What is Cost Accounting?
A cost accounting it is the area of accounting that deals with expenses incurred in the production of goods or services. In a more technical way, we can define it as the accounting record of the company's production operations, through costing accounts, which can be divided into:
- Accounting for Costs of Services - expenses incurred in rendering services
- Accounting for Industrial Costs - expenses incurred in the production of products
Its main objective is to determine the costs of the products and / or services sold and should be a tool to support decision-making, especially in the formation of the selling price of the company.
It is within a broader scope of study in General Accounting, which is the science that uses a series of techniques and calculations to keep track of a company's equity. Regardless of whether you know how to do it or not, you need to provide details of your company's equity and financial evolution over the years. Usually this calculation and statement is made by your accountant, but it doesn't hurt to understand and stay on top of the subject.
To learn more about the topic, see an article on Accounting!
Types of Costs
- Direct Costs - they are objectively linked to the production of a product or service
Example: In a brewery the bottles, lids, labels and liquid are direct costs, because for each beer produced, if you have an extra expense with these items
- Indirect costs - are costs that are not directly identified in products and services
Example: Expenditures with the financial, marketing and management teams within the same industry would be considered indirect costs
In the case of indirect costs, in some cases it will be important to carry out apportionment criteria between products so that they are properly allocated.
PS - direct and indirect costs can sometimes also be called fixed and variable costs.
Main Costing Methods
I say this, because it is precisely the costing methods that will allow you to understand how to divide the costs of your business among the products:
- Absorption Costing - As its name already says, in this method all costs related to the manufacture of the product or provision of the service are absorbed, regardless of whether it is a direct or indirect cost. Thus, expenses are distributed (prorated) for all products or services.
- Direct or Variable Costing - In this case, only the variable production costs of the period are considered. Fixed costs (relative to production), because they exist even without the development of products or services. In short, this costing separates costs into variables and fixed costs. (obs - it is not accepted in external statements for hurting one of the accounting principles accepted in Brazil)
- Activity Based Costing (ABC) - This method uses the criterion of activities that were performed and generated some type of cost to make the allocation of costs between developed products or services rendered.
In the end, the costing method that makes the most sense for your company should be used and, depending on your business, it may not even make sense to use a specific costing method. Now let's see a step by step on how to apply cost accounting in your company's day-to-day.
How to do cost accounting
- Step 1 - List all the costs and expenses that exist in your company
- Step 2 - Separate the direct costs related to each product
- Step 3 - Compare the direct cost of this product with the applied selling price
If the direct cost is higher this product does not have contribution margin, that is, it will not contribute to pay indirect costs (also called fixed costs)
If the selling price is greater than the direct cost, move on to the next step
- Step 4 - Provision of indirect (fixed) costs between products
There are some ways to do this costing. We discuss some of them more in the same article. If you do not have the data that is conducive to a "fair" division, a simple way that can give you a notion is by making the percentage of sales of each product and making a balanced division of costs between them
With the apportionment made and the contribution margin understood, you can identify how many units would need to be sold from each product or service to match revenues and expenses. If you only have one product, the calculation of the break-even point is easier to do.
- Step 6 - Based on the previous 5 steps, work out the best selling price formation for your business and redo the steps if necessary.
- Step 1 - To list the costs I'll use a toy store with 3 different products:
a) Product 1 - cost of R $ 100 per manufactured product and sale price R $ 200
b) Product 2 - cost of R $ 150 per manufactured product and sale price R $ 300
c) Product 3 - cost of R $ 70 per manufactured product and sale price R $ 50
d) Employee Salary - R $ 20.000
e) Rent and other expenses - R $ 10.000
- Step 2 - Now, see only the direct costs (you can forget the indirect costs for now)
Product 1 (R $ 100), Product 2 (R $ 200) and Product 3 (R $ 70)
- Step 3 - The calculation to find the contribution margin (MC) is very simple: MC = Selling Price - Direct Costs
a) Product 1 - MC of R $ 100 (200 - 100)
b) Product 2 - MC of R $ 150 (300 - 150)
c) Product 3 - MC of - R $ 20 (50 - 70)
In our case, a good insight we could have would be to take the 3 Product out of the market or modify its selling price, since in the current scenario it only damages the company.
- Step 4 - Now is the time for assessment
Indirect Costs = R $ 30.000 (10.000 + 20.000)
In this case, as we have shown, there are some forms that can be used. Assuming we used a proportional method according to the contribution margin of each one, we would have the following scenario (see that I already removed the 3 product from the account.) If it still were, the sales number would probably have to be larger according to the loss calculated by him):
a) Product 1 - 40% apportionment (Product 1 MC / Total MC = 100/250 = 0,4 = 40%)
b) Product 2 - 60% apportionment (Product 2 MC / Total MC = 150/250 = 0,6 = 60%)
In this case, 40% of 30.000 = R $ 12.000 for sales that the 1 product will need to make and 60% of 30.000 = R $ 18.000 that the 2 product will need to sell to reach its equilibrium point
- Step 5 "Now we'll see how to get the amount that should be sold." The calculation is also simple, Point of Balance = Fixed Costs (Indirect) / Contribution Margin
In the case of 1: Balance Point P1 = 12.000 / R $ 100 = 120 1 products need to be sold to break even
In the case of 2: Balance Point P2 = 18.000 / R $ 150 = 120 2 products need to be sold to break even
- Step 6 - Now assuming that the company internally believed that it would be impossible to sell (or manufacture) 120 products 1 and 120 products 2. In this case, the formation of the selling price should be questioned in order to understand whether it is possible to achieve better contribution margins and, consequently, reduce the quantity of products needed to match.
Obviously, all the effort we've taken was to find the point where the revenues and expenses are the same and if you have a business, you will think about how to make a profit after finding that value.
Had he looked at the bookkeeping that way?
I do not know about you, but I've seen a lot of people who are averse to the word accounting, because it looks difficult and messes with a lot of numbers, calculations and statements, but the truth is that if you do not stick to the more technical definitions, process of cost accounting is nothing more than a calculation of your expenses that you can do yourself without any difficulty.
To close, it is worth remembering how this analysis helps in the formation of sales prices and in decisions about the pricing of your products, services and choice of how to position yourself in the market.