What is Cost Accounting?

Have you ever wondered how companies calculate a particular product's cost? How do they ensure that the selling price covers all expenses and still generates a profit? The process involves various factors, such as direct material costs, labor costs, manufacturing overhead, and other indirect costs.

For example, in a manufacturing setting, the cost of a product could include raw materials, machine maintenance, and labor wages. This intricate task is accomplished through cost accounting. Cost accountants meticulously analyze all expenses involved in production, distribution, and administration to arrive at a comprehensive cost figure. This allows businesses to make informed decisions about pricing strategies and profitability, ensuring their long-term success.

What is Cost Accounting?

Cost accounting, which is also a form of managerial accounting, is processed to capture the company’s overall cost of production. It involves tracking and analyzing all expenses incurred during production, including raw materials, labor, overheads, and other indirect costs. By doing so, companies clearly understand how much it costs to make each product.

This information is invaluable for the management team in making important pricing, budgeting, and overall profitability decisions. Cost accounting helps identify areas where costs can be minimized, efficiency can be improved, and resources can be optimized. Additionally, it allows organizations to compare actual costs with estimated costs, giving them insights into their performance and financial health. When compared to financial accounting, cost accounting can be flexible depending upon the company’s internal management.

Must Explore- Cost Accounting Courses

Learn about Difference Between Cost Accounting and Management Accounting

What is Cost?

In cost accounting, "cost" refers to the expenses incurred in producing goods or services, including direct material costs, labor costs, and overhead costs. Cost accountants analyze and allocate these expenses to determine the true cost of each product or service. This information is crucial for businesses to make informed pricing, budgeting, and profitability decisions.

What are the Elements of Cost in Cost Accounting?

The elements of cost in cost accounting are the variables that make up the total cost of a product, service, or project. Cost comprises three main elements i.e, Material, Labor, and Overhead.

1. Material- This includes the raw materials used to produce a product or service, such as wood, steel, or plastic.
2. Labor- This includes the wages and salaries paid to workers directly involved in producing a product or service, such as production workers, machine operators, and assembly line workers.
3. Manufacturing Overhead- Costs other than the material and labor come under overhead or expenses. This includes indirect costs associated with producing a product or service, such as rent, utilities, depreciation, and insurance.

Read more: Difference between Realisation Account and Revaluation Account

Objectives of Cost Accounting

1. Determination of the cost of products: Cost accounting provides the information necessary to determine the cost of products, services, and projects. This data is used to make informed pricing, production planning, and resource allocation decisions.

2. Offer Base for cost control and cost reduction: Cost accounting gives detailed information about the costs of production, which can be used to identify areas for cost control and cost reduction.

3. Assist in budget preparation and control: Cost accounting provides information essential for budget preparation and control. The information is used to compare actual results with budgeted results and identify improvement areas.

4. Helps in decision-making: Cost accounting provides relevant and accurate information that is used to support decision-making. The information is used to make informed decisions about product pricing, production methods, and resource allocation.

5. Measure organization's performance: It is a tool used to measure the organization's performance. The information is used to compare actual results with budgeted results, to evaluate the efficiency of operations, and to identify areas for improvement.

6. Provide information for product pricing: Cost accounting is essential for pricing products and services. The information is used to determine the cost of production, determine the profit margins, and make informed pricing decisions.

Explore more:  Objectives of Cost Accounting

Suggested read: What is Cost Audit?

Importance of Cost Accounting

Cost accounting is important for a business because it provides managers and executives with the information they require to make successful decisions about how to operate the business more efficiently. Some of the key benefits of cost accounting include

Cost Control: Cost accounting helps businesses identify and control costs by offering information on the costs associated with developing a product or providing a service. This allows managers to identify areas where costs can be reduced and improve profitability.

Budgeting and Forecasting: Cost accounting helps businesses create accurate budgets and forecasts by providing information on past and expected costs. This allows managers to plan for the future and make adjustments as necessary.

Pricing Decisions: Cost accounting helps businesses set prices for their products or services by providing information on the costs associated with producing them. This allows businesses to charge fair prices to customers and still generate a profit.

Decision-making: Cost accounting gives managers the information they need to make the right decisions about operating the business more efficiently. This includes decisions about production processes, product mix, and resource allocation.

Performance Evaluation: Cost accounting provides managers with the information they need to evaluate the performance of different departments and business units. This allows managers to identify areas that are performing well and areas that need improvement.

Must read: Difference between Standard Costing and Budgetary Control

Must Know Key Terminologies

Cost	The total amount of resources (e.g., materials, labor, overhead) required to produce a product, provide a service, or complete a project.
Costing	Costing is the process of determining the cost of a product, service, or project. It gives businesses the information they need to understand their costs and make informed decisions about pricing, production, resource allocation, and other critical business decisions.
Cost Center	A unit or department within an organization that incurs costs but does not directly generate revenue. Examples of cost centers include the accounting department, the human resources department, and the marketing department.
Budgeting	Budgeting is the process of creating a financial plan for a specified period of time, typically a year. It involves forecasting expected revenues and expenses and determining the resources required to achieve specific financial goals.
Variance	Variance is a term used in cost accounting to describe the difference between actual results and budgeted or expected results. It measures the deviation of actual results from a predetermined plan or standard.
Variance analysis	Variance analysis is the process of comparing actual results with the budget or forecast, and determining the reasons for any differences.
Standard costing	Standard costing is a method of cost accounting that uses predetermined standards to determine the cost of a product, service, or project
Marginal costing	Marginal costing is a method of cost accounting that only includes the variable costs, such as direct materials and direct labor, in the cost of a product. In this, fixed costs are excluded from the calculation of the cost of a product.

Also read: Difference Between Marginal Costing and Absorption Costing

Applications of Cost Accounting

Cost accounting is a versatile tool that can be applied to various industries, which helps businesses to make better decisions, reduce costs, improve profitability, and evaluate their performance. Some of the most common cost accounting applications are: 

Manufacturing: Cost accounting is essential for manufacturing companies as it helps them determine the cost of producing a product, including direct materials, direct labor, and overhead costs. This information is used to set prices, create budgets, and make decisions about production processes and product mix.

Service Industry: Service companies also use cost accounting to determine the service cost. This information sets prices to create budgets and decides on resource allocation and service delivery.

Healthcare: Healthcare organizations use cost accounting to determine the cost of medical care. This information is used to set prices, create budgets, and make decisions about resource allocation, including staffing, equipment, and facilities.

Government: Government organizations use cost accounting to determine the cost of public services. This information is used to create budgets, make decisions about resource allocation, and evaluate the performance of different programs and departments.

Retail: Retail companies use cost accounting to determine the cost of buying and selling products. This information sets prices to create budgets and decides on inventory management and product mix.

Construction: Construction companies use cost accounting to determine the cost of building a project, including direct materials, direct labor, and overhead costs. This information is used to set prices, create budgets, and decide on resource allocation, including labor and equipment.

Difference Between Financial Accounting and Cost Accounting

Financial Accounting	Cost Accounting
Financial accounting is focused on providing information to external stakeholders, such as investors and creditors	Cost accounting is focused on providing information to internal stakeholders, such as managers and executives.
Financial accounting helps make informed decisions about the company's financial position.	Cost accounting assists in making decisions about how to operate the business more efficiently.
Financial statements, such as the balance sheet, income statement, and statement of cash flows, are the primary tools used in financial accounting.	Cost accounting focuses on the costs associated with producing a product or providing a service and uses tools such as cost-volume-profit analysis and budgeting to help managers make better decisions.
In short, financial accounting is mainly focused on external reporting.	In short, cost accounting is mainly focused on internal reporting and decision-making.

Must check: Difference Between Cost Accounting and Financial Accounting

Classification of Costs

Costs can be classified in various ways, depending on the purpose of the analysis. Still, the most common classifications of costs are as follows:

1. Based on nature or traceability: Direct costs and indirect costs. 
2. Based on function: Production, Sales, Administration, Marketing, Selling, Advertisement, distribution, research, and development, etc.
3. Based on normality: Normal costs and abnormal costs.
4. Based on behavior: Fixed, Variable, Semi-Variable.
5. Based on time: Historical costs and predetermined costs. 
6. Based on controllability: Controllable and Uncontrollable Costs.
7. Based on decision-making costs: Costs involved in managerial decision-making:
   1. Marginal costs
   2. Differential costs
   3. Opportunity costs
   4. Relevant cost
   5. Replacement cost
   6. Shutdown cost
   7. Capacity cost
   8. Sunk cost
   9. Other costs

Difference between Direct and Indirect Costs

Direct Costs	Indirect Costs
Direct costs can be traced directly to a specific product, service, or project.	Indirect costs cannot be traced directly to a specific product, service, or project. Instead, they are costs incurred by a business but cannot be assigned to a specific product, service, or project.
Direct costs are also referred to as traceable costs.	Indirect costs are also referred to as common costs or indirect expenses.
For example, the cost of raw materials used to produce a specific product would be a direct cost of that product.	For example, rent, utilities, and administrative expenses would be indirect costs because they support the business as a whole, rather than a specific product, service, or project.

Types of Cost Accounting

1.Job Order Cost Accounting

This type of cost accounting is used by businesses that produce custom products or services. It tracks the costs of each job or project separately, including direct materials, direct labor, and overhead costs.

2.Process Cost Accounting

Businesses that produce a large volume of similar products, such as manufacturing companies, use process cost accounting. It tracks the costs of each production process separately, including direct materials, direct labor, and overhead costs.

3.Activity-Based Costing (ABC)

It is used by businesses to allocate indirect costs to specific products, services, or activities. It identifies the activities that drive indirect costs and then assign those costs to specific products, services, or projects based on their usage of the activities.

4.Target Costing

Organizations and businesses utilize this type of cost accounting to determine the cost of a product at the design stage and then work backward to reduce costs while still delivering the desired level of quality and performance.

5.Lean Accounting

This type of cost accounting is used by businesses that use Lean manufacturing techniques. It emphasizes the importance of reducing waste, increasing efficiency, and delivering customer value.

Who can go for a Certification in Cost Accounting?
Fresh Graduates | Finance Executives | Staff Accountants/Assistant Accountants | Administrative Assistants

Explore Finance Courses
Which are the Most Popular Cost Accounting Certification and Courses?

If you are planning to start or grow a career in cost accounting, you can take up exam based courses like Cost Management Accounting (CMA) which was previously known as ICWA.

In India, Institute of Cost Accountants of India ICAI, formerly known as the Institute of Cost and Work Accountants of India (ICWAI), develops, promotes, and regulates the profession of cost and management accountancy. Thus, this course will help you get a certificate to practice Cost Accountancy as a profession and grab high-grade career opportunities.

Also understand: What is Cost Accountant?

CMA/ICWA course details

The course is structured in three phases in which the candidates are given knowledge of cost accounting, and at the end of each step, one exam is conducted.
CMA Eligibility 
For CMA foundation course, students who have cleared their 10+2 from any recognised board.

Check out- CMA Courses To Choose in 2023

Levels of CMA/ICWA
1. CMA foundation
2. CMA intermediate
3. CMA final
Explore- CMA (CWA-ICWA) Online Courses & Certifications

Best Online Courses to Learn Cost Accounting

Course Name	Provider	Difficulty	Duration	Register
Cost Accounting - A Comprehensive Study	Udemy	Basic to Advance	38 hours	Enroll Now
Cost Accounting Specialization	Coursera	Beginner	3 months	Enroll Now
Management Accounting for Decision Making	edX	Beginner	7 weeks	Enroll Now
Cost Accounting: Profit and Loss Calculation	Coursera	Intermediate	4 hours	Enroll Now
The Complete Masterclass On Managerial Cost Accounting	Udemy	Intermediate	1.5 hours	Enroll Now

Must Explore - Popular Accounting and Control Courses

Popular Cost Accounting Course Providers

Coursera	Microsoft
Udemy	Great Learning
edX	Alison

Best Books to Learn Cost Accounting

Book	Author
Cost and Management Accounting (Theory and Problems); Himalaya Publishing House,	M.N. Arora
Cost and Management Accounting; Sultan Chand & Sons,	V.K. Saxena& C.D. Vashist
Management Accounting; Vikas Publishing House (P) Ltd.	I.M. Pandey
Cost Accounting: Texts And Problems	M.C Shukla
Principles and Practice of Cost Accounting	Asish K. Bhattacharyya
Practical Problems in Cost Accounting	Dr. B. K. Mehta