Cost accounting is an accounting process that measures and analyzes the costs associated with products, production, and projects, so that correct amounts are reported on a company's financial statements. Cost accounting aids in decision-making processes by allowing a company to calculate, evaluate, and monitor its costs.
Below are some of the types of costs used in cost accounting:
Direct costs are related to producing a good or service. A direct cost includes materials, labor, expense, or distribution cost associated with producing a product. It can be easily traced to a product, department or project. For example, Ford Motor Company (F) manufactures cars and trucks. A plant worker spends eight hours building a car. The direct costs associated with the car are the wages paid to the worker and the parts used to build the car.
Indirect costs, on the other hand, are expenses unrelated to producing a good or service. An indirect cost cannot be easily traced to a product, department, activity or project. For example, with Ford Motor Company (F), the direct costs associated with each vehicle include tires and steel. However, the electricity used to power the plant is considered an indirect cost because the electricity is used for all the products made in the plant. No one product can be traced back to the electric bill.
What Are The Different Types Of Costs In Cost Accounting?
Fixed costs do not vary with the number of goods or services a company produces over the short term. For example, suppose a company leases a machine for production for two years. The company has to pay $2,000 per month to cover the cost of the lease, no matter how many products that machine is used to make. The lease payment is considered a fixed cost as it remains unchanged.
Variable costs fluctuate as the level of production output changes, contrary to a fixed cost. This type of cost varies depending on the number of products a company produces. A variable cost increases as the production volume increases, and it falls as the production volume decreases. For example, a toy manufacturer must package its toys before shipping products out to stores. This is considered a type of variable cost because, as the manufacturer produces more toys, its packaging costs increase. However, if the toy manufacturer's production level is decreasing, the variable cost associated with the packaging decreases. For more on how fixed and variable costs affect the profit of a company, please read "How Do Fixed Costs and Variable Costs Affect Gross Profit?"
Operating costs are expenses associated with day-to-day business activities but are not traced back to one product. Operating costs can be variable or fixed. Examples of operating costs, which are more commonly called operating expenses, include rent and utilities for a manufacturing plant. Operating costs are day-to-day expenses, but are classified separately from indirect costs – i.e., costs tied to actual production. Investors can calculate a company's operating expense ratio, which shows how efficient a company is in using their costs to generate sales.
Opportunity cost is the benefit given up when one decision is made over another. In other words, an opportunity cost represents an alternative given up when a decision is made. This cost is, therefore, most relevant for two mutually exclusive events. In investing, it's the difference in return between a chosen investment and one that is passed up. For companies, opportunity costs do not show up in the financial statements but are useful in planning by management.
For example, if a company decides to buy a new piece of manufacturing equipment rather than lease it. The opportunity cost would be the difference between the cost of the cash outlay for the equipment and the improved productivity versus how much money could have been saved had the money been used to pay down debt.
Sunk costs are historical costs that have already been incurred and will not make any difference in the current decisions by management. Sunk costs are those costs that a company has committed to and are unavoidable or unrecoverable costs. Sunk costs (past costs) are excluded from future business decisions because the costs will be the same regardless of the outcome of a decision.
Controllable costs are expenses managers has control over and have the power to increase or decrease. For example, deciding on how supplies are ordered or the payroll for a manufacturing company would be controllable, but not necessarily avoidable.