What Is Cost Accounting? Definition, Concept, and Types

Cost accounting is the reporting and analysis of a company's cost structure. Cost accounting is a process of assigning costs to cost objects that typically include a company's products, services, and any other activities that involve the company.

Cost accounting is helpful because it can identify where a company is spending its money, how much it earns, and where money is being lost. Cost accounting aims to report, analyze, and lead to the improvement of internal cost controls and efficiency. In short, cost accounting is a system of operational analysis for management.

Understanding Cost Accounting

Even though cost accounting is commonly referred to as a costing method, the scope of cost accounting is far broader than mere cost. Cost accounting has elements of traditional bookkeeping, system development, creating measurable information, and input analysis.

Modern methods of cost accounting first emerged in the manufacturing industries, though its advantages helped it spread quickly to other sectors. For many firms, cost accounting helps create and measure business strategy in a more organic way. Companies that are looking to expand their product line would need to understand the cost structure. Cost accounting helps management plan for future capital expenditures, which are large purchases of plant and equipment.

Types of Costs in Cost Accounting

Although there are many types of costs that businesses can incur depending on their industry, below are a few of the most common costs involved in cost accounting.

Direct Costs

A direct cost is a cost that's directly tied to the production of a product and typically includes direct materials, labor, and distribution costs. Inventory, raw materials, and employee wages for factory workers are all examples of direct costs.

Indirect Costs

Indirect costs can't be directly tied to the production of a product and might include the electricity for a factory.

Variable Costs

Costs that increase or decrease with production volumes tend to be classified as variable costs. A company that produces cars might have the steel involved in production as a variable cost.

Fixed Costs

Fixed costs are the costs that exist to keep the company running and don't fluctuate with sales and production volumes. The lease on a factory building or equipment would be classified as fixed costs.

Operating Costs

Operating costs are the costs to run the day-to-day operations of the company. However, operating costs—or operating expenses—are not usually traced back to the product being manufactured and can be fixed or variable.

Cost Accounting vs. Financial Accounting

Financial accounting and cost accounting systems can be differentiated based on their respective target audiences. Financial accounting is designed to help those who don't have access to inside business information, such as shareholders, lenders, and regulators. For example, retail investors who analyze financial statements benefit from a company's financial accounting.

Alternatively, cost accounting is meant for those who are inside the organization and are responsible for making critical decisions. There is no legal requirement for cost accounting—unlike financial accounting for publicly traded firms.

Cost accounting is distinct and separate from general financial accounting, which is regulated by generally accepted accounting principles (GAAP) and is critical for creating financial statements.

Cost accounting is helpful because it allows executive management of companies to understand how to use its resources more effectively by tracking and measuring them and studying their effects.

Objectives of Cost Accounting

Often, the simplest and most important objective of cost accounting is to determine selling prices. A business that sells sandwiches, for example, would need to track the cost of bread, lettuce, sandwich meats, mustard, and other ingredients. Otherwise, it would be difficult to calculate how much to charge for a sandwich.

Cost accounting is also used to help with cost controls. Firms want to be able to spend less on their inputs and charge more for their outputs. Cost accounting can be used to identify inefficiencies and apply the necessary improvements needed to control costs. These controls can include budgetary controls, standard costing, and inventory management.

Cost accounting can help with internal costs such as transfer prices for companies that transfer goods and services between divisions and subsidiaries. For example, a parent company overseas might be the supplier for its U.S. subsidiary, meaning the U.S. company would be charged by the parent for any purchases of materials.

Cost accounting can contribute to the preparation of the required financial statements, an area otherwise reserved for financial accounting. The prices and information developed and studied through cost accounting are likely to make it easier to gather information for financial accounting purposes. For example, raw material costs and inventory prices are shared between both accounting methods.

Entrepreneurs and business managers rely on actionable information before making allocation decisions. Cost accounting buoys decision-making because it can be tailored to the specific needs of each separate firm. This is different than financial accounting, in which GAAP and International Financial Reporting Standards (IFRS) regulate method and presentation.