounting?
Cost accounting comes down to two words – “cost” and “accounting”. First, let’s understand what “cost” is. Then we will look at “accounting”.
What is “cost”?
Cost is an expense incurred by a particular unit. In another way, the cost is what the business sacrifices in order to produce one unit of product.
What is “accounting”?
Accounting is the art and science of recording, classifying, summarizing, and analyzing inputs to make a sense of the information related to financial, management, or cost.
If you are new to accounting you can learn basic accounting here
Cost Accounting Definition
Cost Accounting Definition – Cost accounting is the art and science of recording, classifying, summarizing, and analyzing costs to help management make prudent business decisions.
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Purpose of Cost Accounting
There are basically three purposes of cost accounting –
- Cost control: The first function of cost accounting is to control the cost within the budgetary constraints management has set for a particular product or service. This is important since management allocates limited resources to particular projects or production processes.
- Cost computation: This is the main function of cost accounting and this is the source of all other functions of cost accounting. In the section below, we will see how 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 material and direct labor that is used in producing goods. These costs we can identify as direct costs.
Indirect costs, on the other hand, are costs which can’t be identified easily. The reason these costs can’t be identified 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 rent is used for the production of goods, how much is used for preparing the raw material, how much is used to install the simulation systems that can train the workers.
Understanding these two types of costs is important since we would be using these costs in calculation of cost of sales per unit for a particular product.
Fixed Costs, Variable Costs, & Semi-variable Costs in Cost Accounting
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 cost changes, per unit cost per unit, remain same irrespective of changes in production units. For example, the cost of raw material is a variable cost. The total cost of raw material changes if the production increases or decreases. But per unit cost of raw material remains same even if the production increases or decreases.
In semi-variable costs, both components are present. Semi-variable costs are the combination of fixed costs and variable costs. Let’s say that you pay $1000 per month as 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. But still, cost accounting 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: $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 Stock||(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 has been a guide on what is Cost Accounting, definition, the purpose of cost accounting, types of costs – direct & indirect, fixed and variable costs along with Cost accounting statement examples and formats. You may learn more about accounting from the following recommended articles