Advantages of Cost Accounting

The advantages of cost accounting refer to the list of benefits that the process brings to the parties, whose decision making depends on it. Cost Accounting is a tool used by the company's management that helps identify, record, and assess an entity’s cost of production to measure the performance of various products and divisions, thus aiding in decision making.

As opposed to financial accounting, the management uses cost accounting internally for budgeting and decision-making, not external financial reporting. Implemented effectively, a sound cost accounting system would help improve product and divisional profitability, thereby enhancing the overall organizational profitability. Below is a summary of the advantages of cost accounting.

The advantages of cost accounting must be known to the firms and individuals who use and maintain it. This is because this accounting helps keep track of the costs involved in a business and also lets businesses know where to control costs. When these expenses are well-recorded, the pricing decisions are easier to make.  

Cost accounting supplements financial accounting to provide management with insights on how the various product lines and activities involved in the production process affect the movements of costs, thereby impacting overall company profitability. A good cost accounting system provides inputs for timely management decisions for cost control and cost reduction by reducing inefficiencies, redundant activities, and avoidable losses.

Cost accounting is done by the internal management team, which works internally to assess the business costs and also identify room for cost control. This process being internally used can see changes in the methods adopted to track figures and assess the same. The only aim of this type of accounting is to work on costs in whatever way it can become profitable.

The advantages of the method not only benefit a business but also acts as a guidance for the internal management, helping them decide best way to leverage from the power of cost accounting.

Some of the merits of this process are as follows:

#1 - Various Items of Costs

It includes direct material cost, labor cost, and overhead cost.

A) Material Costs

• A cost accounting system, when implemented effectively, ensures timely order fulfillment by providing uninterrupted production.
• Reduction of inventory holding costs by synchronizing the frequency of material order placement with the production schedule.
• Identify and avoid abnormal/ unnecessary losses and wastages during storage or production.
• It helps achieve economies of scale by identifying optimal reorder quantity to reduce inventory purchase costs—appropriate valuation of inventory and scrap.

B) Labor Costs

• An effective labor cost control system helps to:
• Recognize and eliminate situations of overstaffing or understaffing by determining human resources requirements in different divisions across product lines.
• Control idle time and overtime by assessing of time consumed in different processes and departments;
• Institute wage systems, incentive schemes, and a bonus plan commensurate with productivity;

C) Overhead Costs

Cost accounting helps ensure better monitoring of the consumption of resources by various cost centers and ensures better departmental control.

#2 - Aids Cost Control and Cost Reduction

A good cost accounting system helps management decrease the entity’s production cost by employing cost control and cost reduction.

• Cost control ensures that the actual cost incurred is in line with the planned amounts.
• Cost reduction aims to lower the per-unit production cost without compromising the product's quality.

Comparing costs across periods in respect of the same product or with competitors or industry standards helps to determine avenues for cost control and reduction.

#3 - Elimination of Wasteful Activities

Cost accounting systems help identify redundant activities, inefficiencies, and abnormal and avoidable losses. Thus, cost accounting is useful for identifying the cause of fluctuations in the business's profitability. Additionally, the cost of idle capacity can be estimated in case divisions or plants are not working to their full capacity. It would help identify the unprofitable product or product lines and wasteful activities so that they may be better managed or eliminated. Cost analysis also helps management decide if it is economically better off making a product in-house or sourcing the same from external vendors.

#4 - Aids in Fixing Appropriate Price to Improve Product Profitability

• Cost accounting enables the management to find the ideal range of prices that would be most profitable to the company, given the output level and the prevailing market scenario.
• Cost accounting enables the fixation of reasonable prices by distinguishing between fixed and variable costs that are not otherwise made in financial accounting systems.
• For example, in a global recession, an entity may be required to lower prices to keep up with the demand for its products. In such a situation, the management may decide to sell at a price that does not cover its total cost.
• The company would then sell the product at a price over its variable cost of production. Since the fixed costs are to be incurred whether or not the entity manufactures the product, the management would price the products so that at least the incremental cost of producing each additional unit is covered.

#5 - Improvement of Division & Organizational Profitability by Fixing Appropriate Prices for Inter-Departmental Transfers

Cost accounting also helps determine a suitable price for the interdepartmental transfer of semi-finished products or materials in a production chain. This system would push department managers to improve individual division profitability by holding them accountable for the same. The divisions would then be encouraged to make optimum utilization of capacity, which would, in turn, boost the overall profitability of the organization as a whole.

#6 - Helps Management by Exception, Leading to Timely and More Informed Decisions

Cost accounting systems help identify deviations from planned amounts. For example, excessive use of materials compared to the standard requirement, extra time taken to complete a particular activity/product than that estimated, additional services consumed by a division of the entity than normal, etc., will be brought to light by a good cost accounting system. Management can then focus their efforts on such material variances that are identified. Cost accounting aids the management in making informed decisions promptly, with some degree of foresight.

#7 - Allows Fixation of Accountability and Responsibility

Budgeting costs and revenues define clear targets for the entity's various product lines and divisions. It helps create division-level accountability within the company, making it easier to fix responsibility for inefficiencies or the award of performance-based incentives.

#8 - Cost Accounting Benefits Economy as Whole

Various government departments use cost records maintained by the entity that is shared with government agencies as part of statutory requirements in their efforts to regulate the sector utilizing price control, price fixation, tariff protection, fixation of minimum wage levels, etc., ensuring equitable allocation of resources and compensation.

This has been a guide to what are Advantages of Cost Accounting. Here, we explain the concept besides talking about the top 8 advantages of the process. You can learn more about financing from the following articles –

• Cost Accounting Objectives
• Cost Accounting Careers
• Cost Accounting vs Management Accounting