INSIGHT

What is cost accounting? A guide to smart business decisions

Chris Rosales, Jamie Emerson-Heery • April 21, 2025

Product-led businesses constantly struggle with the balancing act of maximizing profits while maintaining operational efficiency. Cost accounting cuts through the complexity by revealing exactly where your money goes and why.

When you understand the true cost behind every product and decision, you gain the power to set strategic prices, eliminate waste, and focus resources where they matter most. This visibility transforms guesswork into precision, helping you build stronger margins and sustainable growth.

So, what is cost accounting and how can it help your business improve profits? Let’s find out.

What is cost accounting?

Cost accounting is a specialized field of accounting that focuses on analyzing, standardizing, forecasting, and comparing cost data to determine the true cost of products or services.

The core purpose of cost accounting is to track, analyze, and manage all expenses associated with producing goods or delivering services. This systematic approach helps businesses understand their cost structures, identify inefficiencies, and implement strategies to enhance profitability and operational performance.

It goes beyond traditional accounting by providing detailed insights into where money flows within a business, helping management make informed decisions about pricing, resource allocation, and process improvements.

Unlike financial accounting, cost accounting is not required to follow Generally Accepted Accounting Principles (GAAP). This enables businesses to develop tailored systems that provide the most useful information for their unique decision-making processes. Additionally, for financial reporting purposes, companies can choose to align their cost accounting processes to include GAAP compliant costing for inventory valuation purposes via Accounting Standards Codification (ASC) 330.

Keep in mind that organizations working with government contracts may need to follow specific Cost Accounting Standards (CAS), which helps ensure consistent and equitable methods of accounting for costs related to government work.

In essence, cost accounting empowers teams to provide management with the most relevant and actionable information for internal decision-making.

How does cost accounting differ from financial accounting?

Just because it has the word ‘accounting’ in the name doesn’t mean cost accounting and traditional accounting are the same.

In fact, they are quite distinct.

Cost Accounting	Traditional Accounting
Focus: Provide detailed internal insights (efficiency, overhead, costs) about specific operations and products.	Focus: Report the overall financial health of a business to external stakeholders and regulatory bodies.
Regulation: Since it’s for internal purposes, it’s flexible to meet certain management needs.	Regulation: Follows strict regulatory standards like GAAP and IFRS.
Point of view: Often looks forward with forecasting and planning.	Point of view: Often looks backward at historical performance.

Both play a different yet complementary role in a business’s financial function.

How (and why) do businesses use cost accounting?

Cost accounting provides businesses with crucial data to make informed decisions that drive growth and profitability. By tracking and analyzing costs, companies gain insights that help them optimize operations and maximize returns.

Here are some key reasons businesses use cost accounting:

Strategic decision-making

Cost accounting data serves as the foundation for strategic business decisions. When companies understand their true costs, they can make informed choices about which products to develop, markets to enter, or operations to expand. This data helps leadership evaluate alternatives based on financial impact rather than gut feelings.

For example, automotive manufacturers use cost accounting to decide whether to produce components in-house or purchase them from suppliers by comparing all associated costs of each option.

Efficiency improvements

By identifying cost drivers and analyzing process expenses, businesses can pinpoint inefficiencies and implement targeted improvements. Cost accounting reveals which activities consume disproportionate resources relative to their value, allowing companies to streamline operations.

Budgeting accuracy

Cost accounting enhances budgeting precision by providing detailed historical cost data and helping forecast future expenses. This granular understanding of costs enables more realistic budget planning and reduces the gap between projected and actual spending.

When businesses understand their cost structures in detail, they can create budgets that accurately reflect operational realities rather than relying on broad assumptions or previous years’ figures.

Profit maximization

Through detailed cost analysis, businesses can identify their most profitable products, services, and customers. This insight allows companies to focus resources on high-margin offerings and optimize their product mix for maximum profitability.

Cost control and reduction

Regular review of cost accounting data reveals areas of overspending or waste. Companies can implement targeted cost control measures based on this information, tracking their effectiveness over time through continued cost monitoring.

Cost accounting helps businesses identify unnecessary expenses, redundant processes, and opportunities for consolidation that might otherwise go unnoticed.

Pricing strategy development

Cost accounting provides the foundation for effective pricing strategies by calculating the true cost of producing goods or delivering services. This data helps to ensure prices cover all costs while maintaining competitive positioning.

When launching new products, companies use cost accounting to determine unit production costs, including materials, labor, overhead, research and development, and marketing expenses. This comprehensive view enables them to set prices that support profitability while remaining competitive in the marketplace.

Cost accounting infrastructure

What do you need to do cost accounting right? The following framework provides the structure needed to capture all expenses associated with producing goods or delivering services.

Materials: Materials tracking involves monitoring the flow of raw materials, components, and supplies throughout the production process. This includes recording purchases, tracking inventory levels, and measuring consumption rates to determine the true cost of materials used in each product or service.
Labor allocation: Labor allocation focuses on assigning employee time and associated costs to specific products, services, or activities. This includes direct labor (employees directly involved in production) and indirect labor (supervisory or support staff). Effective labor allocation requires systems to track hours worked, wage rates, benefits, and other personnel expenses.
Overhead distribution: This involves allocating indirect costs like facility costs (rent, utilities), equipment depreciation, maintenance, and administrative expenses.
Technology integration: Tech automates data collection and analysis. Enterprise resource planning (ERP) systems integrate with production equipment, time-tracking applications, and financial software to create a comprehensive cost management ecosystem.

Building a robust cost accounting infrastructure requires thoughtful integration of these components. When implemented effectively, this framework provides the visibility and insights needed to make data-driven decisions that improve efficiency and profitability across your business.

Cost accounting methods

Cost accounting offers several methodologies that businesses can implement based on their specific needs, industry, and operational structure. Each cost accounting system provides unique insights into costs and helps management make informed decisions.

Some entities may have more labor-intensive production while others are heavy on materials costs; some may have a single production line while others multiple. Choosing the right costing method for your business is important, because it can allow you to identify variances that are most applicable to your production processes while giving you the level of granularity in product costs you want. – Chris Rosales – Senior Manager, Advisory

Standard cost accounting

Standard costing establishes predetermined cost expectations for products or services, then compares these standards against actual costs to identify variances. This method helps businesses spot inefficiencies by analyzing where and why actual costs deviate from expected standards.

For example, a furniture manufacturer might set standard costs for materials, labor, and overhead for each chair produced, then analyze variances to identify production inefficiencies or material waste.

Activity-based costing (ABC)

Activity-based costing allocates overhead costs to specific activities and then assigns those costs to products or services based on their consumption of each activity. This provides a more accurate picture of product costs by recognizing that different products consume resources differently.

ABC is particularly valuable for businesses with diverse product lines where traditional allocation methods might distort the true cost of production for each item.

Lean accounting

Lean accounting aligns with lean manufacturing principles by focusing on value streams rather than departmental or product costs. This method emphasizes eliminating waste, improving flow, and measuring performance in ways that support continuous improvement.

Unlike traditional cost accounting, lean accounting simplifies financial reporting and provides information that’s more relevant to operational decision-making in a lean environment.

Marginal costing

Marginal costing (also called variable costing) separates costs into fixed and variable components, focusing on the change in costs that occurs with each additional unit produced. This approach helps businesses make short-term decisions about pricing, production volumes, and special orders.

By understanding marginal costs, companies can determine contribution margins and break-even points, which are essential for profit planning.

Process costing

Process costing is used in industries where identical units are mass-produced through a series of uniform production steps or processes. This method accumulates and assigns costs to each production process rather than to individual products.

Industries like chemical processing, food production, and oil refining typically use process costing because their products move through consistent, continuous production processes.

Job costing

Job costing tracks costs for specific customer projects or jobs, accumulating direct materials, direct labor, and overhead costs for each distinct job. This method is ideal for businesses that provide unique, customized products or services.

Construction companies, custom furniture makers, and professional service firms often use job costing to help ensure each client project is properly priced and profitable.

Cost accounting metrics and KPIs

Tracking the right metrics is essential for effective cost accounting. These key performance indicators help businesses measure efficiency, profitability, and operational performance.

Cost of goods sold (COGS) represents the direct costs of producing goods sold by a company, including materials and labor. This metric is calculated as: Beginning Inventory + Purchases – Ending Inventory.
Work in progress (WIP) tracks partially completed products still in the production process, representing capital tied up in unfinished goods.
Efficiency ratios like inventory turnover and capacity utilization help identify how effectively a business uses its resources.
Cost variance metrics compare actual costs against budgeted or standard costs, highlighting areas where spending deviates from expectations and identifying opportunities for improvement.

These metrics provide a comprehensive view of cost performance, enabling better decision-making and resource allocation.

You can also use all of these figures to accurately track (and predict) your overall return on investment (ROI).

Pros and cons of cost accounting

Cost accounting offers significant advantages for businesses, but also comes with certain limitations that should be considered before implementation.

Benefits for different business sizes

Cost accounting empowers businesses of all sizes to make data-driven decisions, enhancing profitability through better cost control and more accurate forecasting. The transparency it provides helps management understand exactly where money is being spent.

Small businesses benefit from cost accounting through improved budgeting accuracy and resource allocation, helping them identify inefficiencies early.
For medium-sized companies, cost accounting enables strategic pricing decisions and helps optimize production processes.
Large enterprises gain comprehensive visibility across complex operations, allowing them to identify cost-saving opportunities across departments and product lines.

Potential challenges

Despite its many benefits, cost accounting does come with some potential challenges to consider:

Implementing cost accounting can be resource-intensive, requiring specialized knowledge and potentially new software systems. The initial setup costs and learning curve may be prohibitive for very small businesses.
Cost accounting isn’t GAAP compliant, which means it can’t replace financial accounting for external reporting purposes. This necessitates maintaining two accounting systems simultaneously.
Some cost allocation methods may introduce subjectivity when distributing overhead costs, potentially leading to inaccurate product costing. Additionally, excessive focus on cost reduction might inadvertently lead to quality compromises if not balanced with quality metrics.

While these challenges exist, working with cost accounting professionals can help companies navigate these potential drawbacks and maximize the benefits of cost accounting systems.

Is cost accounting right for you?

Cost accounting provides businesses with the visibility and insights needed to make informed decisions, optimize operations, and maximize profitability.

By implementing the right cost accounting methods for your specific industry and business size, you can gain a competitive advantage through better resource allocation and strategic pricing.

“Whether you’re experiencing issues related to labor, material, overhead, or some other internal decision-making capability, the inability or misunderstanding of where to turn the dial to move in the right direction can be frustrating. Perhaps you aren’t experiencing particular problems and just want an external team to help solve a particular challenge or achieve the costing granularity you desire. By gaining an understanding of a client’s operations, BPM can guide them on where to focus their time to make improvements in their operations. BPM can help identify data gaps that once filled will help achieve desired results. BPM can bring clarity through applying the needed experience to each unique situation.” – Chris Rosales

Ready to improve your cost accounting practices? Start by assessing your current cost tracking systems, identifying your most important cost drivers, and selecting metrics that align with your business goals. Then, enlist the support of a professional cost accounting team to get an approach tailored to your unique needs.

Get in touch with BPM’s outsourced accounting division today.