What Is Cost Accounting?

Cost accounting analyzes a company’s total production costs for its products or services.
A form of management accounting, cost accounting examines all variable and fixed
expenses and is meant for internal eyes only. Company decision-makers use the results
to identify which products and services are most profitable and which ones cost too much
to produce relative to sales.

Cost accounting informs budgeting decisions, product/service pricing and business

strategy.

Key Takeaways
 Cost accounting is integral to business decision-making and provides methodologies for
ascertaining, controlling, and reducing costs to optimize profitability.
 While the benefits of cost accounting include enhanced decision-making and effective
production control, challenges like accurate cost allocation remain hurdles for some
organizations.
 The future of cost accounting is intertwined with technological advancements,
necessitating professionals to integrate tools like AI and big data for strategic
management.
 Differentiating cost from financial accounting is crucial, yet their interrelationship forms
the backbone of holistic financial management.

Cost Accounting Explained

Cost accounting is the process of tracking, analyzing and summarizing all fixed and
variable “input” costs related to the production of a product, acquisition of goods for sale
or the delivery of a service. These include material and labor costs, as well as operating
costs associated with a product or service. Cost accounting helps companies identify
areas where they may be able to better control their costs, and also informs pricing
decisions to ensure profitability.

Cost accounting figures are used only by a company’s internal management team, so
collection methods can be customized according to company needs.

Cost Accounting vs Financial Accounting

Cost accounting details the costs associated with producing or acquiring goods for sale
or providing a service. Because it’s not mandatory to perform, cost accounting is not
bound to the same standards required of financial accounting to meet the requirements
of external parties.

This table presents a side-by-side comparison of each form of accounting:

Cost Accounting Financial Accounting

Organizes and analyzes costs to facilitate cost Organizes and records a company’s financial transactions.
control and efficiency improvements.

Reports only to internal management. Reports the financial position of the company to shareholders,
creditors, the government (including tax agencies), investors and
external analysts.

Can be organized according to the needs of Must conform to accounting standards such as GAAP and IFRS.
management and the characteristics of the
business.

Deals with objective, cost-related data Aims to present an objective (“true and fair”) view of the
requiring managerial judgment for allocating company’s finances.
expenses.

What Is the Purpose of Cost Accounting?

Cost accounting helps organizations evaluate the costs associated with manufacturing a
product or providing a service. While the process itself requires a considerable level of
detail and time, the strategic insights gained make it a worthwhile endeavor for most any
organization.

Among the areas where cost accounting can help:

Budgeting: Cost accounting is at the heart of budget planning. By analyzing actual

expenses, an organization can more accurately estimate future fixed and variable costs
and allocate them to product lines.

Efficiency: Standard costs are based on the efficient use of labor and materials. Cost
accounting gives managers a bird’s-eye view of how closely (or not) budgeted costs
match actual costs.

Profit: Uncontrolled variations in expenses can diminish or eliminate profits even if sales
are strong. Cost accounting pinpoints when and where specific production expenses
begin to outweigh sales, enabling managers to make adjustments.

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 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.