Understanding Cost Accounting

Cost Accounting What Is Cost Accounting? Managerial accounting which is popularly known as cost accounting by many, is a system where efforts are directed to establishing the total cost of production by evaluating both variable and fixed costs in an organisation. As stated by financial accounting principles cost accounting does not meet these requirements because it is used by businesses solely for management decisions. Understanding Cost Accounting Cost accounting is used for the purposes of internal management, to figure out all the variable and fixed costs that can be attributed with production processes of the said company. And processes the company is to determine its output in cost terms. This is a way of evaluating financial and operational performance for the company and determining the appropriateness of the strategic management that has been adopted. Types of Cost Accounting Standard Costing Setting expenses based on strategic costing implicates the allocation of what is known as "standard" prices instead of the genuine selling prices on its immediate manufacturing costs and warehoused stock of materials. These standard costs concern the level of labor and raw materials which the firm's employees are requested to apply to a given quantity of usual output or activity at a pre-decided efficiency level; they are in reality the budgetic levels. (Even though standard costs are applied to the products, the company is still liable for paying for the real costs.) This method is called variance analysis and with respect to an organization, the difference in the best—standard—cost to the cost that actually did occur is evaluated. When there is an indication of the cushion effect, and the analysis shows that the real expenditures are more than what was predicted, this is regarded as an adverse variance. Otherwise, when the analysis reveals that costs were incurred below those that were estimated, this is seen as a favorable variance. There are two killing factors in cost accounting that traverse between efficiency and cost – input cost and the efficiency or the quantities of input. Input cost is the cost of labour and material. This is referred to as a rate variance. On the other hand, the efficiency or the quantities of input is measured through a volume variance. Let’s say company XYZ is expected to output 400 widgets in a period and ends up producing 500 widgets; the material cost will be higher because the total number or volume produced is greater than was expected. Activity-Based Costing (ABC) Activity-based costing assigns the costs of the overheads of each department to the particular cost objects such as goods or services. The concept of ABC cost accounting relies on the concept of activities, activities which are any event, unit of work, or task performed with a specific objective say setting up machines for production, designing products, marketing the finished products, as well as operating the machines. These activities are also regarded as cost drivers and are the measurement equivalents employed to share the accommodation restorative costs. Historically, overheads were attributed on the basis of a single universal factor such as machine hours. Under ABC, what is known as activity analysis is carried out and the relevant measures are found out to be the actual cost drivers. Thus, the manner in which the ABC played a role in the evaluation of the labour costs and profits of these services and products was much more accurate than traditional cost systems. For instance, consider a case in which both trinkets and widgets are produced by a particular company. Trinkets are those items produced in more of a manner by skilled workers and involve more of the butchered activities. The production of widgets is mainly an automation process; where raw materials are entered into a machine and left for several hours to come out as a completed product. Since the use of machine hours would lead to the same overhead cost for the two different products and the making of trinkets uses no machine hours, it would not be necessary to adopt machine hour method of allocating overhead to the two products. Speaking about the trinkets in the context of activity-based costing trinkets require more of cost based on labor whereas with widgets machinery usage is the major cost causing factor. Marginal Costing Some commentators posit that the purpose of marginal costing is in essence to analyse profit in respect of each single or added product, i.e. the profit added by making one more unit of that product. For this reason, marginal costing is optimal in the context of the decision at hand. Management, through the use of marginal costing, can discard those components of cost which, if varying, would become too expensive for the company. This particular vital perspective is very critical in terms of estimation of economic profitability of new products, the determination of selling prices of the available products, and examination of the impact of promotional efforts. They may provide focus on the one and only goal which would be to earn the anticipated level of revenue from the sales of the product in question. The break-even analysis part of management accounting concerns the estimation of sales a company needs to pay off all its costs indicated in the profit and loss account. Break-even point is therefore all expenses included and the expenses plus mark-up on the price of the goods is total revenue, i.e. how much the liabilities of the firm will be. The contribution margin thus turns out to be the revenues which remain after all costs have been charged on overheads.