Cost Accounting focuses on company’s total cost of production by assessing the variable and fixed costs at each step of production and selling. It is critical aspect of accounting as cost directly affects the revenue of the company and also helps in determining the pricing strategy of the product/service.
Unlike financial accounting which provides information to external users (Public, Government, Banks etc), Cost accounting provides vital information to the internal users (mainly management) for decision making.
Two main types of costs are Variable and Fixed costs. Fixed cost refers to the part of cost which does not vary or depend on the level of production. For example, Rent of office or factory. It has to be paid even when the facility is not being utilised or there is no production or sales. However, Variable cost varies according to the level of production. For example, labour wages or cost of raw material.
To understand costing better, let’s understand different elements it comprises of-
- Cost of material consumed is the sum of all the cost spent to procure a raw material, store it till it gets consumed. All such costs are added with the actual cost of raw material purchased to arrive at the cost of materials consumed.
- Employees Benefit expenses- The benefit provided to employees are summarised into four categories:
- benefits in the short-term (benefits payable to employees shortly after they provide the service, e.g. a salary)
- benefits in the long-term (such benefits may become payable long after the employees provide the service e.g. a long-service award)
- benefits of post-employment (i.e. after they have retired from employment e.g. a pension)
- termination benefits (those that would be payable if the employees were to be terminated before normal retirement age (e.g. a retrenchment package)
- Purchases of stock in trade, refers to all the purchases of finished goods that the company buys towards conducting its business.
- Other Expenses are not directly related to the business but are ancillary in nature. It is of utmost importance and have to be accurately differentiated from the expenses, as per the prescribed guidelines and based on the nature of the business.
- Amortisation and Depreciation expenses- Amortization is a method of spreading the cost of an intangible asset over a specific period of time, which is usually the course of its useful life. The goal in amortizing an asset is to match the expense of acquiring it with the revenue it generates. Depreciation is a method of spreading the cost of a tangible asset over a specified period of time, typically the asset’s useful life. The purpose of depreciation is to match the expense of obtaining an asset to the income it helps a company earn.
In order to reduce costs substantially which ultimately increases the revenue of the company, elements of the total costs need to be analysed and reduced, if possible. It helps in examining the costs step by step, stage of production wise which is an essential process to determine the price per unit and also determining the relationship between each cost and how it affects the Cost of goods sold and the net profit. These elements are grouped together on the basis of their similar nature and hence, it becomes easier to reduce cost element by element.
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