What is cost accounting?

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. Instead, cost accounting aims to report, analyze and lead to the improvement of inter-business cost control and efficiency. Cost accounting is a system of operational analysis for management.

Even though cost accounting is commonly referred to as a costing method, the scope of cost accounting is broader than just costing. In cost accounting, there are 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.

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 (i.e. the consumers who analyze financial statements). 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); companies use it because it's highly advantageous to do so. It's much easier for a business to know how to use its resources better when it can track them, measure them and study their effects. This is what cost accounting provides.

Often, the simplest and most important objective of cost accounting is to determine selling prices. To use a basic example, the seller of sandwiches needs to be able to track the cost of bread, lettuce, sandwich meats, mustard and other ingredients. Otherwise, it would be difficult to know how much to charge for a sandwich. 

A second, related objective is cost control. Firms want to be able to spend less on their inputs and charge more for their outputs. Cost accounting can be used to identify possible inefficiencies or areas of necessary improvement to control costs. This can take the form of budgetary controls, standard costing or inventory management.

Cost accounting can contribute to the preparation of requisite 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, where GAAP and international financial reporting standards (IFRS) regulate method and presentation.

(For related reading, see: What are the different types of costs in cost accounting?)