What Is Cost Accounting?

Cost accounting is an internal accounting method utilized for noting and analyzing all costs involved in the production of goods and services.

Written by Anthony Corbo
Published on Dec. 16, 2021
What Is Cost Accounting?
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Kristen Pascoe | Aug 11, 2022

This allows management teams to have a 360 degree view of the company's production operations, facilitating more informed decision making. Cost accounting is different from financial accounting, which is the process of preparing external financial information.

What are 4 types of costs?

  • Four common types of costs include fixed costs, variable costs, opportunity costs and sunk costs.

All costs in business can be categorized for organization and budgetary reasons, including four common categories. Categorizing costs allows for thorough analysis of spending so optimizations can be made to increase the profitability of the business.

Fixed costs remain constant despite changes in production or process, such as the costs of salaries of office workers which remain constant despite any changes in production. Unlike fixed costs, variable costs may change based on the number of units produced and include costs like raw materials. Fixed costs and variable costs are unique in that there is no overlap between the two categories.

In addition, opportunity costs are those incurred when one option must be selected over another, such as choosing to manufacture one item over another. Sunk costs are those which are irrecoverable once incurred, such as machinery costs or wasted materials. Fixed and variable costs may also be opportunity costs, sunk costs or both. In addition to these four costs, there are also direct costs and indirect costs of the production process.

What is the cost accounting formula?

To determine prime cost, or the aggregate cost of materials, labor and expenses, add the cost of materials consumed to the cost of direct labor (prime cost = direct materials consumed + direct labor.)

To determine conversion cost, or the cost of turning materials into finished goods, add the cost of direct materials to factory overhead (conversion cost = direct materials + factory overhead.)

To determine factory cost, add the costs of direct materials, direct labor and factory overhead together (factory cost = direct materials + direct labor + factory overhead.) To determine the cost of goods manufactured, one would add the costs of direct materials consumed, direct labor, factory overhead and opening work-in-progress, then subtract the closing work-in progress (cost of goods manufactured = direct materials consumed + direct labor + factory overhead + opening work-in-progress - closing work-in-progress.) 

Lastly, to determine the cost of goods sold, add the costs of direct materials consumed, direct labor, factory overhead and opening work-in-progress, subtract closing work-in-progress costs, add opening finished goods costs and subtract closing finished goods costs (costs of goods sold = direct materials consumed + direct labor + factory overhead + opening WIP - closing WIP + opening finished goods – closing finished goods.)

What are the methods of cost accounting?

  • Some techniques used when trying to make managerial decisions through cost accounting include marginal costing, standard costing, direct costing, historical costing, uniform costing and absorption costing.

Marginal costing is used to help management understand how production can be expanded or contracted while remaining profitable. Changes to variable costs are considered but fixed costs can not be as they do not vary with changes in production.

Standard costing compares the costs incurred when developing a product, process or project to its predetermined cost to optimize cost-effectiveness.

Direct costing charges all costs incurred when creating a product, process or service directly to the product, process or service, with indirect costs written off as a profit or a loss.

Historical costing compares all costs incurred after a process is performed. Uniform costing ensures the same costing processes are utilized across particular units to allow fair comparison.

Absorption costing is a full costing method in which all costs are charged to a product, process or project.

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