Cost accounting is the process of computing costs in a systematic, accurate, and reliable manner. The main goal of cost accounting is to reduce costs and improve performance by analyzing and reporting on costs for the current accounting period and past periods. The costs of a business’s operations are categorized by functions, activities, products, and types of transactions. The process incorporates both objective and subjective assessment. In this way, the company can better control costs and improve profitability.
Using cost accounting techniques will allow you to identify unnecessary costs and estimate future costs. This helps you deter from making unprofitable decisions. Ultimately, cost accounting can improve your public image and your financial accounting responsibilities. For example, a bike manufacturer calculates a break-even point for a new mountain bike product by selling 7,500 bikes at a price of $600 each. In this case, he’d have to sell 7,501 of these bikes for a total of $6 million to break even.
The costs that are directly tied to a product or service are called direct costs. On the other hand, indirect costs are difficult to trace and apply to more than one business activity. Examples of indirect costs are HVAC expenses and lighting expenses. These costs include the entire production of a table, not just the coffee beans. Indirect costs can be difficult to track, but inventory management software has largely solved this problem. It’s important to understand how to properly allocate costs to make the most profit.
In addition to determining direct costs, cost accounting also determines the break-even point, which represents the point at which all expenses are covered by sales. The break-even point is the starting point for calculating the profit, and all sales beyond this point represent profit. Using the break-even point in cost-volume-profit analysis will allow you to determine the number of units you need to sell to break-even, and determine how much each unit of production costs.
Another key benefit of cost accounting is the ability to capture indirect costs. While not directly tied to a product or service, indirect costs support direct patient care activities. Cost accounting processes allow indirect departments to allocate costs, and less than half of health care organizations optimize their cost-management process. These costs are important to track for accurate pricing and management. Without this data, it’s impossible to manage. By determining costs of a product or service, healthcare leaders will be better equipped to make informed decisions.
Another important aspect of cost accounting is its ability to identify overhead costs and allocate them to specific activities. The activity-based approach is particularly useful for companies that have different product lines and require varying levels of labor and material. Using activities as cost drivers will enable them to determine which activities contribute the most value. In short, cost accounting allows managers to see how they spend their money and how they can make improvements. If you’re interested in improving your business’s profitability, you should invest in cost-based accounting.