It is the branch of accounting in which all the costs incurred during an activity or to accomplish an aim are collected, classified and recorded. This information is then processed and summarized to analyze the cost incurred in different processes and to arrive at a selling price and also to determine the areas where cost saving measures can be taken to improve efficiency and save cost.
One of the major objectives of cost accounting is to control cost. Every business wants to control costs on inputs and to charge more for its outputs, this can be achieved through cost accounting, as it would help in finding out inefficiencies in the production process which would further enable the management to take necessary action to improve the efficiency of such a process and lead to higher profits in the long term.
Cost accounting also equips the businesses to ascertain the selling price of products. The selling price can only be decided upon after taking into account all costs and then deciding how much profit a firm wants to earn and thus it can decide the selling price accordingly.
Cost accounting helps in ascertaining profits and also helps to see the profitability of a certain product and how that particular profit figure is reached upon. Thus the firm also knows what all it can do to maximize profits and minimize costs as cause and effect relationship can be made, which will enable the firm generate maximum value as well as profits.
It is an important tool that helps the management make cost decisions and thus take the best route to profitability.
This concept can be illustrated with the following example of a sandwich seller:
A sandwich seller was found to have the following costs to sell sandwiches in a day:
|Raw materials (Bread, vegetables etc.)||$250|
|Food truck rent||$50|
|Wages to helper||$50|
He expects to sell 100 sandwiches in a day and wants to earn 30% of profit on costs. Now he has to decide the cost of each sandwich so as to earn desired profit.
He first adds all the expenses i.e. = $500
Now he wants to earn a profit of 30% on cost thus he finds out that he has to makes sales worth $500 to break even and thus, he has to sell sandwiches worth $650 to earn desired profits.
As he expects to sell 100 sandwiches in a day he decides to price each of his sandwiches at $6.5.
The following example can be further extended to include many variations like how competitors price their sandwiches.
To further illustrate the point consider the previous example the only change being that the other sandwich sellers in the area sell their sandwich at $6.
Now the sandwich seller either has to decrease his profit margin or the cost incurred. Cost accounting helps him find the areas where he can reduce costs so as to attain desired levels of profits. After accounting for different areas where he find that he can reduce the other expenses that he incurs on selling the sandwiches by $30 and can negotiate a reduction of $10 on renting of truck thus saving $40 as expenses which reduces the cost to $460 thus to get his desired profit margin he has to sell $598 worth of sandwiches which allows him to price his sandwiches at $5.98. He thus has a little edge over his competitors and this may help him sell 10 more sandwiches each day thus helping him sell more and in turn earn more.