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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 financial statements. Cost accounting aids in decision-making processes by allowing a company to evaluate its costs. Some types of costs in cost accounting are direct, indirect, fixed, variable and operating costs.

A direct cost is related to producing a good or service. A direct cost is the material, labor, expense, or distribution cost associated with producing a product. It can be accurately and easily traced to a product, department or project. For example, suppose a worker spends eight hours building a car for a car manufacturing company. The direct costs associated with the car are the wages paid to the worker and the parts used to build the car.

On the other hand, an indirect cost is an expense unrelated to producing a good or service. An indirect cost cannot be easily traced to a product, department, activity or project. For example, a semiconductor company rents office space in a building and produces microchips. The wages paid to the workers and the material used to produce the microchips are direct costs. However, the electricity used to power the entire building is considered an indirect cost because it appears on one bill and is difficult to trace back to the semiconductor company.

For more on direct and indirect costs, read How are direct costs allocated differently from indirect costs?

A fixed cost is also associated with cost accounting. A fixed cost does not vary with the number of goods or services a company produces. 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. The lease payment the company pays per month is considered a fixed cost as it remains unchanged.

Contrary to a fixed cost, a variable cost fluctuates as the level of production output changes. 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.

Fixed and Variable costs affect the profit of a company. See how here - How do fixed costs and variable costs affect gross profit?

An operating cost is an expense associated with day-to-day business activities and may be variable or fixed. An example of an operating cost is a company's inventory. Suppose a company produces and sells microchips. The microchips must be stored and maintained, which is an operational cost to the company. Operating costs can also be used to calculate a company's operating expense ratio, which shows how efficient a company is in generating sales.

  1. How are fixed costs treated in cost accounting?

    Learn how fixed costs and variable costs are used in cost accounting to help a company's management in budgeting and controlling ... Read Answer >>
  2. What is the difference between fixed cost and total fixed cost?

    Learn what a fixed cost is, what a variable cost is, what total fixed costs are, and the difference between a fixed cost ... Read Answer >>
  3. Do production costs include all fixed and variable costs?

    Learn more about fixed and variable costs and how they affect production costs. Understanding how to graph these costs can ... Read Answer >>
  4. How can I tell if a cost is a direct cost?

    Find out how to tell if a cost is a direct cost, why that's important and why direct costs don't tell the whole story about ... Read Answer >>
  5. What are the differences between absorption costing and variable costing?

    Examine the main differences between absorption costing and variable costing, along with the advantages and disadvantages ... Read Answer >>
  6. Are marginal costs fixed or variable costs?

    Understand how to identify marginal costs as a function of fixed and variable costs. Read Answer >>
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  1. Fixed Cost

    A cost that does not change with an increase or decrease in the ...
  2. Direct Cost

    A price that can be completely attributed to the production of ...
  3. Production Cost

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  4. Full Costing

    The full costing technique is a managerial accounting method ...
  5. Variable Overhead

    The indirect costs of operating a business that fluctuate somewhat ...
  6. Account Analysis

    1. In cost accounting, this is a way for an accountant to analyze ...
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