What Is the Cost Accounting Method?

The cost accounting method, which assesses a company's production costs, comes in a few broad styles and cost allocation practices. But these share primary advantages and disadvantages.

Cost accounting was originally developed in manufacturing firms, but financial and retail institutions have adopted it over time.

Contrasted with general accounting or financial accounting, the cost accounting method is an internally focused, firm-specific system used to estimate cost control, inventory, and profitability. Cost accounting can be much more flexible and specific, particularly when it comes to the subdivision of costs and inventory valuation. Unfortunately, this complexity-increasing auditing risk tends to be more expensive and its effectiveness is limited to the talent and accuracy of a firm's practitioners.

Advantages of Cost Accounting

The benefits of cost accounting include:

Adaptability

Managers appreciate cost accounting because it can be adapted, tinkered with, and implemented according to the changing needs of the business. Unlike static, the Financial Accounting Standards Board (FASB)-driven financial accounting, cost accounting need only concern itself with internal eyes and internal purposes.

Ease of Monitoring and Controlling Labor Costs

Labor costs are easier to monitor and control through cost accounting. Depending on the nature of the business, wage expenses can be taken from orders, jobs, contracts, or departments and sub-departments. This means management can pick and choose how it determines efficiency and productivity. This is very important when estimating the marginal productivity of individual employees.

Ability to View Data in Different Ways

Cost accounting can be thought of as a sort of three-dimensional puzzle. Accounts, calculations, and reports can be manipulated and viewed from different angles. Management can analyze information based on criteria that it values, which guides how prices are set, resources are distributed, capital is raised, and risks are assumed. It's a crucial element in management discussion and analysis.

Disadvantages of Cost Accounting

Cost accounting is not without drawbacks.

Costs

The benefits of cost accounting come with a price. Since costing methods differ from organization to organization, it's not clear how these costs might manifest themselves until a specific firm is examined.

Complexity

Generally speaking, complex cost accounting systems require a lot of work on the front end, and constant adjustments need to be made for improvements.

Additional Steps to Verify Accuracy

Even if the rigidity of financial accounting creates some inherent disadvantages, it does remove the uncertainty and misapplication of accounting guidelines of cost accounting. Uncertainty equals risk, which always comes at a cost. This means additional—and often more vigorous—reconciliation to verify accuracy.

Reliance on Highly-Skilled Talent

Higher-skilled accountants and auditors are likely to charge more for their services. Employees have to receive extra training and must sufficiently cooperate with data input. Non-cooperation can render ineffective an otherwise beautifully constructed system.

Special Considerations

The repeated trade-off in any accounting method is accuracy versus expediency. Cost accounting reflects this more dramatically than other accounting methods because of its pliability. Every business needs to find its own balance between the two.

Costing methods are typically not useful for figuring out tax liabilities, which means that cost accounting can't provide a complete analysis of a company's true costs. It's easy enough to compensate for this by combining financial accounting with cost accounting but it, nevertheless, highlights a flaw in cost accounting.

Key Takeaways

  • The cost accounting method is an internally focused, firm-specific system used to estimate cost control, inventory, and profitability.
  • It can be much more flexible and specific when compared to general accounting methods.
  • The complexity of cost accounting, however, means that it can be costly in a number of ways.