Difference Between Cost Accounting and Financial Accounting

Difference Between Cost Accounting and Financial Accounting

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Jaya
Jaya Sharma
Assistant Manager - Content
Updated on Mar 6, 2024 18:39 IST

Cost accounting and financial accounting are two of the main accounting methods that are widely used by accountants the world. While cost accounting calculates the total cost, financial accounting involves analysis of business transactions.

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While we need to learn the difference between cost accounting and financial accounting, we must also know about the two accounting systems in detail. Let us get started. 

Table of Contents

Difference Between Cost Accounting and Financial Accounting

Following are the difference between cost accounting and financial accounting:

Parameter Cost Accounting  Financial Accounting
Types of Cost Recorded Historical and pre-determined costs Historical costs
Information Production related information Financial information
Purpose Controlling and reducing the cost Maintaining accounting records related to financial transactions
Confidentiality Private Public 
Stock value Estimated at cost Estimated at cost/ Net Realizable Valuable
Forecast possibility Possible through budgeting Not Possible
Profit Measurement Cost accounting focuses on the profitability of a product or service. It focuses on the overall profitability of the firm. 
Benefits Identifying areas with extra expenditure and losses For comparing business outcomes, financial evidence

Now, let us learn about these two methods separately in detail.

About Cost Accounting

Cost accounting is a branch of accounting that calculates the total cost of production. This is done by assessing all input costs such as fixed and variable costs at each step in the production process. Here, it measures the costs individually and records them. 

After that, it compares input costs with the output. This helps in measuring financial performance and accordingly making business-related decisions. There are the following five types of costs:

  1. Direct cost: This is a cost related to the production. Suppose, the product is dyed fabric, ten the direct costs of the end product will include the hours of the labourer dying the fabric and the cost of fabric and dye. 
  2. Indirect cost: This is not directly related to the product. Instead, it will calculate the cost involved in certain processes and therefore, they can be inaccurate and difficult to calculate. For instance, here, indirect costs will include energy used by the dying machine. 
  3. Fixed cost: This is the cost of an investment that is depreciated at a fixed monthly rate. Fixed costs are the expenses that the company must pay regardless of the business operations. The cost of product level does not have any impact on fixed costs. 
  4. Variable cost: These costs vary with the production level. As production increases, variable costs also increase. For example, a popular mobile phone’s inventory will incur higher charges with its increasing sales. Variable costs involve expenses related to the business operation based on the output and sales.
  5. Operating cost: This refers to costs related to day-to-day business operations. These can be either fixed or variable.

Explore free cost accounting courses

Types of Cost Accounting Methods

Following are the four different cost accounting methods:

1. Activity-Based Costing (ABC)

This identifies overhead costs from every department and assigns them to the specific cost objects (goods and services). It is an activity-based accounting system such as tasks associated with a goal such as setting up machinery for production, distribution of finished goods, etc. These activities are used as the basis for overhead cost allocation. It is a much more accurate system for reviewing the cost and profitability of a company’s products and services. 

2. Lean Accounting

It helps in improving financial management practices within the organization. It uses the principles of lean manufacturing and production. According to this philosophy, minimum waste optimizes productivity. Lean accounting replaces the traditional costing methods with value-based pricing and lean-focused performance measurements. 

3. Marginal Costing

Marginal costing identifies the impact of varying levels of costs and volume on the operating profit. Also known as cost-volume-profit analysis, it determines breakeven points for different sales volumes and the cost structure. This is useful for businesses in making short-term economic decisions. 

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4. Standard Costing

Instead of actual costs, this type of costing assigns standard costs to its inventory and Cost of Goods Sold (COGS). Standard costing is based on the efficient use of materials and labour to produce goods and services under standard operating conditions. The company must pay both actual and standard costs.  

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About Financial Accounting

Financial accounting is a branch of accounting. It involves the processes of recording, summarising, and reporting financial transactions over a time period. These business-related transactions are summarised in different financial statements. Financial accounting uses globally accepted accounting principles including International Financial Reporting Standards and Generally Accepted Accounting Principles. The financial statements represent the five classifications of data: equity, revenue, expenses, assets, and liabilities. Asset, liability, and equity are reported into the balance sheet that uses financial data for economic benefits in the future. Revenue and expenses are reported in the income statement.

Read more on IFRS vs. GAAP

Types of Financial Accounting Methods

Accrual and cash methods are the two methods used for performing financial accounting These two methods can sometimes be used in combination for financial accounting. 

1. Accrual Method

In the accrual method, revenue is recorded before receiving product payment. Revenue is recorded in the company’s accounting books before the actual cash transaction occurs. It is based on the matching principle that expenses and revenues must be recognized during the same period. 

Accrual allows the combination of current cash inflows and outflows with expected inflows and outflows in the future. It represents the current financial position of the company. However, it is a complex method, thus making it expensive to implement. 

Most large and medium-scale businesses use the accrual method as the standard accounting method. They can correlate expenses and sales during the same accounting period. Through this method, businesses can identify their profitability. 

2. Cash Method

It is a method where payment receipts and expenses are recorded only when they actually occur. This means payment receipts are recorded when actually received and expenses are recorded when actually paid. 

The cash method of accounting is used by small-scale businesses as it is simple and straightforward. It is less accurate in nature since they affect the company books with delay when the transaction actually occurs.

However, any organization following GAAP will have to use the accrual accounting method. 

Check out accounting interview questions

Both accounting methods are important and have their own significance. Together provide users with comprehensive records of the financial situation of an organization. If you want to learn accounting, then you must learn about all three methods in detail. 

FAQs

Is cost accounting better than financial accounting?

Yes, cost accounting is better than financial accounting. Cost accounting can reduce cost and improve cost efficiency without any negative impact on the production level.

What are the functions of cost accounting?

Cost accounting, cost control and cost ascertainment are the three main functions of cost accounting.

What is the importance of cost accounting?

Cost accounting helps management with the detailed information on costing. Through this information, management can effectively maintain control over inventory, improve efficiency and prevent wastage.

About the Author
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Jaya Sharma
Assistant Manager - Content

Jaya is a writer with an experience of over 5 years in content creation and marketing. Her writing style is versatile since she likes to write as per the requirement of the domain. She has worked on Technology, Fina... Read Full Bio