What is Cost Accounting?

When running a small business, being clear on the costs associated with the production process and ensuring you have the information to hand that will help you plan for the future with confidence is vital. The process of cost accounting can help with both of these.

What Is Cost Accounting? 

Put simply; cost accounting is the process of recording, analysing and reporting all of the costs related to the production of a product. This includes fixed and variable costs, such as rent, overheads, materials and labour. By analysing this information, you will better understand which products are profitable and identify any areas that may need more focus.

Types of costs

There are many types of costs involved in cost accounting, including:

• Fixed costs: These stay the same regardless of the level of business activity, such as mortgage or lease payments.
• Variable costs: These costs are tied to activity levels, so buying extra inventory or bringing in additional staff to cover peak times.
• Operating costs: These are costs associated with the day-to-day operations of a business and can be either fixed or variable, depending on the situation.
• Direct costs: These are specifically related to a cost object, such as producing a product or service, a department or project, such as software, equipment and raw materials.
• Indirect costs: These cannot be directly linked to a product, such as administration, personnel and security costs.

What Is the Purpose of Cost Accounting? 

Cost accounting plays an important role when it comes to budgeting, efficiency and profitability. As a small business, it's vital that you understand where money is being spent. While this may be relatively easy to track regarding fixed costs, such as rent and utilities, it can be harder to keep on top of variable expenses that change with output. Not only is it essential that these are tracked and analysed to budget more accurately, but it's also worth any business knowing that their spending is sensible and isn't negatively impacting profit. Cost accounting can provide the information needed to ensure this is the case and to help you make more informed financial decisions.

Indeed, by regularly assessing costs, you'll also identify areas where they're rising, budgets are being exceeded, or where it may be possible to introduce efficiencies. This, in turn, could lead to greater profits as you can ensure a lean operation that produces the same output for less outlay.

Disadvantages of Cost Accounting 

While all of this is undoubtedly important information, cost accounting does have several potential drawbacks. For example, cost accounting doesn't show the current state of the business as it relies on historical data. Particularly in these days of rapidly rising costs, the information it gives will only be enough to estimate future outgoings.

Cost accounting and recording the transactions that will give it value can also be complex, requiring expertise to record and accurately interpret the data. It can also be time-consuming and, therefore, costly.

What Are the Types of Cost Accounting?

Depending on your aims, there are several different types of cost accounting. 

• In standard cost accounting, popular in the manufacturing industry, costs are based on what is produced under typical operating conditions. However, even though these standard costs are assigned to the product, the business still has to pay actual costs, and the difference can be significant. It is, however, a relatively quick method for budgeting.
• Activity-based costing, or ABC, is a more popular cost accounting method, particularly for dealing with specific services and goods. It identifies overhead costs from each department and assigns them to specific cost objects, such as goods or services. It produces more accurate costs and better classifies those costs incurred by the company during its production process. It can also help determine which products are not profitable because every associated cost has been identified.
• Lean accounting is designed to improve financial management practices within a business. It is an extension of lean manufacturing, which focuses on delivering value while minimising waste. When using lean accounting, traditional costing methods are replaced by value-based pricing based on a consumer's perceived value of a product or service and lean-focused performance measurements. Lean-focused performance measurements look to streamline production cycles and lead times.
• Another form of cost accounting is project accounting, which involves assessing costs related to an individual project. Project accounting reports will evaluate project execution and whether it remains on track, including all revenues, costs, assets and liabilities. 
• Life cycle costing considers the total cost of product ownership from inception to completion. For instance, if you needed to buy new equipment to deliver a new product or service, you wouldn't just look at the purchase price but also consider financing, maintenance, disposal and all other costs associated with its use throughout its life. This helps a business ensure an accurate and complete picture of all of a product's related costs.