What Is Cost Accounting?

Cost accounting refers to analyzing and carefully recording all expenses related to the production of a company's product. Cost accounting entails looking at both fixed and variable costs, reporting expense patterns, and examining cost anomalies to see where budgeting can be improved.

Thorough cost accounting can help reduce and eliminate business costs by identifying actual costs rather than relying on estimates. Therefore, it's important for business owners to be familiar with this process to generate an accurate accounting methodology.

Skynova offers accounting software that can assist in your company's bookkeeping, from tracking sales tax to managing recurring invoices. This article will provide an overview of what goes into cost accounting, why it's an important facet of business success, and what cost accounting looks like on a small business scale.

Why Does Cost Accounting Matter?

Cost accounting leads to more responsible decision-making in business by providing cost information that can highlight areas of cash flow concern or places where cost behavior can be improved. This process heightens efficiencies in accounting that can lead to greater profits, faster throughput, and a reduction in the total cost of running a business.

Accurate budgeting means you can learn how to produce the same amount of a given item using less of your business's money and find weak spots in your activity-based costing that can result in healthier financial statements overall.

5 Types of Costs to Consider

As most small business owners know, all business costs are not created equal. There is a multitude of cost types that should go into your company's regular financial analysis. Below, we'll walk you through the types of cost accounting to consider.

Variable Costs

In standard cost accounting, variable costs relate directly to the cost of producing something and often fluctuate. Examples of variable costs include production process costs like raw materials, labor, sourcing, and shipping. Variable costs may also show up on the customer side in the form of advertising and publicity or on the staff side in the form of sales commissions.

In most accounting principles, variable costs are subtracted from sales to provide a company with its contribution margin.

Fixed Costs

Fixed costs typically don't change and aren't directly related to production. Fixed costs can include rent allocation, payroll, equipment depreciation, amortization, insurance, and even property taxes.

When figuring this kind of pricing into your managerial accounting, you usually work with the actual cost and not a flexible estimate. The total fixed costs of a company are divided by their contribution margin to produce a "break-even point" (BEP), which refers to a production level wherein total revenue equals total expenses.

Operating Costs

Operating costs refer to expenses associated with day-to-day business administration and maintenance. A few examples of operating costs include selling, general, and administrative (SG&A) expenses, raw materials, building maintenance, internet service, and the cost of goods sold (COGS).

When developing your business's income statement, operating costs are typically subtracted from revenue. Managing operating costs effectively can impact any company's profitability. For example, if you're the owner of a small printing company, cutting costs on common usage items like packing slips by utilizing customizable templates like the one provided by Skynova can streamline your operating and labor costs significantly.

Directs Costs

Direct costs refer to any expense incurred through the production of your company's goods or services. They're often referred to as "production costs" because they relate to the creation of a company's product.

Direct costs could be anything from the unit cost of a given piece of raw material to wages, power, fuel consumption, facility overhead, or manufacturing supplies. Direct costs can be variable or fixed, but they always relate to a single cost object (e.g., a service, product, or department).

Indirect Costs

Indirect costs are expenses that arise from the daily maintenance and operation of your business. Direct materials and general supplies, computer and network systems, utilities, and any office equipment rentals qualify as indirect costs.

Like direct costs, indirect costs may be fixed or variable. Let's say you are the proprietor of a small ad consultancy that utilizes shared office space to meet clients. Whatever rent and facility fees you pay for that shared office space would be counted as your business's indirect costs.

What Are the Methods of Cost Accounting?

Much like the costs they monitor, the methods available for proper cost accounting are many and varied. The types of cost accounting that appeal to you may change with your company's growth and evolving accounting needs. Below, you'll find descriptions of a few of the more frequently used cost accounting principles.

Activity-Based Costing (ABC)

Activity-based costing (ABC) is a popular cost accounting system because of its comprehensive approach to pricing. An ABC system takes every activity required for the production of your company's product and assigns a dollar value to it. This method can greatly enhance cost control by showcasing places where a given item's prices might need to be lowered to meet market standards and by identifying products that aren't profitable. The detail associated with ABC cost accounting can help you generate a more realistic bill of materials for a client while also letting you remain competitive.

Lean Accounting

Lean accounting takes the approach of managing costs by measuring and streamlining their effect on the total profitability of the company. This means that a company taking a Lean accounting stance will try to align value-based costing with whatever is most favorable to the bottom line.

For example, if you run a courier service, you might decide to accept or deny a sales order based on the time or distance that order would impose. You might also consider whether the client has been responsible for recurring invoices and weigh the potential revenue against the financial outlay associated with fulfilling the order. In a Lean accounting system, costs are categorized by value stream rather than by department, and this ultimately means that a business owner has greater control over how costing impacts the company's profit from any given item.

Marginal Costing

The marginal costing methodology is also sometimes referred to as "cost-volume-profit analysis." Marginal costing works by adding in the cost of one additional unit for each unit ordered for production.

Let's say you run a coffee shop and it typically costs your business $10 to produce nine cups of coffee. If making one additional cup of coffee was estimated to cost $0.85, that $0.85 is your marginal cost and you would build that into the production cost of your nine cups of coffee, making it $10.85 total.

In this way, marginal costing allows management to gauge and analyze how different ratios of cost and volume impact the business's operating profit. Such insight can inform small business owners on what might be their best marketing campaigns, which items currently in production should soon go on sale, and even what new products might do well.

Let Skynova Help You Manage Your Small Business Financial Statements

It's always advisable to seek advice from a professional certified public accountant (CPA) when making any financial accounting decisions for your business. For everything else, though, there's Skynova business software. Whether you need help organizing your company's receipts or want access to a standardized bill of sale without having to create one from scratch, Skynova has the software to simplify your bookkeeping. Learn how Skynova's software products — including accounting software — and templates can help you today.

Notice to the Reader

The content within this article is meant to be used as general guidelines and may not apply to your specific situation. Always consult with a professional accountant for specific advice regarding you small business finances.