What is cost accounting?

Cost accounting is an area of ​​accounting that deals with the planning, classification, accumulation, control, and allocation of costs. It is also known as analytical accounting and forms, together with administrative accounting and financial accounting, the accounting structure of the organization. Next, answer the questions, what is cost accounting, what are its objectives, how can it be applied, what is its importance, and what are its characteristics, we try to propose an introductory guide to the wide and interesting world of cost accounting.

What is cost accounting?

Here are some definitions of cost accounting that will allow you to understand and expand its concept.

For García and Jordà (p. 107) cost accounting is defined as an information system that allows the valuation of goods and services derived from the company’s productive activity, complying with generally accepted accounting principles.

Hargadon and Múnera (p. 1) indicate that, in a general sense, it would be the art or technique used to collect, record, and report information related to costs and, based on said information, make appropriate decisions related to planning. and their control.

Reveles points out (p. 38), that cost accounting is an information system used to predetermine, record, accumulate, distribute, control, analyze, interpret, and report on the costs of production, distribution, administration, and financing. It is an area of ​​accounting that includes the predetermination, accumulation, registration, distribution, information, analysis, and interpretation of production, distribution, and administration costs.

According to Cárdenas (p. 43), cost accounting is the name given to an ordered system of use of general accounting principles to record the operating costs of a company, in such a way that the accounts that are carried out about production, administration, and sale, serve the administrators to determine unit and total costs of the items produced or services provided, to achieve economic, efficient and lucrative exploitation.

For their part, Sinisterra and Polanco (p. 20) point out that cost accounting is generally understood as any accounting technique or mechanics that allows calculating what it costs to manufacture a product or provide a service. It is a general accounting subsystem that is responsible for handling all the details regarding total manufacturing costs to determine the unit cost of the product. By manipulation of cost, data should be understood in its classification, accumulation, allocation, and control. Contributes to the income statement by determining the cost of products sold; Collaborates with the balance sheet, determining the cost of work-in-process inventory and finished goods inventory.

Horngren, Foster, and Srikant (p. 2) establish that cost accounting measures, analyzes, and presents financial and non-financial information related to the costs of acquiring or using resources in an organization. It provides information for both management accounting and financial accounting. For example, calculating the cost of a product is a function of cost accounting that responds to the inventory valuation needs of financial accounting and the decision-making needs of management accounting. (for example, the choice of products to offer). Modern cost accounting takes the view that the collection of cost information is a function of the management decisions that are made. Thus, the difference between management accounting and cost accounting is not clearly defined and both terms are often used interchangeably.

What are the objectives of cost accounting?

García and Jordà (p. 108) establish the following three, as the fundamental objectives of cost accounting:

1. Planning and control. Planning is part of the business management process in which the long-term goals of the organization and the strategies to achieve them are determined. In this case cost targets. Control is part of the business management process used to measure whether the proposed objectives are being achieved.
2. Valuation of goods and services. Cost accounting allows the valuation of the goods produced and services provided, which also means obtaining the valuation of the stocks that remain at the end of the period in the company.
3. Decision making. Cost accounting provides the necessary instruments to determine the most suitable product policies based on their costs.

Sinisterra and Polanco (p. 83) propose, as objectives of cost accounting, the following:

• Accumulate cost data to determine the unit cost of the manufactured product.
• Provide the company’s administration with cost data necessary for the planning of manufacturing operations and the control of production costs.
• Contribute to the control of manufacturing operations.
• Provide the different levels of administration with all the cost information necessary for budgeting, economic studies, and other special decisions related to long and medium-term investments.

Hargadon and Múnera, (p. 2) propose, as the main purposes of cost accounting, the following

1. Determine the cost of inventories of manufactured products, both unitary and global, to present the balance sheet.
2. Determine the cost of products sold, to be able to calculate the profit or loss in the respective period, and to be able to prepare the statement of income and expenses.
3. Provide management with a useful tool for planning and systematic control of production costs.
4. Serve as a source of cost information for economic studies and special decisions related mainly to long-term capital investments, such as replacement of machinery, plant expansion, manufacturing of new products, setting sales prices, etc.

According to Reveles (p. 40), the objectives of cost accounting are:

• Provide timely and sufficient information to the management of the company, for better decision-making.
• Generate information to help management in the planning, evaluation, and control of the company’s operations.
• Determine the unit costs to regulate management policies, to evaluate the inventories of production in process and of finished articles.
• Generate reports to determine profits, providing the cost of items sold.
• Contribute to the planning of profits and the choice of alternatives by management, contributing in advance to the costs of distribution, production, and financing.
• Support in the elaboration of the company’s budgets, in the sales, production, and financing programs.
• Collaborate in the strengthening of coordination and support mechanisms between all areas, for the achievement of the company’s objectives.

How can cost accounting be applied?

According to Reveles (p. 41), the application of cost accounting in a company involves the following phases:

1. Record of expenditures under appropriate classifications, as they are incurred, for example, purchases of material, consumption thereof, rent payments, application of depreciation, etc., using an appropriate chart of accounts for this purpose.
2. Reclassification to apply these disbursements to the corresponding activity; that is, precise application to the respective manufacturing order or process.
3. Determination of unit cost, the primary object of cost accounting.

On the other hand, to apply a cost system based on activities, the following steps must be followed (Barragán, p. 25):

1. Identify and define relevant activities.
2. Organize activities by cost centers.
3. Identify cost components.
4. Cost allocation: Identify cost drivers.

When it comes to the implementation of a production order costing system, the following steps are taken (Joya, p. 53):

1. Identify the job or order to be costed.
2. Identify the direct costs of the job.
3. Select the cost allocation bases that will be used to allocate overhead costs to the job.
4. Identify the indirect costs associated with each cost allocation base.
5. Calculate the indirect costs associated with the job.
6. Calculate the total cost of the order.

For the application of a process cost system (for a process), the steps are as follows (Joya, p. 54):

1. Summarize the flow of physical units.
2. Calculate the final output in terms of equivalent units.
3. Calculate the cost per equivalent unit.
4. Summarize the total costs that must be accounted for.
5. Allocate total costs to units completed and units in ending work-in-process inventory.

The selection of the cost system to be implemented in a company must be based on its characteristics in terms of its production and operations, its possibilities, and its limitations, but always to achieve an improvement of the information that enables the optimal decision-making by management.

What is the importance of cost accounting?

Cost accounting is an essential part of the accounting system of companies, among others, the information it provides affects the policies and objectives of senior management as follows:

• It determines optimal amounts of inventories, important for, for example, calculating financial liquidity ratios and making decisions about it.
• Provides specific information for determining the sale price of the products. It is possible to define which products yield higher profits and which do not, based on which it is possible, for example, to focus the production and commercial efforts of the firm.
• Through the analysis of fixed and variable costs, it is possible to determine the economic equilibrium point of the company.
• It disaggregates the different elements that make up the cost of the product, which allows, for example, to know where investments are required in plant and equipment improvement or in human resource training to improve productivity and efficiency, or where there is a waste of resources, materials, time, and labor that affect production and decrease profit. That is, they serve to control and measure the efficiency of business production.
• Assigns quantitative values ​​to the different production scenarios (budgets) that management studies and proposes.

An integrating vision of the importance of cost accounting for the company and its administration is provided by Arredondo (p. 2), who very accurately explains this relationship as follows:

Let’s imagine products or services, they can be from plays, cinematographic films, computer equipment, beauty products, edible products, etc.; All these products and services generate income, perhaps millions of pesos, however, each and everyone also generates costs. Before deciding to launch them on the market for sale, not only a market study must be carried out to predict their acceptance, but also a cost study to know their future profitability.

Cost accounting must be considered a key element of management in all planning, control, and strategy formulation activities since it provides the essential accounting tools to achieve the proper functioning of some phases of the administrative process such as planning, control, and operations evaluation.

In the planning phase, cost accounting makes future projections through budgets. With this, future costs in terms of materials can be determined. wages, salaries, and manufacturing expenses that are involved to manufacture a product.

These projections can be used to determine prices or to optimize profits considering some strong determinants in the market such as competition.

Additionally, it helps decision-making by increasing the productive capacity of the company or its facilities. manufacture or buy, rent or buy, include additional processing to the product, decrease or increase a working day.

When we talk about control, cost accounting refers to the present time, since it compares the actual results obtained with what is budgeted in the planning phase. In this phase, some operational failures can be identified that allow us to reach the maximization of profits.

Finally, the evaluation phase involves a critical analysis of the results that were obtained and the problems that arose, and the deviations that were obtained concerning the expected results are analyzed. in such a way that the causes that originate them can be eliminated or isolated. In addition to providing corrective actions for current operations, the evaluation phase should provide management with suggestions for improving future planning activities.

What are their characteristics?

Going back to Sinisterra and Polanco (p. 21), cost accounting is found:

• Use special documents to collect the information. Examples of these documents are purchase orders and purchase requisitions, requisitions, raw material consumption reports, time cards, payment sheets, and cost sheets.
• It uses its very own accounts and registration procedures. Some examples of these accounts are raw materials, work in progress, finished goods, cost of goods sold, indirect costs, and factory payroll.
• The reports it provides, cost statements, are prepared to know in detail the expenditures and charges made to produce the goods.

Ramírez, García, and Pantoja (pp. 48 and 49), note the following characteristics:

1. It provides permanent inventories of materials or raw materials, products in process, and finished products with their respective valuations, which is why it provides a lot of help in inventory management.
2. Contributes to the timely and objective presentation of statistics, accounting information, and operational information derived from the activities associated with production.
3. It facilitates the establishment of controls related to the acquisition, conservation, and disposition or use of the elements that concur in the elaboration of the products and on the products themselves.
4. It is the pillar of the permanent inventory system, whose contributions allow for objective and timely valuations and, additionally, reinforce product controls.
5. It allows the determination of unit costs, which among other things are used to plan and control production volumes, and product costs and promote sales and pricing policies.
6. It provides the accounting and operational information with a degree of detail and the requirements of the users.
7. Contributes to budget formulation, presentation, and controls and facilitates profit planning.

Bibliographic references

• Arredondo González, María Magdalena. Accounting and cost analysis. Homeland Publishing Group, 2015.
• Barragán V., Nataly C. Implementation of a cost system for the company Soldimontajes Ltda. Pedagogical and Technological University of Colombia. Thesis, 2015.
• Cárdenas and Nápoles, Raúl Andrés. Costs 1. Mexican Institute of Public Accountants, AC, 2016.
• García Parra, Mercedes and Jordà Lloret, Josep M. Financial management. Univ. Politec. of Catalonia, 2004.
• Hargadon, Bernard J. and Múnera Cárdenas, Armando. Cost accounting. Norma Publishing Group, 1996.
• Horngren, Charles T., Foster, George, and Datar, Srikant M. Cost Accounting: A Managerial Approach. Pearson Education, 2007.
• Joya R., Juan S. Design of a cost system for the company Industrial de Accesorios Ltda. The Industrial University of Santander. Thesis, 2016.
• Ramírez M., Carlos V., García BM and Pantoja A., CR, Fundamentals and cost techniques. Free University Editorial, Cartagena Headquarters, 2010.
• Reveles Lopez, Ricardo. How to understand elemental costs without being an accountant. Mexican Institute of Public Accountants, AC, 2019
• Sinisterra V., Gonzalo and Polanco I., Luis E. Administrative Accounting. ECOE EDITIONS, 2007.