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.
Cost accounting comes in a few broad styles and cost allocation practices, but they share primary advantages and disadvantages. It was originally developed in manufacturing firms, but financial and retail institutions have adopted it over time.
Main Advantages of Cost Accounting
Managers appreciate cost accounting because it can be adapted, tinkered with and implemented according to the changing needs of the business. Unlike static, Financial Accounting Standards Board (FASB)-driven financial accounting, cost accounting need only concern itself with internal eyes and internal purposes.
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 subdepartments. 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.
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.
Main Disadvantages of Cost Accounting
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.
Generally speaking, complex cost accounting systems require a lot of work on the front end, and constant adjustments need to be made for improvements. This complexity consumes time and resources and leaves room for misinterpretation.
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.
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.
Cost Versus Benefits of Cost Accounting
The repeated tradeoff 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 business' 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.