Cost accounting is a methodology which seeks to capture and analyse all incurred cost during the accounting period enabling management to make relevant decisions such as the best selling price as well as make cost saving decisions. Cost accounting is used as an internal management tool and varies from one company to another.
Cost elements are those elements that contribute to the overall cost of producing goods and services which include – Material, Labour, Expense, and Overhead Cost. Each can be sub-divided into direct and indirect costs. In cost accounting, money is viewed as the economic factor of production, while in financial accounting, money is viewed as the measure of economic performance.
The four (4) primary types of cost accounting are:
- Standard Cost Accounting – This is used to identify, analyse, and investigate the variances between the actual cost incurred and cost that should have been incurred in the production of goods. Standard cost includes direct material cost, product cost, direct labour costs and manufacturing overheads incurred to deliver the goods.
- Activity-based cost accounting – This identifies various activities in an organization for the purpose of allocating costs to these activities. Such activities include manufacturing activities – transporting, processing, purchasing etc. These costs are further distributed to products and services based on actual consumption by every product
- Marginal cost accounting – This type of costing involves assigning only variable costs to the product while fixed costs (e.g., rent, electricity) are considered the costs for the period and included in the income statement as expenses. The cost assigned to products such as direct labour costs, direct material costs, varies proportionately with changes in the production volume. This approach provides the difference between total revenue and total variable costs.
- Lean Accounting – This provides numerical feedback for manufacturers to help them implement lean inventory and lean manufacturing management practices. Unlike traditional accounting system which recognizes unutilized inventory as an asset, lean accounting considers only required inventory and defines efficiency based on how much time it takes to process an order.
The objective of cost accounting is to determine the methods by which expenditure on materials, wages and overhead are recorded, classified and allocated; to ensure costs are accurately ascertained. Some of the objectives of cost accounting are summarized below:
- To determine the cost per unit of the different products of a business
- Provide requisite data required to fix the price of products manufactured or services rendered
- Determine the profitability of each of the products and help management maximise profit
- Exercise effective control of stocks of raw material, work-in-progress, consumable stores, and finished goods to minimize the capital invested in them
- Present and interpret data for management planning, decision-making, and control
- Aid budget preparation, implementation of budgetary control and assists management to formulate and implement incentive bonus plans based on productivity and cost savings
STRATEGIC COST MANAGEMENT
Traditional cost management lays emphasis on cost reduction and control by allocating production overheads and costs. However, this could impact negatively on quality, customer experience, development and business growth, making traditional methods somewhat unreliable.
Strategic cost management technique does not only aim to reduce costs but also improves the strategic position of a business. This process involves combining cost information with the structure of decision-making to reinforce the overall business strategy. Thus, it may be useful to increase costs which support the company’s strategic position while cost reduction initiatives are focused on those costs that either weaken the strategic position of a company or have no impact.
Strategic cost management is a continuing process as the strategy of a firm may change over time. Thus, certain costs may be sacrosanct when one strategy is being used but can be readily eliminated when the strategy shifts.
The primary importance of strategic cost management lies in its ability to constantly improve the quality of products offered to customers. Strategic cost management is not cost control but a method to use the information for efficient managerial decision-making.
The importance of strategic cost management is that:
- It can be considered an updated cost analysis program that improves the overall position of an organization by clearly and formally placing each strategic element
- It can be used to analyse cost information and achieve sustainable competitive advantage by developing various measures
- It offers a better understanding of an organization’s overall cost structure to gain a competitive advantage in a market
- It specifically governs the formulation, communication, implementation and control stages of a strategic management process by using cost information
- It identifies the cost relationship between value chain activities and the process of management
This is the process of reporting separate elements that results in a product or service (e.g., labour, equipment, materials) in a cost proposal as well as its proposed profit. Often referred to as cost-benefit analysis or cost-effectiveness analysis, a cost analysis is a useful tool for various aspects of business planning.
A cost analysis provides an opportunity to evaluate the efficiency of initiatives. The results of a cost analysis report may assist a company in efficiently utilizing available resources. It also serves as documentation that demonstrates evidence of accountability. A cost analysis can track expenses and spending, which can help a company determine if funds are misappropriated or not.
It promotes awareness of the cost structure involved with a company’s products and services. When managers are required to collect data to prepare a cost analysis, they will have a deeper awareness of specific elements, such as required labour and overhead. This allows managers to acquire additional knowledge of company costs and to make informed decisions.
While cost analysis is largely advantageous, it generally represents quantitative items; therefore, it may become problematic when a company wants to consider qualitative or intangible factors. In this instance, a cost analysis may require a skilful analyst to ascertain that quantitative metrics back up qualitative goals.
Break-even Point refers to the point at which total cost and total revenue are equal, meaning there is no loss or gain for your business. In other words, you’ve reached the level of production at which the costs of production equals the revenues for a product.
A Break-even Point is used in a wide variety of situations. For new businesses, potential investors will want to know their expected return and when the return will be realised. Some new businesses may take years before breaking even and subsequently turn into profit. Existing businesses use Break-even Points to analyse costs and evaluate profits, in addition to showing their ability to rebound from difficult circumstances.
In accounting, Break-even Point refers to a situation where a company’s revenues and expenses were equal within a specific accounting period. The stock market is another industry in which Break-even Point can be frequently seen. The Break-even Point (or Price) for a trade or investment is determined by comparing the market price of an asset to the original cost.
Benefits of a break-even analysis includes:
- Price Smarter – A lot of psychology goes into pricing but knowing how it will affect your profitability helps you price your products better.
- Catch Missing Expenses – Expenses can be easily overlooked when thinking through a new business idea. A completed break-even analysis ensures all financial commitments are figured out, limiting surprises in the future.
- Set Revenue Targets – Completed break-even analysis help you set sales goals for your business as you will know exactly how much you need to sell to be profitable.
- Make Smarter Decisions – Business decisions should not be based on emotions. Break-even analysis will help ensure your business decisions are based on facts.
- Limit Financial Strain – Mitigates risk by showing when to avoid a business idea. It helps potential businesses avoid failure as well as limit the financial toll of a bad idea through realistic analysis of potential outcomes.
- Fund Your Business – The break-even analysis is usually a requirement to take on investors or debt to fund your business. It proves that your plan is viable, which will also help you feel better about taking on financing.