Cost accounting can be defined as the art and science of recording, classifying, summarizing, and analyzing costs to help management make prudent business decisions, says Investopedia. In simpler terms, cost accounting is simply an amalgamation of accounting for all the business costs – the expenses incurred by a particular segment or the business as a whole.
The purpose behind cost accounting is simply to keep track of all business expenses to control the costs, compute the essential expenses, get rid of the auxiliary ones, and reduce costs where possible. Controlling of costs refers to the process where budgets are set, targets are decided, and then management makes strategies to achieve those targets in the most cost efficient way possible. Computing costs simply refers to the process whereby cost projections are made for future projects. And therefore, cost reduction then simply means to apply the cost reducing strategies, pick up lowest costing options, and strive to achieve maximum cost efficiencies in a business.
Direct Costs and Indirect Costs
Direct costs are the expenses that go into the core business activities. For instances in a production business, these would be the raw material costs, the machinery used to produce goods, the labor directly involved in the production and so on. Indirect costs, on the other hand, are all auxiliary costs that are necessary for the production of core goods, but are not directly related. These would include the salaries of the employees for HR, research etc., utility expenses, insurance of raw material stocks and work in progress products and so on. Indirect costs are also harder to calculate and predict, making them a more significant part of cost accounting process.
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Cost Accounting Outsourcing
Outsourcing, for any business segment, is a cost accounting decision before anything else. The primary motive of getting an outsourcing partner on board is to reduce costs of business operations which makes it a key decision of outsourcing. In terms of cost accounting, an outsourcing decision can then be simply a choice between producing a good or service in-house or ‘buying’ it at a lower cost from an outside business process outsourcing company.
There is no denying that sometimes outsourcing decisions are made on the basis of availability of resources, proximity in geographical terms to the resources or the market, or simply because of the lack of necessary qualifications or infrastructure. But even in these cases, it is essentially a cost decision because with enough financial strength almost everything can be produced in-house.
Top ways cost accounting can help you in making business decisions:
- You can improve your focus on your core business activities by pre-deciding budgets for different business segments
- You can divide your resources between best of resources; in-house and outsourced
- Eliminate segment or segments that are costing more than generating revenues, or merge two segments with single cost requirements
- Obtain resources necessary for business growth but not internally available
- Free resources from auxiliary activities to be spent on more relevant and lucrative options
What you need to do to achieve most out of cost accounting?
Before you make business strategies based on the cost accounting process, you need to ensure that your cost accounting process itself is properly designed and implemented. For that you need to have accurate measures of your incremental costs of production per year, if you are a going concern. Or the average costs of production for the industry if you are a new entrant. Secondly you need a wide variety of data for different suppliers available in the market, as well as the different prices they are offering per unit for the product or service you require.
The production capacity that you have in-house as well as the expected demand of the projected near future is also a factor to be considered, as is the opportunity cost of the in-house manufacturing Vs outsourcing the same goods or services. Then there are storage costs, inventory processing and replenishing costs, and the operational capacity Vs operational efficiency costs that you need to have on your finger tips for your cost accounting to give you the best results.
Why outsourcing is better?
When it comes to cost accounting itself, you may find that having the appropriately qualified personnel will help you get much better decisions than your own staff. This is because there are some qualitative factors as well that go into cost accounting and the expertise to utilize them comes only from experience, not just good intentions.
Such factors include judging the reliability and consistency of suppliers and their offered prices in the market. The ability to control factors like storage facilities and conditions, quality of goods or services purchased or manufactured, as well as future market capabilities to negotiate better deals with customers and suppliers alike. The predictions about overall economic conditions are also equally relevant and are again something better left to experts. In a nutshell, the process of cost accounting can help you achieve massive targets, but for that the process itself needs to be impeccable. While outsourcing is now being advised and practiced in almost all non-core business activities, hiring a BPO to help you with outsourcing decisions is equally good and useful an advice, especially for newer and growing businesses.