Introduction to Cost Accounting

Introduction to Cost Accounting

Businesses in the manufacturing sector buy raw materials and utilise them in the process of producing the products that they can sell to their customers. Now, you may have a few questions in your mind: How should such firms keep their books of accounts? How do they identify the value of their inventory and the price they should be selling their products?  The answer to all your doubts is cost accounting.

Cost accounting is a subdivision of accounting which has a close relationship to the calculation and control of cost per unit for the products, the way of managing that cost, and so on (Also see What Are Margin and Markup). It is a useful and helpful tool that you can utilise to reduce the costs you incur in your manufacturing process and identify the cost of an item which has a high probability of bringing high profit for your company. Below are some cost accounting concepts which you need to take note.

Categorisation of Costs

In cost accounting, one may classify the manufacturing costs into direct labour costs, direct material costs, non-manufacturing costs, as well as manufacturing overheads.

Direct labour costs

These are the cost you spend in labour that you can trace directly to each unit of the product. As an instance, the salary you pay to an employee in a steel manufacturing business.

Direct material costs

You use raw materials in the manufacturing process, and these are your direct materials. They also act as the essential components of your product. For instance, if you are running a business in car assembling, you may categorise tyres as your direct materials.

Non-manufacturing costs

You may include your administrative expenses and selling expenses in the non-manufacturing costs.  The selling expenses comprises of the cost you incur when you are securing the orders of your customers and sending the products. On the contrary, administrative expenses include the costs which are related to the supervision of the manufacturing process as well as other administrative functions. 

Manufacturing overheads

It may be not very easy for you to trace certain costs to each unit of your product, and these costs are your manufacturing overheads. Some common instances of manufacturing costs are indirect materials, for example, cleaning supplies you use in your automotive company, as well as your indirect labour like security guards.

How to Record the Costs

The product costs (Also see Understanding Product Costs and Period Costs) consist of direct labour, direct materials, as well as manufacturing overheads. The figure of the product costs stands for the inventory for your company, and you should include it in the balance sheet of your business. When you sell this inventory, you need to recognise this sale in the income statement. You should report all your administrative and selling expenses as expenditures in your business income statement.

Conclusion

If you are operating a manufacturing business, knowing the basic categorisation of costs is the first step you should take if you wish to understand cost accounting. If you find the concepts above difficult to understand, you may hire an accounting firm in Johor Bahru to help you with your accounting tasks.

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