Cost Accounting: Definition And Types With Examples


Key Takeaway:

  • Cost accounting is a type of accounting that focuses on determining the cost of producing goods or services. This information is used by managers to make informed decisions about pricing, budgeting, and resource allocation.
  • There are various types of cost accounting, including job order costing, process costing, activity-based costing, standard costing, and marginal costing. Each method is designed to suit different types of businesses and production processes.
  • Examples of cost accounting in different industries include tracking the cost of materials and labor in manufacturing, analyzing overhead costs in service industries, and determining the cost of goods sold in retail businesses. Cost accounting provides vital information for businesses to make informed financial decisions and improve their overall profitability.

Are you confused about cost accounting and the different types? In this article, discover how cost accounting can help you manage your business costs and make informed decisions. Get ready to learn all about cost accounting basics and examples that you can apply.

Types of Cost Accounting

Different cost accounting approaches can help us understand the cost of producing a product. Each one is tailored for a certain business. Five common ones are:

  1. Job Order Costing
  2. Process Costing
  3. Activity-Based Costing
  4. Standard Costing
  5. Marginal Costing

These methods measure the costs of products and services differently.

Job Order Costing

One of the cost accounting techniques that businesses use is the process of customizing manufactured products to suit individual customer requirements.

This cost accounting technique is highly effective for companies that produce low quantities of customized products. It allows them to calculate the cost incurred in manufacturing each product unit separately. The company assigns a unique job number or order number to each customized product. The costing process starts with recording and tracking direct materials, labour, and overhead costs for each job.

Unlike Process Costing that uses average costing for all units produced in a period, Job Order Costing requires detailed calculations for every customized unit produced.

If you're looking to get accurate insights on the true cost of producing customized products, then Job Order Costing is the best option for your business.

Don't miss out on unlocking significant cost savings opportunities! Implement Job Order Costing in your business operations today.

Process costing may sound boring, but it's the bread and butter of accounting - literally, if you're an accountant who loves bread.

Process Costing

For the process-based approach to managing costs, a systematic and accurate tracking and costing of the production processes is required. This approach is employed specifically in industries with standardized products such as food, textile and chemical manufacturing.

For Process Costing, we can create a table outlining different costs that are involved in the production process. The columns would list the expenses for direct materials, direct labor, and manufacturing overheads. Under each column would be listed the actual cost incurred for each item during a given period.

In addition to being used by large manufacturers as an efficient way of tracking inventory-related expenses, Process Costing also includes situational factors like time spent on set-up or downtime losses.

It is said that the concept of Process Costing rises out of a need for better cost management techniques that gained popularity during World War II in America's industrial sector. The industry needed fast solutions to sustain their production levels during wartime, leading to increased efficiency both in terms of operation speed and expense reduction excellence.

Activity-based costing: The perfect way to make your accountant remember why they pursued a career in numbers.

Activity-Based Costing

Activity-based Cost Management helps companies track and measure the cost associated with various activities involved in producing goods and services. This method analyzes the resources spent on each activity and assigns costs based on the consumption of resources by that particular activity.

Through Activity-based Costing, businesses can determine which products or services may be more profitable than others, as well as identifying areas where they can cut down on production costs. By accurately assigning costs to each individual activity, companies can better understand how each activity impacts their overall product or service cost.

This approach differs from traditional costing methods, which assign costs based on arbitrary assumptions about allocation factors such as labor hours or machine time. Unlike these traditional methods, ABC promotes accurate allocation of costs incurred through actual consumption of resources across all activities in an organization.

Activity-Based Costing allows for greater accuracy in pricing and improving profit margins by providing a detailed overview of costs associated with producing specific goods or services. Therefore, it helps organizations make better decisions and improve their bottom line by managing costs effectively.

Standard Costing: Where even the slightest deviation from the norm can send accountants into a panic.

Standard Costing

One of the types of cost accounting that is commonly used in businesses is the process of representing expected costs and actual costs known as "Standardized Costing". It provides firms with a clear picture of the anticipated expenses they will incur during their operations through predetermined standards.

To illustrate, here's an example table for Standardized Costing:


Standard Costing saves companies from budget overruns, as overheads are identified beforehand, along with other direct and indirect expenses.

In comparison to traditional costing methods, standardized costing requires companies to predetermine costs while manufacturing products or delivering services. It then analyses anticipated costs compared to actual expenditures- reducing discrepancies.

Standardized costing was first introduced in the early 1900s by Hamilton Church when he aimed to identify overpriced costs in his lumber business compared to actual spending patterns.

Calculating the marginal cost is like trying to find the last piece of pizza at a party, it's essential but can be a bit messy.

Marginal Costing

Marginal costing is a technique used to measure costs and profitability of goods or services. This method segregates fixed and variable costs to determine the contribution margin of each product or service. The marginal cost is the additional cost incurred in producing one more unit of a particular product or service.

This technique helps businesses to determine if they should continue to produce a particular product or discontinue it based on its contribution margin. It also assists in setting prices for products or services by analyzing their costs. Marginal costing can be useful for short-term decisions but may not provide an accurate picture for long-term financial planning.

In addition, marginal costing is different from absorption costing, which includes all manufacturing costs into the per-unit cost of a product. Whereas, with marginal costing, only variable costs are considered in calculating the per-unit cost.

Interestingly, Marginal Costing was first introduced by C.W. Valentine in 1909 and further developed by Charles E. Sprague and others in the 1930s. The concept has since then become an essential tool for determining various aspects of business operations such as pricing strategies and profit maximization techniques.

Examples that will make you question your life choices (in a good way) - presenting the various types of cost accounting!

Examples of Cost Accounting

This section will give you real-world examples of cost accounting, from manufacturing, service, and retail industries. To comprehend how it works, check out these examples! Discover how cost accounting can boost efficiency, cut down on waste, and make more money.

Manufacturing Industry

The sector that engages in the production of goods is viewed as a generic term to 'Manufacture Things'. It encompasses raw materials transformed into finished goods. The process involves stages like designing, assembling, packaging, labeling, and shipping. Here, cost accounting plays a crucial role in analyzing the manufacturing costs that occur from these various stages involved in producing goods efficiently.

Moreover, cost accounting techniques help firms understand their product costs involving direct(raw materials+labour) and indirect(costs other than raw material) expenses like rent for factory or indirect labour. Companies can determine the actual manufacturing overhead by measuring the overhead rate to minimize costs in service delivery.

The need for consultation with cost accountant engineers who specialize in eliminating internal wasteful processes by providing relevant insight on what costs or wastages need redressal is vital. By promoting lean management methods to reduce unnecessary expenses from inefficient plant functions like excess inventory and defective units manufacture amounts to an increase in profits.

A leading cosmetics company invested heavily in costly advertising campaigns; they hired professional advertisers that created engaging content to promote a new product line. However, upon examining their yearly production reports analyzing departmentalized and assembled products accurately revealed that a significant percentage of those newly formulated products resulted in defects at specific assembly points and missed quality inspections that directly correlated with reduced customer demand over time. As a direct result of this investigation outcome companies have realized the importance of considering cost accounting while making any productive investment decisions because it ensures optimum usage of resources to maximize productivity and profitability.

The only thing more elusive than good service in the service industry is a unicorn with a winning lottery ticket in its mouth.

Service Industry

Industries that provide intangible services, such as healthcare, hospitality and consulting, can benefit from cost accounting. By understanding the costs incurred while delivering the service, a company can efficiently allocate resources and optimize their financial performance. For example, a hospital may use cost accounting to determine the cost of each procedure to negotiate reimbursement rates with insurance companies.

Additionally, service industries have unique cost drivers compared to manufacturing industries. Labour costs are typically higher in the service industry due to the highly skilled nature of work performed by employees. Furthermore, overhead costs are typically lower since there is less equipment involved in providing the service. These differences make it important for companies in the service industry to implement cost accounting strategies specific to their business.

Don't miss out on optimizing your company's financial performance in the service industry. Implementing cost accounting strategies can help you better understand and allocate resources to ensure long-term success.

Retail Industry

The world of consumer goods is constantly evolving, and businesses in the commerce industry must remain competitive by staying up-to-date with cost accounting practices. Analyzing raw materials, production overheads, transportation fees, and storage expenses are some of the aspects that come under the umbrella of cost accounting in retail. With the rapid growth of e-commerce, newer technologies exist to update point-of-sale (POS) systems and improve inventory management methods.

Retailers can minimize their costs by adopting sophisticated techniques such as Activity-Based Costing (ABC), which help them to make smarter pricing decisions. Understanding these cost structures provides retailers with a more accurate evaluation of each product's individual selling price. This real-time data ultimately translates into better decision making that influences strategies across different areas of the retail industry.

Cost accounting has its limitations but proves to be an effective operating procedure for both brick-and-mortar stores and online retail outlets. For instance, different types of products may have varying product margins due to their unique nature and may require diverse costing techniques to achieve profitability.

A popular chain sawdust-ice cream franchise that implements ABC was able to pinpoint which flavours were the best sellers and understand which ingredients played a substantial role in those sales while identifying specific operational costs from also-rans. It allowed them to focus on developing new flavours based on fresh ingredients without compromising overall profits.

Five Facts About Cost Accounting: Definition and Types With Examples:

  • ✅ Cost accounting is a branch of accounting that deals with the recording, analyzing, and tracking of costs associated with a product or service. (Source: Investopedia)
  • ✅ The main types of cost accounting include job order costing, process costing, activity-based costing, and throughput accounting. (Source: AccountingTools)
  • ✅ Cost accounting provides valuable information to managers for decision making, such as determining the selling price of a product or service, evaluating the profitability of different product lines, and identifying areas for cost reduction. (Source: Corporate Finance Institute)
  • ✅ Cost accounting is used in a variety of industries, including manufacturing, healthcare, construction, and retail. (Source: Clutch)
  • ✅ Common cost accounting techniques include cost-volume-profit analysis, break-even analysis, standard costing, and variance analysis. (Source: AccountingVerse)

FAQs about Cost Accounting: Definition And Types With Examples

What is cost accounting?

Cost accounting is the process of recording, analyzing, and reporting all costs associated with producing a product or service. The aim is to determine the true cost of production by taking into account all direct and indirect costs.

What are the types of cost accounting?

The types of cost accounting are job costing, process costing, activity-based costing, and throughput costing. Job costing is used when a product or service is customized for each customer. Process costing is used when a product or service is standard, and the production process is continuous. Activity-based costing is used to allocate overhead costs to products or services based on the activities that create those costs. And throughput costing is used to determine the marginal cost of adding one unit of production.

Can you provide an example of job costing?

An example of job costing is building a custom-made house. The cost accountant will track all costs associated with each stage of construction, from designing, purchasing materials, labor costs, and any other expenses incurred during the construction process.

What is process costing and how is it used?

Process costing is a method used to determine the cost of each unit of production in a continuous production process. This method is used where products are manufactured on a large scale and have a standard costing pattern. The costs involved in the manufacturing process are first accumulated by a department and then allocated to individual units of production.

What is the purpose of activity-based costing?

Activity-based costing is used to allocate overhead costs to products or services based on the activities that create those costs. The purpose is to have a more accurate measure of the true cost of a product or service, which can help in pricing decisions, cost reduction efforts, and making informed business decisions.

How is throughput costing different from other types of costing?

Throughput costing is a method of costing that focuses on the marginal cost of adding one more unit of production. Unlike other types of costing, it only considers costs that vary with changes in production, and excludes all fixed costs such as overheads and administrative expenses. This method can be used to make informed decisions on whether to produce more or less of a product based on the marginal profit of each unit.