What is cost accounting? (definition, utility and examples)

Cost accounting is the process through which the disbursements of a company are identified and measured, the term disbursement being understood not only as an outflow of money, but also as consumption of goods, depreciation of assets and deductions.

The objective of cost accounting is to provide information on the costs of a company, of a certain product or service, of a certain area or department, of a certain client, etc., in order to carry out a better financial analysis. of these.

We can account for costs, for example:

  • of a company or business in order to obtain a fast income statement , and not have to wait for the income statement at the end of the period made by the general accounting.
  • of the product or service we offer in order to find its cost of sales, and thus be able to know its gross profit (sales – cost of sales), likewise, without having to wait for the statement of results at the end of the period.
  • of each product that we manufacture in order to, comparing them with the income they generate, know the profitability of each one and thus, for example, know which are the most profitable and which are those that do not generate profit.
  • of a certain product in order to, taking into account what is the utility that we want to earn, to be able to define its price.
  • of a certain area or department in order to know if the income it generates is greater than its costs and, therefore, if it is profitable for us.
  • of a certain client in order to know if the income it generates is greater than the expenses of maintaining it and, therefore, if it is a profitable client.

Unlike general accounting, cost accounting is for internal use only and, therefore, is not mandatory, so there is no standard cost method or system that is used for all companies equally, but Each company can adopt the method or system that it considers best, taking into account its needs or objectives.

Nowadays where the prices of products and services constantly change it is necessary to always keep in mind the costs of the products and services offered.

In this article you will find:

  • How to count the costs of a company
  • Costs in a marketing company
  • Costs in an industrial company
  • Costs in a service company
  • Summary

How to count the costs of a company

Let’s see below the general steps that must be followed to account for the costs of a company or business:

1. Total Costs or Partial Costs

The first step to account for the costs of a company is to determine what disbursements we are going to consider as costs. There are basically two methods for accounting the costs of a company: the Total Cost method and the Partial Cost method.

Total Costs

In this method, all disbursements related to the product or service, as well as administrative and sales expenses, are considered as costs, and all other disbursements (financial expenses, taxes, etc.) are called expenses. This method is often used to find the equilibrium point .

Partial Costs

In this method, all disbursements related to:

  • the acquisition of merchandise : in the case of a marketing company (company dedicated to the purchase and sale of products).
  • the manufacture of the product : in the case of an industrial company (company dedicated to the production or manufacture of products).
  • the provision of the service : in the case of a service company.

And all other disbursements (administrative expenses, sales expenses, financial expenses, taxes, etc.) are called expenses. This method is usually the most convenient and easy to use.

In general, costs are outlays related to the product or service; while expenses are disbursements related to the administration or management of the company.

2. Variable and Fixed Costs or Direct and Indirect Costs

Once we have decided what disbursements we will take as costs, for a better analysis we proceed to classify them in Variable Costs and Fixed Costs or, in any case, in Direct Costs and Indirect Costs.

Variable Costs and Fixed Costs

In this case, we classify costs according to their behavior in relation to fluctuations in activity:

  • Variable Costs : these costs vary according to changes in activity levels, be it the number of units sold (in the case of a trading company), the volume of production (in the case of an industrial company), or the number of services performed (in the case of a service company). Examples of variable costs are raw materials, fuels, spare parts, packaging, hourly wages, etc.
  • Fixed Costs : these are costs that are not affected by variations in activity levels. Examples of fixed costs are rents, machine and equipment maintenance, depreciation, insurance, fixed wages and salaries, etc.

Something important to take into account is that when production increases, Variable Costs increase, but not Fixed Costs or Variable Unit Cost.

For example, if we produce 10 products with a Variable Cost of 400 and a Fixed Cost of 1600, the Total Costs, the Unit Cost, the Unit Variable Cost, and the Unit Fixed Cost would be the following:

  • Total Costs: 400 + 1600 = 2000
  • Unit Cost: 2000/10 = 200
  • Unit Variable Cost: 400/10 = 40
  • Unit Fixed Cost: 1600/10 = 160

And if our production increases by 10 products, the production would be 20, the Variable Costs 800, the Fixed Costs 1600, and the Total Costs, the Unit Cost, the Unit Variable Cost, and the unit Fixed Cost would be the following:

  • Total Costs: 800 + 1600 = 2400
  • Unit Cost: 2400/20 = 120
  • Unit Variable Cost: 800/20 = 40
  • Unit Fixed Cost: 1600/20 = 80

Variable costs are called “varial” since their value varies (increases or decreases) when sales or production also do; while fixed costs are called “fixed” since their value does not vary when sales or production do.

Direct Costs and Indirect Costs

In this case we classify the costs according to the identification with the object of the cost.

  • Direct Costs : these costs intervene directly in the elaboration of the product or service, or are part of it. In order to identify them we see what are the costs that can be distributed among the products; for example, the raw material (since it is known how much of raw material is used for each product), electricity (when it is known how much electricity is used for a certain product), etc.
  • Indirect Costs : these costs intervene indirectly in the manufacture of the product or in the provision of the service. To be able to identify them we see what are the costs that cannot be distributed among the products; for example, electricity.

3. Determine Expenses

Once we have decided which disbursements we are going to consider as costs (Total Cost or Partial Cost method), and we have classified them into Variable Costs and Fixed Costs, or Direct Costs and Indirect Costs, we proceed to identify the Expenses ( that would be all the disbursements that we have not considered as costs).

Expenses are classified into:

Operating expenses

The Operating Expenses in turn are classified into:

  • Administrative Expenses : these are disbursements that are related to management activities; for example, the labor expenses (salaries, bonuses, insurance) of the managers, administrators and assistants of the company, rents, office supplies and materials, insurance, depreciation (of administrative buildings, office equipment, machines, furniture), taxes, electricity, water, etc.
  • Sales Expenses : are disbursements that are related to the marketing activities of the products; for example, the labor expenses (salaries, bonuses, commissions) of the sales manager and the sellers or collectors, advertising, sales tax, packaging, transport, storage, etc.

Note: When we use the Total Cost Method, Operating Expenses are considered as costs .

Financial expenses

Financial Expenses are disbursements related to financing the operations of the company (interest).

Other expenses

Other expenses include disbursements such as losses, bad debts, contingencies, etc.

4. Identification and analysis

Finally, once we have determined which elements we are going to consider as costs, we have classified them, and we have determined the expenses, we proceed to identify each element with its respective cost, and subsequently, we proceed to analyze them according to the need or the objective that we have to account for costs.

Here are some examples of how to account for and analyze costs in a trading company, an industrial company, and a service company.

Remember that cost accounting does not have a standard method or system that is used by all companies equally, but that a company can adopt the method or cost system that it deems best according to its needs or objectives.

Costs in a marketing company

When it is a trading company (company dedicated to the purchase and sale of products), it is usual to name costs only the Acquisition Costs ; that is to say, to the costs conformed by the value of the merchandise that is bought, as well as to the disbursements related to said purchase, such as freight, insurance, import duties, etc.

Let’s see below an example of how to account for costs in a marketing company:

Suppose we start operations with an initial inventory of 30 televisions at a cost of US $ 100 each, then we buy 10 televisions at US $ 100 each, and then sell 5 televisions at US $ 300 each. If we have operating expenses of US $ 400 (administrative expenses: US $ 100 and sales expenses: US $ 300), what would be our net profit?

The Income Statement would be:

Sales (300 x 5) 1500
(-) Cost of Sales (100 x 5) 500
GROSS PROFIT 1000
   
(-) Administrative expenses 100
(-) Selling expenses 300
NET PROFIT 600

When the merchandise that is acquired has different sale values; for example, that the televisions in the initial inventory be US $ 100, but the 10 that were purchased are US $ 120, in this case it is not possible to find the exact Cost of Sales, since the Unit Cost of a television varies. In this case what we must do is find a weighted average.

If we find the weighted average:

30 televisions x 100 = 3000

10 televisions x 120 = 1200

Total Cost = 4200

Average Unit Cost: 4,200 / 40 = US $ 105

The new Income Statement would be:

Sales (300 x 5) 1500
(-) Cost of Sales (105 x 5) 525
GROSS PROFIT 975
   
(-) Administrative expenses 100
(-) Selling expenses 300
NET PROFIT 575

Costs in an industrial company

When it is an industrial company (company dedicated to the production or manufacture of products), it is usual to name costs only the Production Costs ; that is, at the costs that occur within the production process.

These production costs are made up of the following elements:

Acquisition Costs of Raw Materials or Direct Materials

Acquisition costs of the goods that will be transformed into finished products or that will be part of it; for example, supplies, parts, labels, etc.

Direct Labor Costs

Costs made up of the wages and benefits of workers who work directly in the production of the product.

Indirect Manufacturing Expenses

Costs of the elements necessary for the manufacture of the product, but which intervene indirectly in its elaboration.

Indirect Manufacturing Expenses in turn are made up of:

  • Indirect Materials : made up of auxiliary materials, factory supplies, fuels, spare parts, lubricants, cleaning tools, etc.
  • Indirect Labor Force : made up of the salaries and wages of professional, technical, specialized or auxiliary personnel in charge of complementary tasks not directly linked to the production process, such is the case of the plant manager, supervisors, cleaning staff, maintenance, security, etc.
  • Other Indirect Expenses : made up of insurance against irrigation, depreciation, rents, electric energy, water, telephone, maintenance services, subsidies, etc.

Let’s see below an example of how to account for costs in an industrial company:

Suppose we are asked to make 40 tables. What would be the net profit and the price of each table if we expect to obtain a 20% profit?

The data we have are:

  • the raw material (wood) has a cost of US $ 800 for the 40 units.
  • the salary for the operators who will carry out the work of cutting, planing, assembling and painting is US $ 380 in total.
  • glue, nails, varnish, etc. will be used, with a total value of US $ 140.
  • Depreciation, energy and others are estimated to be worth US $ 80.
  • administrative and sales expenses total US $ 180.
  1. First we find the Production Cost:
Raw material 800
Direct Labor 380
Indirect Manufacturing Expenses  
(-) Indirect Materials 140
(-) Other Indirect Expenses 80
Production cost 1400
  1. Once we have found the Production Cost, we proceed to find the Unit Cost:

Unit Cost: 1400/40 = US $ 35

  1. Then we proceed to find the price at which we should sell each table to earn a gross profit of 20% of the Production Cost:
Production cost 1400
20% profit 280
Sales 1680

The sale price of each table would be: 1680/40 = US $ 42

  1. To find the net profit, we make our projected Income Statement:
Sales 1680
(-) Cost of Sales (40 x 35) 1400
GROSS PROFIT 280
   
(-) Operating expenses 180
NET PROFIT 100

Costs in a service company

When it comes to a service company, it is usual to name costs only related costs are the provision of the service.

These costs are made up of the following elements:

Miscellaneous Supply Costs

Costs made up of purchases made by the company to be able to provide the service.

Labor costs for the service

Costs made up of the wages of the workers who provide the service.

Indirect costs

Costs made up of elements that intervene indirectly in the provision of the service, such as depreciation, electricity, water, telephone, rents, maintenance, repairs, etc.

Let’s see below an example of how to account for costs in a service company:

Suppose in our auto repair shop we are asked to repair a car that has a crash on the right side, in addition to a broken headlight. The costs are:

  • Faro: US $ 50
  • Putty: US $ 5
  • Welding: US $ 15
  • Labor: US $ 25

How much do we have to charge for the service in order to earn 30%?

Total costs (70 + 25) 95
30% profit 28.5
Sale price 123.5

Summary

Cost accounting is the process through which the disbursements of a company are identified and measured, the term disbursement being understood not only as an outflow of money, but also as consumption of goods, depreciation of assets and deductions.

Unlike general accounting that a company is obliged to keep (for example, to be able to declare and pay its taxes), cost accounting is not mandatory, but is carried out only for internal reasons when company managers do so. consider necessary.

It is also for this reason that, unlike general accounting, which is governed by globally accepted accounting standards, there is no standard method or system to carry cost accounting that is used by all companies equally, but the company can adopt the method or system that you consider best, taking into account your needs or objectives.

 

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