What is Cost Accounting?

what is cost accounting

Cost accounting is about reporting all of the fixed and variable costs involved in producing something. It corrals in numbers like overhead costs, materials, and labor. And others.

It gives your small business a solid framework to plan with. And it shows your enterprise what’s working and profitable and what needs to be tweaked.

What Exactly is Cost Accounting?

what is cost accounting

Cost accounting involves several different metrics. It’s about cost control to increase profits. By looking at numbers like marginal cost versus standard costs to name a few.

Businesses put the pieces together for a cost volume profit analysis that provides a cost accounting system tracking production. It tracks an SMB’s financial performance. By recording, analyzing, and then reporting on costs.

There’s one goal here to analyze such costs. To bump up a small business’s net profit margins by increasing the sales level for a product or service.


Cost TypeDescription
Fixed CostsRemain unchanged regardless of the numbers produced or sold. Examples: Lease, rent, utilities, salaries. Process costing integrates mass production.
Variable CostsFluctuate with sales. Include raw materials, distribution. Labor costs can be variable. Used in calculating the contribution margin.
Direct CostsTied directly to a specific product. Examples: Material for a car. Known as COGS in manufacturing and COS in retail. Affected by factors like currency exchange.
Indirect CostsNot directly tied to production. Examples: Business admin salaries, managerial accounting costs, office expenses.
Operating CostsAlso known as operating expenses. Include utilities, rent. Indicate efficiency of production processes. Can be fixed or variable.
Sunk CostsHistorical cost that is unrecoverable. Money already spent and doesn't figure into current business decisions.

Main Costs Analyzed by a Cost Accountant

Cost accountants are the people that work these numbers. They use the following cost accounting methods.

Fixed Costs

Fixed costs don’t change regardless of the numbers produced or sold. Like lease and rent, utilities and salaries.

Process costing is a way to fold mass production into total fixed costs.

Variable Costs

These are costs incurred that fluctuate with sales. These variable costs change and include raw materials and distribution. Labor costs can be added in.

Fixed and variable costs are the types most small businesses deal with.

These work with what’s called a contribution margin. That’s leftover revenue after subtracting variable delivery costs from production costs.

Direct Costs

This type of financial accounting isn’t that simple. Good decision-making needs great data, so the direct cost needs to be included in the production process numbers. This cost is tied directly to a specific item, like the material used for a car.

Here’s another example. In manufacturing, these are called the cost of goods sold (COGS) and in a retail business that buys from suppliers, these are called cost of sales (COS).

Direct costs change when production or purchasing increases or decreases. Changes in currency exchange or supplier prices have an effect.

Indirect Costs

Indirect costs show up on a balance sheet in a different way. They are not tied directly to what’s produced. Think business administration salaries and managerial accounting costs. Utilities and office expenses count as indirect costs too.

Operating Costs

These can be called operating expenses in the financial accounting world, which includes utilities and rent. They can be fixed or variable and they are used to gauge how efficient production processes are.

Sunk Costs

This cost is historical. A certified public accountant lists these as unrecoverable. Money already spent. They don’t figure into current business decisions.

Cost accounting often needs to factor in a work in progress. That’s a term for goods that are being produced but aren’t completely finished.

Types of Cost Accounting

what is cost accounting

There are common types of cost accounting and the results show up on financial statements. Cost accounting systems work well in a number of industries. For example, steel companies have many departments to keep track of.

Standard Cost Accounting

The costs are based on what is produced under typical operating conditions. Cost accountants look for differences between standard and actual cost. That leads to variance analysis.

Activity-Based Costing

Often called ABC, this is cost accounting dealing with specific services and goods. A business assigns overhead costs to either and the activity-based costing provides accurate numbers.

Absorption Costing

This is used to corral all the costs that go into any product. Common input costs in this category that go on financial statements include:

  • Wages for the employees who build the product.
  • The type and quantity of raw material needed
  • overhead costs.

This type of cost accounting results in lower expenses on an income statement.

Read More: what is financial accounting

Lean Accounting

This is a bit different than standard costing. Lean focused performance measurements look to streamline production cycles and lead times.

Done right, this can free up 25% more production capacity.

Marginal Costing

This is used for budget preparation and to make short-term decisions. Marginal costing looks at how variable costs affect production.

Throughput Accounting

This is an alternative to other methods. Two factors are taken into account. Sales and production variable costs. It also assumes that labor is a fixed cost.

Cost Accounting Vs. Financial Accounting

There are distinctions that need to be made for good business management. Like the differences between cost accounting and financial accounting.

If you’re wondering: “What is financial accounting?” There’s a definition below.

In a nutshell:

Cost accounting classifies costs for a total quantity over a specific time. It’s designed to uncover and control them.

Financial accounting takes a different approach. It’s a record of all monetary transactions. This includes Balance Sheets, Cash Flow Statements, and Income Statements.

Following are some pluses and minuses to the cost accounting model.

Advantages of Cost Accounting

Small businesses will find advantages to hiring a cost accountant. Here are five.

Cost Control: A cost accounting standard fixes a budget and expenses don’t go beyond the budgeted amount. Compare actual costs to standard costs to find an unfavorable variance.

Planning Future Production: This allows you to compare input costs and other numbers like sales prices, and plan future production.

Analyze Trends

what is cost accounting

Use a trend line to track a cost. This kind of variance analysis highlights spikes and declines in expenses. Look for anything abnormal.

Do A Cost Objects Analysis

Cluster revenues and expenses together this way. Use categories like product and distribution channels to find reasonable profit.

Make Better Decisions

This kind of management accounting can help your team stay informed. That means decisions are made based on accurate assessments.

Disadvantages of Cost Accounting

Cost accounting was developed to look at cost control. But there are some drawbacks.

The Expense

It costs a fair amount to set this system up. For example, you need a double set of accounting books.

  • Initial Setup and Maintenance: Setting up a cost accounting system demands significant financial resources. Beyond the initial setup, the ongoing maintenance and updating of the system can also be costly.
  • Duplication of Work: For firms that use both financial and cost accounting, there’s a need for a double set of accounting books, which not only increases expenses but can also lead to duplicated efforts and inefficiencies.
  • High Software Costs: With technological advancements, many companies opt for sophisticated cost accounting software. These can be pricey, and the return on investment isn’t always immediate.

It Can Be Complicated

what is cost accounting

There are a number of steps involved, like collecting and classifying expenses. That means more documents and forms to put reports together.

It Requires Skilled People

what is cost accounting

This kind of accounting requires highly skilled auditors and accountants. Employees would need special training.

Addressing Challenges in Cost Accounting

While cost accounting offers numerous benefits, small businesses may face challenges in its implementation, such as the complexity of data collection and analysis and the need for ongoing adjustment of cost accounting models to reflect business changes.

  • Simplifying Data Collection: Streamlining the process of data collection by identifying key cost drivers and focusing on critical areas of expense can mitigate the complexity. Employing automated data collection methods can also significantly reduce the effort involved.
  • Adapting to Business Changes: Cost accounting systems should be flexible enough to adapt to changes in the business environment, such as shifts in production techniques, changes in supply chain costs, or new product developments. Regular reviews and updates of the cost accounting system ensure its continued relevance and accuracy.

Strategic Implementation of Cost Accounting

Implementing cost accounting within a small business requires strategic planning and a clear understanding of the business’s operational dynamics. It involves identifying the specific cost accounting methods that align with the business’s production processes, product offerings, and financial goals.

  • Customized Cost Accounting System: Creating a customized cost accounting system tailored to the unique needs of your business can provide more accurate and actionable insights. This system should integrate seamlessly with existing financial systems, ensuring comprehensive tracking and analysis of all relevant costs.
  • Training and Development: Investing in training for your team to understand and effectively apply cost accounting principles is crucial. This includes not only the accounting department but also managers and decision-makers across the business who can benefit from cost-related insights to optimize their operations.

Leveraging Technology in Cost Accounting

Advancements in accounting software have made it easier for small businesses to adopt and benefit from cost accounting practices. Selecting the right technology tools can automate many aspects of cost tracking and analysis, reducing the manual workload and improving accuracy.

  • Cost Accounting Software Solutions: There are numerous cost accounting software solutions available that cater to different business sizes and industries. These tools can help in tracking costs in real-time, performing variance analysis, and generating detailed reports for informed decision-making.
  • Integration with Business Processes: Integrating cost accounting software with other business systems, such as inventory management and CRM platforms, can provide a holistic view of your business’s financial health. This integration allows for a more dynamic approach to managing costs and optimizing profitability.

How Much Does it Cost to Hire a Cost Accountant?

The Bureau of Labor Statistics pegs the average hourly rate at $40 per hour. The actual fee can be above or below that depending on:

  • The experience of the cost accountant.
  • The tasks your small business needs to be performed.
  • How often you’ll need to use their services.

Remember most of these professionals charge on per-service rate or hourly. Some might even charge for specific projects like doing small business taxes.

Is Cost Accounting Right for Your Business?

Cost accounting systems analyze and report on a small businesses’ cost structure. There are several different types including lean accounting and standard costing.

There are advantages and disadvantages to this type of accounting. For example, it can help your business plan production. But you need skilled people to work the numbers. And that can be expensive.

You can hire one of these accountants or look at DIY software.

Either way, make sure to look at the services you need to start. Many small businesses will need everything from business advice to bookkeeping.

Don’t forget to consider the financial gains when using these services. And how your small business can avoid fines and filing mistakes.

Image: Depositphotos

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Rob Starr Rob Starr is a staff writer for Small Business Trends and has been a member of the team for 7 years. He is a graduate of Ryerson University in Toronto with a Bachelor of Journalism degree. His print credentials include employment with various Toronto area newspapers and three works of fiction: The Apple Lady (2004), Creekwater (2006) and Sophistry By Degrees (2008) published by Stonegarden Press In California.