What Is Cost Accounting? (Plus Different Types of Costs)

Updated 28 January 2023

Cost accounting is a financial process that many businesses utilise. It involves recording and analysing the costs of a business to help form strategies and budgets. Learning what cost accounting is can help you understand some of the financial processes within the business industry. In this article, we discuss what cost accounting is and what cost accountants do, explore the different types of cost accounting and how this field differs from financial accounting and answer some frequently asked questions.

What is cost accounting?

Learning the answer to 'what is cost accounting?' is your first step if you're interested in entering this field. Cost accounting is a financial practice that involves managing and analysing costs within a business. By reviewing the business's expenditure, a financial team can reduce costs and plan accurate budgets. Companies that produce large amounts of goods often have many variable costs. These large companies might employ a cost accountant to review the business' expenditures and help plan strategies.

How a company conducts their cost accounting can vary depending on the needs of the business. There are general steps in cost accounting, but the process can be unique for each company. This is because cost accounting is internal, meaning the information doesn't reach the public.

What do cost accountants do?

Below are some typical responsibilities of a cost accountant:

Compare profits to costs

Cost accountants compare different expenditures with the associated income it generates. For example, a business may allocate a part of its budget to marketing. It costs the business to employ marketing professionals, but increased advertising leads to more sales. The cost accountant compares the value of the extra sales with the cost of employing marketers. These comparisons can help a financial team identify what expenditures are cost-effective.

Help formulate business strategies

A cost accountant may assist a business with developing management strategies. For example, a cost accountant may show the business that its expenditure on safety glasses is rising. The management team may discover it's because their employees use a new pair of glasses every week. Management can then implement strategies to ensure employees are more mindful in the future.

Plan budgets

Cost accountants help prepare budgets by estimating how much a business may earn over a specific period. They use this figure to plan the business' expenditures and allocate resources to different departments. The role of a cost accountant when planning a budget can depend on the type of budget the business requires. For example, a company may plan for a surplus budget if its expected revenue exceeds its expenses.

Types of cost accounting

Below are three different accounting methods a cost accountant may use when planning financial strategies:

Standard costing

Standard costing refers to comparing expected costs to actual costs. Expected costs are an estimate of the business' production expenditure. Actual costs refer to the true production expenditure. A cost accountant analyses the comparison to determine which expenditures are a cost variance. Cost accountants may use the data of these variances to highlight which departments may require additional resources.

Activity-based costing

Cost accountants may use a method known as activity-based costing to categorise costs. The process involves the allocation of indirect expenditure to the cost of production. For example, a business may produce a screw for one cent, but after activity-based costing, the cost of the screw increases to three cents. This is because the cost of producing the screw includes the business's overhead costs, such as marketing, administration and insurance.

Marginal costing

Marginal costing is estimating a change in profit from an increase in production. Cost accountants determine the impact of increased production on fixed and variable costs. If a business increases its production rate, it may require additional employees, training personnel and facilities. This usually increases expenditure. The data a business gathers from marginal costing can help optimise its production and profitability.

Types of costs

A cost accountant often allocates expenditures to a category. This makes it easier for financial teams to find and analyse data. Instead of calculating individual expenditures, cost accountants can calculate profits using grouped costs. It's helpful to remember that many costs can belong to more than one category. Below are the types of costs that a cost accountant analyses:

Opportunity costs

Opportunity cost refers to the potential financial benefits of an alternative business decision. For example, a business allocates a portion of its budget to its advertisement department. The alternative decision may have been to invest that money in upgrading plant equipment. The opportunity cost is the potential revenue that new plant equipment may have yielded.

Controllable costs

A controllable cost is an expenditure that management has the authority to control. This means management has the decision to incur the cost. For example, a business can decide if the office requires new chairs and tables. Some controllable costs can include marketing, office supplies and training. Controllable costs are often short-term decisions that management can quickly change.

Indirect costs

An indirect cost is usually a cost that is important to a business's function but doesn't directly relate to its service. For example, the accounting expenses of a construction business might be an indirect cost. The accounting team provides financial advice to the business, though the advice is unnecessary for the construction business to perform its function.

Direct costs

Direct costs are the expenses of providing the business's service. For example, a manufacturing company producing window frames often purchases raw materials. The expenditure on these materials is a direct cost because the materials are necessary for the production of the window frames.

Fixed costs

A fixed cost is an expense that remains constant regardless of the business's production output. For example, a fixed cost of a business might be its rent. The business's rent remains the same, regardless of how much they increase their production. A fixed cost includes the costs over a specific time period. This is because some fixed costs, such as rent, may increase over time.

Operating costs

An operating cost is very similar to a direct cost because they are both expenses incurred from business operations. The major difference is that operating costs also include expenses that are not directly involved with production. For example, accounting services and raw materials are both operating costs. Some cost accountants might merge variable and direct costs to form the business' operating costs.

Variable costs

A variable cost is usually an expense that changes relative to a business's production rate. For example, if a car manufacturer wants to increase its production rate, the manufacturer may pay for additional raw materials. The business expense on raw materials is a variable cost because it increases as production increases.

Cost accounting vs. financial accounting

The fundamental difference between cost and financial accounting is that financial accounting involves public documents. The management of a business uses cost accounting as an internal financial process. This means the information gathered by a cost accountant is for internal managerial decisions. Cost accounting is essentially a tool for improving the financial efficiency of a business.

Financial accounting is gathering information to display to potential clients and investors. Financial accountants are often subject to strict guidelines and regulations that ensure they conduct their duties with professionalism. Because cost accountants only produce documents for internal management, they're usually not subject to extensive accounting regulations. A cost accountant may still uphold the values and policies of the business.

Frequently asked questions

Here are some answers to commonly asked questions about cost accounting:

What's the most effective method of cost accounting?

The most effective method of costing can vary between businesses because cost accounting is an internal process. Depending on the business's goals and values, a cost accountant may implement several cost accounting methods. For example, a cost accountant may implement a marginal costing method if the business is launching a new product on the market. Marginal costing can help the business estimate the potential profit of the new product.

Is it hard to become a cost accountant?

The minimum requirement to become a cost accountant is typically a bachelor's degree in finance or commerce with a major in accounting. Becoming a cost accountant can require dedication and commitment to the financial industry. If you have a qualification but minimal work experience, you may consider an internship or entry-level accounting role. You can search for cost accountants' careers using the Indeed Job Board.

What Is Cost Accounting? (Plus Different Types of Costs)