Cost Accounting Definition – Introduction to Cost Accounting

Cost Accounting can be defined as a system put in place by the management to generate the amount incurred in the production of goods and services so as to determine the cost of production and profit generated in the organization.

NB: Profit in an organization is determined by the relationship between revenue and cost. If revenue is constant, the cost must be minimized or control before profit can be maximized.

What you will learn today.

  1. Cost Accounting Definition
  2. The uses and users of Cost Accounting
  3. Cost Accounting Methods
  4. Cost Accounting Techniques
  5. Cost Accounting Principles
  6. Cost Accounting Reports/Information
  7. The difference and similarities between Cost and Financial Accounting
  8. The functions of the Cost Accounting department in an organization
  9. Objectives of Cost Accounting
  10. Elements of Costs
  11. Classification of Costs

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Having said that, let’s get started with today’s topic.

1. Cost Accounting Definition

First of all, what are the costs? (1) Costs are the economic resource that has value and can be utilized to generate either quantitative or non-quantitative benefits. (2) Cost can also be defined as the value of economic resources used in the production of goods and services in order to generate profit.

According to CIMA (Chartered Institute of Management Accountants), Cost Accounting is defined as a system put in place by the management to generate the amount incurred in the production of goods and services so as to determine the cost of production and profit generated in the organization.

NB: Profit in an organization is determined by the relationship between revenue and cost. If revenue is constant, the cost must be minimized or controlled before profit can be maximized.

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2. Uses/Users of Cost Accounting

In simple words, Cost Accounting information is used by management. It is the act or process of collecting, collating, analyzing, coding and interpreting of cost accounting information and record of its information for the purpose of planning, controlling, and decision making.

Therefore, it is a system put in place by management in order to generate financial and non-financial information for the purpose of planning, controlling, and decision making. It is also a quantitative method that accumulates, classify, summarize and interpret the cost accounting information for three (3) main purposes;

  1. To determine the cost of production/services
  2. For planning and controlling, and
  3. For decision making.
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3. Cost Accounting Method

This refers to the system used by the management for COST FINDING AND COST ASCERTAINMENT. It is also used to accumulate and summarize the cost incurred on a product or service. Eg:

  • Unit costing
  • Batch costing
  • Job costing
  • Contract cost
  • Service cost
  • Process cost
  • Joint product costing

4. Cost Accounting Techniques

This refers to the various ways by which the management can convert COST DATA INTO COST INFORMATION. They also represent the various alternatives that are used to generate the cost incurred on a project, process or job. Eg:

  • Actual costing technique
  • Absorption costing technique
  • Marginal costing technique
  • Standard costing technique.

5. Cost Accounting Principles

These are the RULES AND REGULATIONS that are always followed when preparing and using cost accounting reports. They also represent the guidelines, procedures or standards that will guide all the parties that are using the cost accounting report. The following principles are attributable to cost accounting;

  • Costing Accumulation.
  • Cost Verification.
  • Identification Cost.
  • Allocation Cost.
  • Apportionment of Cost.
  • Cost Coding.
  • Absorption of Cost.

6. Cost Accounting Reports

Also, known as Cost Accounting Information, represents the end results of all the costing activities that occurred in an organization or within an organization at a PARTICULAR PERIOD OF TIME. They represent the summary of the financial and non-financial activities of an organization at a particular period of time.

Types of Cost Accounting Report

  1. Financial report or quantitative report (related to figures).
  2. Non-financial report or qualitative report.

7. Costing Accounting and Financial Accounting

In a nutshell, the primary objective of Cost Accounting is to provide information that can assist the management in running the affairs of the business, while the primary objective of Financial Accounting is to report to the owner of the business, the position of the business at a particular date. Click here to read more on the users of Accounting Information. The differences between Cost and Financial Accounting are as follows;

1. HISTORICAL

Cost Accounting is Futuristic (for projections etc). Financial Accounting is Historical (based on past events).

2. FORMAT

Applicable in Cost Accounting, Not applicable in Financial Accounting.

3. AUDIT

Applicable in Cost Accounting, Not applicable in Financial Accounting.

4. TIME OF REPORTING

In Cost Accounting, auditing can be done at any time. In Financial Accounting it is done at year-ending.

See Also:  Overhead Costs Definition - What is Overhead Costs?

5. METHOD OF REPORTING

In Cost Accounting, reports are filed based on Product, Process, and Department. In Financial Accounting reports are filed in total.

6. ESTIMATE AND APPROXIMATION

Allowable in Cost Accounting, Not allowable in Financial Accounting.

7. USERS

Used by Internal management in Cost Accounting, Used by Internal and External management in Financial Accounting.

Similarities Between Cost and Financial Accounting

  • Both provide information to the management for planning controlling and decision making.
  • Both use the same method of keeping books which are always double entry.
  • Both use certain concept and convention which includes monetary concept, cost concept, and conservatism.

8. Functions of the Cost Accounting Department in an Organization

The cost accounting department in any organization is responsible for developing and, reporting cost data and information with respect to material, labor, and overhead.  Also responsible for maintaining the necessary record relating to the cost incurred. Their major functions are as follows;

  1. To keep costing recording
  2. Delegation of authority
  3. Adequate business organization
  4. Analyses cost both past and future
  5. Education of the workers by training.

9. Objectives of Cost Accounting

The 6 major objectives of Cost Accounting are;

  1. To Plan (Planning)
  2. To Control (Controlling)
  3. To Evaluate (Evaluating)
  4. For Decision Making
  5. For Communication, and
  6. For Organizing

10. Elements and Classification of Cost

The elements of cost are the component into which the total cost of production can be broken. Product cost consists of three elements which are

  1. Material cost
  2. Labor cost
  3. Overhead cost or expenses

The above element of cost can be further be divided into Direct cost and Indirect cost.

Direct cost:

These are cost which can be directly identified with a job, batch, product or services examples are:

  • Direct materials like raw materials, direct wages, direct labor.
  • Remuneration paid to production workers.
  • Direct expenses like royalties paid per unit for a copyright design. 

Direct cost simply means those costs that cannot be spread between various categories because the whole cost can be attributed directly to a production unit or saleable service.

Indirect Cost

Indirect cost is the materials of labor and expenses cost which cannot be identified as a direct cost. The three elements are:

  • Indirect material
  • Indirect labor
  • Indirect expenses, which are collectively known as overheads. Eg: (1) Factory supervision (2) Rent and rate for the factory, plant insurance, etc… Read more on overhead costing here.

11. Classification of Costs

Cost classification is the process of arranging items into groups according to their degree of similarity. Cost classification means classification to various heads. It can be classified in many ways as it involves grouping of items into similar leads in order to satisfy specific needs.

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Methods of classifying cost are as following:

  1. Classification by Nature: This shows the relationship with the cost center and costs unit. It is divided into two ways namely direct cost and indirect cost.
  2. Classification through Behavior: This is the degree of responsiveness of an item of cost to changes in the level of activity.
  3. Classification by Function: This is based on the function an item of cost performs in the production process. Under this, we have production cost, administrative cost, selling and distribution cost.
  4. According to Time: Under this classification, budgeted cost, standard cost, industrial cost, and current cost will be analyzed.
  5. Classification According to Economic Characteristics: This is based on the need for the analyzed situation in which management is faced with more alternatives.
  6. Classification According to Traceability: This is useful to determine the profitability of a process product line, division, and market.
  7. According to Responsibility: This is a classification of cost according to where the cost is incurred e.g. cost center process department. This is useful for the purpose of cost control.
  8. According to Volume: These are broadly divided into the total cost, cost per unit, cost per packet and cost per batch.

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