What Are the Types of Costs in Cost Accounting

Cost accounting is a form of managerial accounting that aims to capture a company’s total cost of production by assessing the variable costs of each step of production as well as fixed costs, such as a lease expense.

Types of Costs in Cost Accounting

What is costing?

Costing, or cost accounting is a system for determining a company’s cost of production. This type of accounting looks at both variable and fixed costs incurred throughout the production process. Companies use costing information to make informed business decisions and ensure each area of production is financially effective and efficient.

An organization’s internal management performs costing activities, and, unlike other forms of accounting, isn’t seen by outside clients or institutions. As a result, there are no set standards that cost accounting must meet, and it has more flexibility in comparison to other types of accounting.

The 8 Major Accounting Costs

How you divide accounting costs into each section is described below. But you will need to define what type of cost accounting methodology you are going to use before you can accurately complete this step. The types of cost accounting are explained below in the classification of major accounting costs.

Direct Costs

Direct costs are among the most common. They are the direct cost associated with the production of a product. Direct costs would include labor or materials. They may also include distribution costs and other expenses, depending on the method of accounting.

You can see how such costs are direct. The training of the employees, supervision, utilities and other costs are not factored in. Direct costs are the same as the Cost of Goods Sold, a very relevant metric for general accounting purposes. Cost of Goods Sold (‘COGS’) is sometimes referred to as the Cost of Sales.

Variable costs: 

These costs vary with the production,  process, or project changes. For example, in an organization manufacturing toys, the material and labor cost will be dependent on the production. 

Opportunity cost: 

The cost incurred in selecting one option over another is called opportunity cost. For example in a toy manufacturing unit with limited labor hours and material, the decision to produce one particular toy says ‘Dancing Monkey’ will result in non-production of another toy say ‘Spinning top’.

Sunk cost: 

Certain costs are incurred and cannot be recovered these are sunk costs.  Continuing with our example of the toy manufacturing unit, sunk costs would refer to machinery cost that has been incurred.

Operating costs:

These are costs associated with the day-to-day running of the business. They can be either fixed or variable.

Indirect Costs

Indirect costs are a little more difficult to trace. Indirect costs often cannot be traced back to an individual department. The workers in a car manufacturing plant might all use the internet, water, and lighting to create a vehicle.

But these costs are indirect and are used all over the plant. Other indirect costs can include IT and office maintenance staff. They are indirect but still highly relevant to the business and the end product.

Costs in Cost Accounting

Variable Costs

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.

Controllable Costs

Controllable costs are ones where a manager (or board) decides what will happen at a particular cost. Bonuses, charitable donations, advertising, office supplies, employee events, are all examples of controllable costs.

Elements of Cost Accounting

Cost accounting is based on three principal elements: materials, labor, and overhead.

Material

Materials are inputs to production. They are typically broken down into two groups: direct and indirect.

Direct materials are materials and parts used in production and reflected in a completed product. Materials can be subdivided into raw materials, such as cotton for clothes or plastic for a phone case; work-in-progress, or products that are not yet complete; and finished goods, meaning products that are ready for sale.

Indirect materials are treated as an overhead expense. Examples include safety equipment and cleaning supplies. Only direct materials are shown on the cost sheet.

Labor

Workers directly involved in the production or distribution of goods or delivery of services must be paid. Their salaries or wages might include overtime and bonuses; employee benefits are part of the total cost, too.

As with indirect materials, indirect labor costs are treated as an overhead expense, not a labor expense.

Expenses/overhead

These are costs related to the production or distribution of goods or provision of services, but which cannot be directly attributed to specific goods or services. Typical overhead costs include:

  • Equipment set up, such as for factory machinery.
  • Utility bills, such as factory electricity, water and sewerage.
  • Facilities costs, including rent/mortgage and property taxes.
  • Payroll taxes and pension contributions.
  • Depreciation of fixed assets, such as factory machinery and store equipment.
  • Interest payments.

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