Cost Accounting – What is it?

Cost accounting is a type of management accounting. It looks at all the money a company spends to make and sell its products. Cost accountants keep track of budgets and what the company pays. They compare the two to see if there are any differences.

Why Cost Accounting Matters

Cost accounting is essential because it helps managers know if the company can hit its goals. Can it make enough stuff? Can it do it while spending the right amount of money? Cost accountants give managers this information to make good choices for the company.

Cost accounting doesn’t have to follow the usual accounting rules that accountants use for taxes and reports outside the company. The cost accounting numbers are just for those who work at the company. They help the company run better.

Elements of Cost

There are different types of costs that cost accountants keep an eye on:

Materials

Materials are things the company buys to make its products. Cost accountants track how much the company spends on materials. They also watch to make sure the company doesn’t run out of the materials it needs.

Labor

Labor means the money a company pays its workers. There are two types:

• Direct labor is the pay for workers who make the products, like people who work in a factory.
• Indirect labor is the pay for workers who don’t make the products but still help the company, like the people who fix the machines in the factory.

Cost accountants track how much the company spends on each type of labor.

Overhead

Overhead is all the other money the company spends to make products. It includes things like paying for the building, machines, and electricity in the factory. Cost accountants spread the overhead costs out to each product.

Budgets vs. Actual Costs

Cost accountants make budgets. Budgets are guesses about how much the company will spend to make a certain number of products. Then, as the company makes the products, cost accountants write down how much the company actually spends.

Finding Variances

Cost accountants compare the budgeted numbers to the actual numbers. The difference between the two is called a variance. Cost accountants try to figure out why there are variances.

For example, maybe making one product took more labor hours than expected. The cost accountant would see that the actual labor cost was higher than the budget for labor cost. Then they would try to find out why the workers needed more time than planned.

Explaining Variances to Managers

Cost accountants explain the variances to managers. This helps managers understand why the company is spending more or less money than planned. The managers can then make changes to try to get the actual costs closer to the budgeted costs.

The managers might decide to buy materials from a cheaper supplier. Or they might find ways to make the product faster so labor costs are lower. Cost accountants help managers see where to make these changes.

Types of Costing Systems

There are different methods cost accountants use to track costs. Two common ones are job order costing and process costing.

Job Order Costing

Some companies make lots of different products. Each product is like a separate job. Think of a company that makes furniture. One customer orders a table and another orders a bookshelf. To know if it made money, the company needs to track the materials, labor, and overhead for each piece of furniture separately. That’s job order costing.

With job order costing, the cost accountant makes a job cost sheet for each product. The sheet lists all the costs for that job. At the end, they add up the costs to find the total cost for the job.

Process Costing

Other companies make lots of the same product over and over. Think of a company that makes soda. The company doesn’t need to track the cost of each separate bottle of soda. Instead, it can just track the cost of each batch of soda. That’s process costing.

With process costing, the cost accountant tracks the costs for each step in making the product. Maybe there’s a cost for mixing the soda, a cost for putting it in bottles, and a cost for putting on labels. The costs for each step get added together to determine the total cost.