What is Cost Accounting?

In this post we’ll attempt to answer the question, “what is cost accounting?” Cost accounting is an approach to managerial accounting that creates a clear understanding of the relationship between incurred costs and realized revenues. When implemented correctly and efficiently, cost accounting becomes a critical tool in reviewing operational decisions with the goal of maximizing profits.

Cost accounting techniques began from the perspective of variable inputs into a production process. For example, early stage cost accounting reports highlighted the relationship of revenues to the cost of raw materials and direct labor used in the production of goods. As cost accounting techniques evolved, allocations of fixed overhead expenses started to be included in the reporting outputs. For example, depreciation expenses related to machinery or overhead staff required to manage and administer the production/direct labor staff started to be allocated as part of the costs associated with producing a good.

Today, cost accounting allows business to understand the details and efficiently analyze variances between the actual costs associated with goods against the standard/budgeted costs. The result is a significantly improved understanding of a company’s production/operational behaviors, improved inputs into pricing models and the relationship between production costs and sales, general and administrative costs.

Modern day cost accounting is generally sub-divided into two different techniques.

What is Cost Accounting: Activity Based Costing (ABC)

Activity Based Costing (ABC) is one method used by cost accountants during which specific business functions are analyzed based on the amount of work required. The driver/goal in most ABC accounting systems is to evaluate the most efficient allocation of resources. Ultimately, business processes and profitability are improved once businesses are equipped with a deeper understanding of where inefficiencies exist.

What is Cost Accounting: Cost-Volume-Profit Analysis (CVP)

The second cost accounting methodology commonly employed today is Cost-Volume-Profit Analysis (CVP). The goal of CVP is to obtain a deeper understanding of a Company’s profitability in direct relationship to their costs. CVP is generally considered a simplified version of cost accounting as costs are only affected by a change in the Company’s production output. Considerations for contributory margin become increasing important in CVP analysis.

As with everything, cost accounting techniques and outputs do have some weaknesses that ought to be recognized. It is important to acknowledge, cost accounting is a framework for analyzing how costs behave in a business. It is not a cash flow projection technique, it does not manage Sales, General & Administrative costs for a business, nor does it help to manage inventory. It that regard, it is very helpful to think of cost accounting as a set of just-in-time accounting related feedbacks to executive, management, and production teams.

TGG Accounting helps many businesses implement cost accounting techniques. For more information on how cost accounting can help your business, call us today.

Written by:
Andrew Ruff
TGG Accounting

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