Explanation of the Cost Accounting System

The cost accounting system is used by many companies to establish the estimated development cost of each of their products so that they can perform a profitability analysis or other financial analysis to control production costs.

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Cost Accounting System Video Tutorial With Examples

A business must know the true cost to produce each of its products so that it can identify the most profitable products. Once profitable products are identified the firm may scale up their production, spend more money on marketing them, or cut down production of the less profitable products.

Businesses also can also find the cost of their inventory so that it can be reported on the company’s balance sheet, the cost of goods sold so that it can be reported on the income statement, and other costs. The methods used to determine these costs include operations costing, job-order costing, and process costing systems.

Although many manufacturing businesses have used cost based accounting for decades, the system has been adopted by service businesses to help them become more efficient and determine the most profitable services that they offer. Service businesses use cost based accounting to identify their least profitable services and scale down the promotion or use of those services just like manufacturing companies would do with their products.

Job Order Costing
Job order costing is used to accumulate production costs for each job or contract. Each type of contract or job may be different because of the customer’s potentially unique requirements. Job order costing is effective for certain types of companies such as professional service providers (lawyers and doctors), vehicle repair facilities, construction companies, furniture companies, and many others. These companies benefit from job order costing because they provide customized services to each of their clients or customers.

Process Costing
Process costing shows the costs of each department or sector of a company. This type of costing is normally used by manufacturing companies, chemical production companies, companies that produce textiles, tires, beverages, electronics or any other company with a product that requires several departments working together to produce its products. Process costing shows how production costs flow from one department to another.

In situations where companies use a combination of job order and process costing, it is called hybrid cost accounting.

When cost accounting is used, there are two main methods of cost allocation, traditional costing and activity based costing.

Traditional Costing
Traditional Costing uses one main overhead rate to calculate the cost of each job.

Activity Based Costing
Activity based costing calculates costs for activities in a company, and the costs for products are calculated based on their activity use. In other words, activities in a company cost resources, and since products require activities to be created, they consume resources. It is at least a two stage costing process and it provides more detailed information as opposed to traditional costing.

Costing Reports Are Used Internally
Most costing reports are used internally because they are intended to show management how to reduce the costs of the firm’s products and services and improve the efficiency of its operations. The GAAP accounting standards are not used when creating costing reports, and the company’s management can customize the reports based on the information that they feel is the most important at relevant at the time.

When costing reports are generated they include information such as:

• Expense reports across several months that show how expenses have increased or decreased month by month.
• Expected versus actual costs for the firm’s products or services.
• Month by month profitability reports for each of the company’s products. Profitability reports can also be created for the company’s sales divisions, regions, stores, or any other division in order to compare one sector of the company to another.