Comparing Financial and Cost Accounting Systems in Management

The success of any business depends on the profitability of the products or services a company offers. The profitability of a business is a function of sales price and the cost incurred. Increasing sales prices beyond a specific limit can give you an edge over your competitors and may capture your market share. So, as a business owner, your focus should be on ‘cost’; the lower the cost of production, the higher the profit margins. To keep the cost (i.e. fixed cost and variable cost) optimum, you should implement the ‘cost accounting method’. 

In this blog, we will explore what cost accounting is, its framework and the difference between cost and financial accounting. 

What is Cost Accounting? 

Cost accounting is an accounting process which deals with the recording, summarizing, categorizing and study of expenses attributable to producing goods or services. This accounting approach helps managers make informed decisions to enhance the overall efficiency and effectiveness of the organization, which in turn improves profitability. 

Objectives of Cost Accounting​

Following are the functions of cost accounting that are essential for your organization: 

• Cost allocation
• Cost control 
• Cost reduction
• Budgeting 
• Forecasting
• Strategic pricing decisions 
• Profit maximization and analysis
• Performance evaluation
• Inventory valuation 
• Financial reporting

Advantages of Cost Accounting​

The following are the advantages of implementing a cost accounting system in your organization: 

• Better decision making
• Makes you aware of the areas of improvement
• Allows you to implement cost control measures 
• This leads to accurate product/service costing
• Enables performance evaluation of each process/department
• Helps in evaluating the inventory valuation

Also check out our detailed guide on the 3 Golden Rules of Accounting.

Limitations of Cost Accounting​

The following are the disadvantages of implementing a cost accounting system in your organization: 

• Implementing a cost accounting system is costly 
• It does not provide a comprehensive view of overall business performance
• Understanding cost accounting system is a bit complicated; experience is necessary 
• The result may vary due to improper overhead cost allocation
• Does not have legal bindings

Classification of cost accounting​

There are four different classifications of cost accounting systems, which are as follows: 

• Standard cost accounting
• Activity-based cost accounting
• Marginal cost accounting
• Lean accounting
• Absorption costing
• Job costing
• Process costing

Types of Cost in Cost Accounting System

Following are the various types of costs that are taken into consideration in the cost accounting system: 

• Direct Costs
• Indirect Costs
• Variable Costs
• Fixed Costs
• Operating Costs

Difference Between Cost and Financial Accounting

Cost accounting and financial accounting are the two primary accounting approaches that a company can implement. Each has its own pros and cons; the following is the difference between cost and financial accounting: 

Aspect	Cost accounting	Financial accounting
Purpose	Provides information for internal management-related decisions	Provides financial information to stakeholders
Scope	Deals with detailed costing of a product or service	Deals with overall financial performance of the organization
Regulation	No regulations applies	Regulated by GAAP or IFRS
Reports	Detailed reports are generated for management to make strategic decisions	Standardized reports are generated such as income statements, balance sheets and cash flow statements
Frequency of the reports	Reports are generated as needed or often monthly	Reports are generated generally quarterly and annually
Time orientation	Focuses on the present and future costs	Focuses on historical financial data
Area of focus	Cost control and reduction	Overall financial success of the organization
Inventory valuation	Methods like standard cost and activity-based costing are employed	Historical cost is taken into consideration
Decision-making	Provides insights for short-term decision making	Provides insights for long-term decision making
Legal requirement	Not required legally	Legally required for public companies
Cost classification	Costs are divided into categories such as fixed, variable, indirect, etc	Costs are normally classified by its function (e.g cost of goods purchased, staff salary)

Over to You 

So this is all about the cost accounting system; we hope after reading this blog, you understand the concept of cost accounting and learn the difference between cost accounting and financial accounting systems. If you are looking for accounting software that helps you manage your company finances then do consider subscribing to Munim Accounting and Billing software. Sign up now and get 14 days of free trial. 

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FAQs on Cost Accounting 

1. What are overheads in cost accounting?​

In the cost accounting system, overheads are defined as the costs of operating a business that are not directly related to a product or service. These are indirect costs that a business needs to operate. Following are the examples of overheads in cost accounting: 

• Rent 
• Gas/fuel bill
• Electricity bill 
• Insurance
• Travel and accommodation expense 
• Office Supplies 
• Audit fees 

2. How do you do ABC analysis in cost accounting​?

Following is the step-by-step procedure for ABC analysis using the cost accounting method. 

Step 1: Determine what to analyze: Before starting the procedure, you need to define your expectations and the items to include in the study. 

Step 2: Gather the data: Collect the data regarding the cost associated with executing the a business task

Step 3: Adding up all the costs: Sum up all the costs associated with a task

Step 4: Identify the cost variable: Identify what drives the cost, such as person-hours, machine hours, etc. 

Step 5: Calculate the cost: Now divide the cost type by its variable (e.g. wages with person-hour)

Step 6: Study the results: Identify the key cost type and its variable

3. What is marginal costing in cost accounting​?

Marginal costing is a cost accounting system that takes into account additional costs incurred in the production of goods or services. It is also referred to as variable cost. 

4. What is process costing in cost accounting​?

Process costing is an accounting method that calculates the cost of goods at each step of production. This accounting process is adopted by oil refining, food production, chemical processing, textiles, glass, cement and paint manufacturing companies. 

5. What is idle time in cost accounting​?

The idle time is defined as the time where machines or workers are paid but it does not produce goods or services.