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Cost Accounting

Cost accounting is defined as the "systematic set of procedures for recording and reporting measurements of the cost of manufacturing goods and performing services in the aggregate and in detail. It includes methods for recognizing, claasifying, allocating, aggregating, and reporting such costs and comparing them with standard costs." Often considered a subset of managerial accounting, its end goal is to advise the management on how to optimize business practices and processes based on cost efficiency and capability. Cost accounting provides the detailed cost information that management needs to control current operations and plan for the future.

Cost accounting information is also commonly used in financial accounting, but its primary function is for use of managers to facilitate their decision-making.

All types of businesses, whether manufacturing, trading, or producing services, require cost accounting to track their activities. Cost accounting has long been to help managers understand the costs of running a business. Modern cost accounting originated during the industrial revolution while the complexities of running lage scale businesses led to the development of systems for recording and tracking costs to help business owners and managers make decisions. Various techniques used by cost accountants include standard costing and variance analysis, marginal costing and cost volume profit analysis, budgetary control, uniform costing, inter firm comparison, et cetera. Evaluation of cost accounting is mainly due to the limitations of financial accounting. Moreover, maintenance of cost records has been made compulsory in selected industries as notified by the government from time to time.

In the early industrial age most of the costs incurred by a businesse were what modern accountants would call "variable costs" because they varied directly with the amount of production. Money was spent on labor, raw materials, power to run the factory, et cetera, in direct proportion to production. Managers could simply total the variable costs for a product and use this as a rough guide for decision-making processes.


Some costs tend to remain the same even during busy periods, unlike variable costs which rise and fall with volume of work. Over time, these "fixed costs" have become more important to managers. Example of fixed costs include the depreciation of plant and equipment, and the cost of departments such as maintenance, tooling, production control, purchasing, quality control, storage and handling, plant supervision and engineering.

In the early nineteenth century, these costs were of little importance to most businesses. However, with the growth of railroads, steel and large scale manufacturing, by the late nineteenth century these costs were often more important than the variable cost of a product, and allocating them to a broad range of products led to bad decision making. Managers must understand fixed costs in order to make decisions about products and pricing.

Basic cost elements are:
  1. Material
  2. Labor
  3. Overhead
Material (Inventory) - the materials directly contributed to a product and those easily identifiable in the finished goods are called direct materials. For example, paper in books, wood in furniture, plastic in a water tank, and leather in shoes are direct materials. Others, usually lower cost items and supporting material used in the production of in a finished product are called indirect materials. For example, the length of thread used in a garment.

Furthermore, these can be categorized into three different types of inventories that must be accounted for in different ways: raw materials, work-in-progress, and finished goods.

Labor - any wages paid to workers or a group of workers which may directly co-relate to any specific activity of production, maitenance, transportation of material, or product, and directly associate in the conversion of raw material into finished goods are called direct labor. Wages paid to trainee or apprentices does not come under the category of direct labor as they have no significant value.

Overhead - manufacturing/indirect overheads include:
  • Production or works overhead including factory staff.
  • Administration overhead including office staff.
  • Sales overhead including production and maintenance of catalogues, advertising (development and purchases), exhibitions, sales staff, cost of money.
  • Distribution overhead.
  • Maintenance and repair including office equipment and factory machinery
  • Supplies
  • Utilities including gas, electric, water, sewer, and municipal assessments.
  • Other variable expenses.
  • Salaries/payroll including wages, pensions, and paycheck deductions.
  • Occupancy (rent, mortgage, property taxes).
  • Other fixed expenses.
These categories are flexible, sometimes overlapping as cost accounting principles are applied.

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