Cost Accounting Definition, Principles, & Importance

cost accounting basics

Operating costs are the costs to run the day-to-day operations of the company. However, operating costs—or operating expenses—are not usually traced back to the manufactured product and can be fixed or variable. Fixed costs are the costs that keep a company running and don’t fluctuate with sales and production volumes. A factory building or equipment lease would be classified as fixed costs. Indirect costs can’t be directly tied to the production of a product and might include the electricity for a factory.

cost accounting basics

It assigns an average cost to labor, materials and overhead evenly so that managers can plan budgets, control costs and evaluate the performance of cost management. Many small businesses prefer standard cost accounting due to its ease and simplicity. Direct cost drivers like raw materials are quite easy to allocate to products, but it is more difficult to accurately identify how each activity contributes to indirect costs. A good example of an ABC application would be finding out how employees split their time on the job. Their salaries are then divided by the time spent on each activity to determine the cost of that activity.

Variable Costs

Management can set performance targets based on the results of this comparison to motivate their staff. Apart from providing a clear direction on what the staff should work towards, the standards used in cost accounting also help design incentives based on performance evaluation. These comparisons cost accounting basics offer valuable insights into cost trends, cost efficiencies, and the organization’s overall financial performance. Cost accounting methods, such as marginal costing, also helps understand cost behavior which refers to how costs change in response to changes in production volumes.

cost accounting basics

Our work has been directly cited by organizations including Entrepreneur, Business Insider, Investopedia, Forbes, CNBC, and many others. Our goal is to deliver the most understandable and comprehensive explanations of financial topics using simple writing complemented by helpful graphics and animation videos. This team of experts helps Finance Strategists maintain the highest level of accuracy and professionalism possible. Estimates, plans, budgets, and other aids are provided to management to compare the desired results and the actual results. Cost accounting utilizes several cost classification approaches to suit different managerial needs. To achieve this, planning and use of the standard for each item of cost is needed, which ensures that deviations can be identified and, accordingly, and corrected.