To keep costs, accounts, and finances in place, every company needs a framework that evaluates the average cost of the products of the company. This type of framework is called the cost accounting system. The analysis from this system is used for cost control, analysis of profitability, ROI, inventory evaluation, and much more.
The cost accounting system focuses on estimating a company’s production cost by weighing input costs of every type of production along with capital investment and fixed costs involved. Cost accounting systems are usually of three types.
Actual Cost Accounting System
The first one is the Actual Costing system which shows actual costs flowing within the inventory system. In this, costs of direct entities like labor, material, and factory OVHD are included. This can be further explained with the help of an example. In a company, Rs. 4 is spent on direct materials and includes 6 labor hours working at the rate of Rs. 20 per hour.
This helps them produce a complete unit at the expense of Rs. 124 per unit. Here, the indirect cost is Rs. 4. Hence, the total cost per unit is Rs .128. If the company produces 1000 units, the actual manufacturing costs will be 1000 multiplied by 128 i.e. Rs128,000.
Normal costing system
The second type of costing is normal costing which involves direct material and direct labour. In this type of costing, the overhead is applied to inventory through predetermined overhead rates on the basis of activity measures (Slutzman 2017). For example, in a company, the production run costs of the past two months are Rs.10,000 and Rs.20,000.
The total cost is Rs.30,000 respectively. There are 4,000 and 6,000 units produced totaling Rs. 10,000 for two months. Dividing Rs.30,000 by 10,000 will give you the normal overhead factory cost equaling Rs.3 per unit. Here, the actual direct materials cost is Rs.2 and the labor cost is Rs.8 for one unit. The normal factor overhead is Rs.4 per unit. Hence the normal cost to manufacture one unit will be Rs.14.
Standard costing system
The third one is standard costing which encompasses manufacturing costs with pre-set prices and quantities. In this costing, the difference in value between applied and actual costs is used for variance accounts. This will be more easy to understand with the help of an example. Let’s say in a company, statistical analysis data suggests that Rs.2 and 4 labor hours are required to prepare a single gadget. This consumes a cost of around Rs.8 for one widget.
Now for the upcoming year, the company plans to produce 40,000 gadgets which means the total budget will be Rs.320, 000 as a standard cost. At the end of the year, let’s assume that the company produced 40,000 gadgets but incurred a cost of Rs.380,000 which is more than the expected budget. Hence, with the help of standard costing, the company can compare the estimate and real budget and devise new ways to cut down the cost of expenses. This is an estimate budgeting tool and does not include actual expenses.
Inventory management
The next essential is the inventory management system. This system combines the application of mobile devices, barcodes, and application of barcode scanners, and desktop software to streamline various types of inventory management activities such as stock, supplies, goods, and consumables.
The inventory management system is the method of controlling or overseeing the ordering, storage, and use of components that are applied by an organization in the process of goods production for selling to customers. Inventory management controls and oversees the quantities of goods that are completed for sale. The main aim of this process is to understand accurately the inventory levels while minimizing the situation of overstock and understock inventory.
Inventory management regulates the efficient tracking of quantities within the stocking locations. This gives the manager a competitive advantage as they gain insights and are able to make sufficient inventory decisions. Inventory business remains one of the key assets of an organization which is regularly associated with the sale of the products.
Job costing system
The next and last essential is the job costing system. This system allocates manufacturing costs to an individual product or a complete batch of the product. The job costing is applied to the processed goods with the difference in nature or size. The job costing systems include the accumulation of data based on costs related to a particular service or production task.
The relevant information derived from job costing systems submits cost data to consumers according to a contract in which costs can be refunded. The important information further helps in determining the accuracy of the estimation system. The system quotes prices with permission for a reasonable outcome which helps in increasing the overall productivity. The job costing accumulates direct materials, information labor, and overhead.
In a nutshell
Organizing and streamlining your cost accounting system is an important part of getting your business on the road to success. Understanding various types of costing systems can help you identify, differentiate, and implement policies as per the costing system type.
We hope this blog helped you understand the basics of the cost accounting system. Stay tuned for the next blog entries on this topic to discover more essential tips and information.
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