Cost accounting is accounting for all the fixed and variable costs involved in producing something. It corrals into numbers like overhead, materials, and labor. And others.
This gives your small business a solid framework to plan. And it shows your business what is working and profitable and what needs to be changed.
What exactly is cost accounting?
Cost accounting involves several different measures. It’s about controlling costs to increase profits. Looking at numbers like marginal cost versus standard cost, to name a few.
Companies put together the elements of a cost and profit volume analysis that provides a cost accounting system to track production. It monitors the financial performance of an SME. By recording, analyzing, then reporting on costs.
There is a purpose here to analyze these costs. Increase the net profit margins of a small business by increasing the level of sales of a product or service.
Main costs analyzed by a cost accountant
Cost accountants are the people who work on these numbers. They use the following cost accounting methods.
Fixed costs do not change regardless of the numbers produced or sold. Like lease and rent, utilities and wages.
Calculating process costs is a way to factor mass production into total fixed costs.
These are incurred costs that fluctuate with sales. These variable costs evolve and include raw materials and distribution. Labor costs may be added.
Fixed and variable costs are the types that most small businesses face.
These work with what is called a contribution margin. This is the revenue remaining after subtracting the variable delivery costs from the production costs.
This type of financial accounting is not so simple. Good decision-making requires quality data, so the direct cost must be included in the production process figures. This cost is directly related to a specific item, such as the material used for a car.
Here is another example. In manufacturing, they are called cost of goods sold (COGS) and in a retail business that buys from suppliers, they are called cost of sales (COS).
Direct costs change when production or purchases increase or decrease. Changes in exchange rates or supplier prices have an effect.
Indirect costs appear on a balance sheet in a different way. They are not directly related to what is produced. Consider business administration salaries and management accounting fees. Utilities and office expenses also count as indirect costs.
These may be referred to as operating expenses in the world of financial accounting, which include utilities and rent. They can be fixed or variable and they are used to assess the efficiency of production processes.
This cost is historic. An accountant lists them as unrecoverable. Money already spent. They do not feature in current trade decisions.
Cost accounting must often take into account work in progress. It is a term for goods that are produced but not completely finished.
Types of cost accounting
There are common types of cost accounting and the results appear on financial statements. Cost accounting systems work well in a number of industries. For example, steel companies have many departments to track.
Standard cost accounting
Costs are based on what is produced under typical operating conditions. Cost accountants look for differences between standard cost and actual cost. This leads to an analysis of variance.
Calculation of costs by activity
Often referred to as ABC, it is cost accounting dealing with specific services and goods. A business allocates overhead costs to one or the other, and costing by activity provides hard numbers.
This is used to aggregate all costs that go into any product. Current input costs in this category shown in the financial statements include:
- The salaries of the employees who build the product.
- The type and quantity of raw material needed
- overhead costs.
This type of cost accounting results in lower expenses on an income statement.
Read more: what is financial accounting
It is a little different from the standard cost. Lean-driven performance metrics aim to streamline production cycles and lead times.
Done right, it can free up 25% more production capacity.
Establishing marginal costs
This is used for budget preparation and for making short-term decisions. Marginal cost examines how variable costs affect output.
It is an alternative to other methods. Two factors are taken into account. Variable costs of sales and production. It also assumes that labor is a fixed cost.
Cost Accounting Vs. Financial Accounting
There are distinctions to be made for good business management. Like the differences between cost accounting and financial accounting.
If you are wondering: “What is financial accounting?” There is a definition below.
In a word:
Cost accounting classifies costs for a total quantity over a given period. It is designed to discover and control them.
Financial accounting takes a different approach. It is a record of all monetary transactions. This includes balance sheets, cash flow statements and income statements.
Here are some pros and cons of the cost accounting model.
Advantages of cost accounting
Small businesses will find benefits in hiring a cost accountant. Here are five.
A cost accounting standard sets a budget and expenses do not exceed the budgeted amount. Compare actual costs to standard costs to find an unfavorable variance.
Future production planning
This allows you to compare input costs and other figures like sales prices, and plan future production.
Use a trendline to track a cost. This type of variance analysis highlights peaks and declines in spending. Look for anything abnormal.
Do a cost object analysis
Group income and expenses this way. Use categories like product and distribution channels to find a reasonable profit.
Make better decisions
This type of management accounting can help your team stay informed. This means that decisions are made on the basis of accurate assessments.
Disadvantages of cost accounting
Cost accounting was developed to examine cost control. But there are some drawbacks.
Setting up this system is quite expensive. For example, you need a duplicate set of accounting books.
It can be complicated
There are a number of steps involved, such as collecting and classifying expenses. This means more documents and forms to put reports together.
It requires skilled people
This type of accounting requires highly qualified auditors and accountants. Employees would need special training.
How much does it cost to hire a cost accountant?
The Bureau of Labor Statistics sets the average hourly rate at $40 per hour. Actual charges may be higher or lower depending on:
- The experience of the cost accountant.
- The tasks your small business needs to do.
- How often you will need to use their services.
Keep in mind that most of these professionals charge a per-service or hourly rate. Some might even charge for specific projects like doing small business taxes.
Is cost accounting right for your business?
Cost accounting systems analyze and report on the cost structure of a small business. There are several different types, including Lean Accounting and Standard Costing.
There are advantages and disadvantages to this type of accounting. For example, it can help in the production of your business plan. But you need qualified people to work the numbers. And that can be expensive.
You can hire one of these accountants or check out some DIY software.
Either way, be sure to look at the services you need to get started. Many small businesses will need everything from business advice to accounting.
Remember to consider the financial gains when using these services. And how your small business can avoid fines and reporting errors.
More in: Small Business Accounting