Difference Between Cost Accounting and Financial Accounting

Cost accounting and financial accounting are two of the main accounting methods that are widely used by accountants the world. Cost accounting calculates the total cost, financial accounting involves analysis of business transactions. 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
• About Cost Accounting
• Cost Accounting Methods
  • Activity-Based Costing
  • Lean Accounting
  • Marginal Costing
  • Standard Costing
• Scope of Cost Accounting
• About Financial Accounting
• Financial Accounting Methods
  • Accrual Method
  • Cash Method
• Scope of Financial Accounting

Difference Between Cost Accounting and Financial Accounting

Cost accounting is the branch of accounting that deals with the identification, allocation, and analysis of costs associated with goods or services production. Financial accounting is the branch of accounting through which accountants prepare financial statements, report the financial performance and position of an organization. Let us now look at further difference between Financial Accounting and Cost Accounting in tabular form:

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 costs 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, then 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.

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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. 

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.  

Scope of Cost Accounting

The following points come under the scope of cost accounting:

• Accountants can find out how much money it takes to make a product or provide a service. You need to add up all costs like raw materials, worker time, and other expenses. This helps businesses know how much each item costs to make, which helps them set prices and know their profits.
• Cost accounting is a branch that aims to teach keeping track of all money spent. For materials, you watch what you buy, how you store it, and how you use it. For workers, you track their pay and how long they work. Other costs include things like rent, electricity, and repairs that you can't link directly to making products.
• This means watching how costs go up or down when you make more or less products. Some costs stay the same (like rent) no matter how much you make. Other costs change (like materials) - the more you make, the more you spend. Understanding this helps make better business plans.
• Cost accountants also make decisions on how much to charge for products. You need to make sure the price covers all your costs and gives you some profit. This helps you set different prices for different customers and stay competitive with other businesses.
• The scope of cost accounting extends to keeping the right amount of products and materials in storage. You need to track what you have, how much it costs to store, when to order more, and make sure you do not run out or have too much. Good stock management saves money and keeps customers happy.
• This means making plans for how much each department can spend and checking if they follow these plans. You compare what was actually spent with what was planned, find out why they're different, and fix any problems. This helps in keeping the expenditure under control.
• Cost accountants also determine whether you are spending too much money and if you are trying to save money. You check how things are done, suggest better ways to work, and compare different money-saving ideas. The goal is to spend less while still making good products.

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 it affects the company books with delay when the transaction actually occurs. However, any organization following GAAP will have to use the accrual accounting method. 

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Scope of Financial Accounting

The scope of financial accounting extends to the following:

• It is important to record daily transactions including every money-related activity that happens in a business each day. This includes writing down all sales made to customers and recording all purchases from suppliers. The process also covers tracking money received from customers and noting money paid to suppliers and workers. Additionally, it includes recording bank deposits and withdrawals, along with keeping track of regular business expenses like rent and utility bills.
• Preparing financial statements is important for showing how the business is performing financially. The process includes creating a Balance Sheet that shows what the business owns and owes, a Profit & Loss Statement that details how much money was made and spent, and a Cash Flow Statement that tracks how money moved in and out of the business. These comprehensive reports help owners and stakeholders understand the overall financial health of the business.
• Account management includes organizing and tracking all money owed to and by the business. This includes monitoring customer accounts for money owed to the business and supplier accounts for money the business owes to others. It also involves tracking employee accounts for salaries and wages, managing business bank accounts and transactions, and monitoring credit card accounts for spending and payments.
• Bank reconciliation involves a thorough checking of business records against bank statements. The process includes matching company records with bank statements and finding and fixing any differences that arise. It also involves tracking checks that haven't been cashed, recording bank fees and interest charges, and ensuring all account balances are correct and accurate.
• It is important to follow all tax rules and maintaining proper records for tax purposes. This includes recording sales tax collected from customers and calculating income tax for the business. The process also covers keeping all necessary receipts and documents for tax purposes, filing tax returns on time, and tracking all tax payments and refunds.
• Shareholder reporting focuses on keeping business owners informed about company performance. This involves creating regular reports about business performance and calculating profits available for distribution. It also includes tracking ownership shares and changes, preparing dividend payments, and showing how shareholders' investments are performing over time.
• Legal compliance means following all required accounting rules and laws. This involves using standard accounting methods and keeping records for legally required time periods. It also includes following any industry-specific rules, maintaining proper documentation for all transactions, and being prepared for potential audits.
• Asset management involves tracking everything the business owns. This includes recording the purchase of equipment and property, tracking asset values over time, and managing depreciation calculations. It also covers monitoring asset maintenance and repairs, and recording when assets are sold or disposed of.
• Liability management focuses on tracking everything the business owes. This includes recording liabilities such as loans and their payments, tracking regular bill payments, and managing credit terms with suppliers. It also involves recording lease obligations and monitoring overall debt levels of the business.
• Capital management involves tracking all aspects of business ownership and investment. This includes recording owner investments and tracking owner withdrawals from the business. It also covers managing share capital, recording retained profits, and tracking any changes in business ownership structure.

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.