Cost Accounting vs Financial Accounting – Cost accounting and financial accounting both help management make effective decisions. Though, the nature and scope of both of these accounting are quite contrary.
Cost accounting tells us the expenses of each unit of each product. For example, if a company sells three products – product A, product B, and product C; cost accounting helps us how much material, labor etc. are expended in each unit of product A, product B, and product C.
On the other hand, financial accounting helps us understand how profitable a company is through financial statements. For example, if a company has sold $100,000 worth of products in a year and expended $65,000 for making the sales (cost of goods sold plus other operating expenses), then the profit of the company for the year is $35,000.
This article is structured as follows –
- Cost Accounting vs Financial Accounting [infographics]
- What is Cost Accounting?
- What is Financial Accounting?
- Cost Accounting vs Financial Accounting – Key Differences
- Cost Accounting vs Financial Accounting Head to Head [Comparision Table]
Cost Accounting vs Financial Accounting [Infographics]
The differences between Cost Accounting & Financial Accounting are as follows –
What is Cost Accounting?
To understand cost accounting, first, it’s imperative that we understand the meaning of “cost”.
What is “cost”?
Cost is the amount of expenses incurred to a particular unit. In another way, cost is what amount you give away to get an amount of something.
Direct costs & indirect costs
To understand cost accounting, first, we need to understand two types of costs – direct costs and indirect costs.
Direct costs are those costs which can be directly attributed to transform raw materials into finished products. For example, direct materials and direct labours are direct costs; because they can be directly attributed to the finished products.
On the other hand, indirect costs are those costs which can’t be directly attributed to the finished products. These costs are not attributable because they are used by multiple activities. For example, rent is indirect costs as it can’t be directly attributable to a particular cost object.
Fixed Costs, Variable Costs, & Semi-variable Costs
There are other types of costs that we need to understand before looking at the example. First, we need to understand fixed costs. Fixed costs are costs that don’t change with the increase or decrease in production of units. For example, rent is a fixed cost since the owner of the factory needs to pay the rent irrespective of the production units. In the case of fixed costs, per unit cost differs but total fixed cost always remains same.
Another type of cost is variable cost that change as per the increase or decrease in production of units. For example, the cost of raw material is variable since more units one produces, more would be the cost. In the case of variable cost, per unit cost is always similar, but total variable cost increases or decreases as per the units of productions.
There is another type of cost which consists of both fixed and variable components – we call it semi-variable costs. As an example, if you pay your workers a fixed salary and also a variable portion when they achieve a specific target, it would be a semi-variable wages. Let’s say that you pay $800 per month as fixed salary to all your workers and the workers who produce more than 100 units of toys every month, they get an additional $5 for every additional unit produced. This sort of wages will be called semi-variable wages.
Format & Example of Cost Statement
In this section, we will look at a cost statement so that we can understand how a factory/organization does its cost accounting. Costing is much more than a cost statement, but it will give ideas about computing and ascertaining per unit cost of sales.
Example: ABC Factory has the following information and from the below furnished information, you need to calculate per unit cost of sales.
- Raw Materials – Opening Stock: $40,000; Closing Stock: $30,000.
- Purchases during the period: $125,000.
- Direct labour – $80,000
- Works overheads – $50,000
- Administration overheads – $30,000
- Selling & distribution overheads – $20,000
- Finished units – 100,000.
Find out the cost of sales per unit.
In this example, every input is given. We just need to put the figures in the right place.
Statement of Cost of ABC Factory
|Particulars||Amount (In US $)|
|Raw Materials – Opening Stock||40,000|
|Add: Purchases during the period||125,000|
|Less: Raw Materials – Closing Stock||(30,000)|
|Cost of material consumed||135,000|
|Add: Direct Labour||80,000|
|Add: Works overheads||50,000|
|Add: Administration overheads||30,000|
|Cost of Production||295,000|
|Add: Selling & Distribution overheads||20,000|
|Total Cost of Sales||315,000|
|Finished Units||100,000 units|
|Cost of Sales per unit||$3.15 per unit|
What is Financial Accounting?
Financial accounting helps us understand the financial affairs of the company. Financial accounting is especially helpful to the potential investors who want to invest into the company. That’s why to ensure the interests of the potential investors, companies need to follow certain regulations to disclose their financial information.
Double entry system
The central theme of financial accounting is double entry system.
Double entry system is defined as a system which affects at least two accounts by a particular financial transaction. For example, if a company purchases stocks in cash, this financial transaction will affect two accounts – purchase account and cash account. Purchase account will increase and cash account will decrease.
Double entry system is also responsible for debiting and crediting a particular account.
In the above example, a company purchases $20,000 worth of stocks in cash.
Then, the journal entry would be –
|Purchase A/c ………………….Debit||$20,000||–|
|To Cash A/c…………………………….Credit||–||$20,000|
This journal entry will then be booked in the ledger.
Each of these accounts (in this case “purchase account” and “cash account”) would have separate T-table and we will record the journal entry in the T-tables.
At the end of the period, we will record all the transactions affecting these particular accounts and then if there’s any balance, we will transfer it to the trail balance.
The trial balance looks like following –
Trial Balance as at 31.12.2016
|Particulars||Debit (US $)||Credit (US $)|
Here, we need to make sure that the debit balance and credit balance of trial balance should match.
From journal, ledger, and trial balance we will create four basic statements to analyse the financial affairs of the company –
- Income Statement (This statement helps us understand the “Net Income” or “Profit after Tax” at the end of the period).
- Balance Sheet (This statement helps us see the current state of assets and liabilities of a company during a particular period).
- Shareholders’ equity statement (This statement helps us understand how much equity a company has during a particular period).
- Cash Flow Statement (This statement deals with the cash inflow and cash outflow of a company during a particular period. No non-cash transactions will take place in this statement).
As financial accounting is solely prepared for the right disclosure of financial information of a company, the statements and reports a company produce should be valid and credible. That’s why companies need to follow certain rules as per the Generally Accepted Accounting Principles (GAAP) or accounting standards.
GAAP covers basic principles of accounting that must be followed by companies. These principles include going concern concept, full disclosure concept, matching principle, cost principle and many others to produce the most accurate and reliable reports for the audience of the company.
However, GAAP doesn’t remain same always. GAAP is updated based on the complexities that arise in the world of accounting.
Key differences – Cost Accounting vs Financial Accounting
Let’s look few key differences between cost accounting & financial accounting –
- Cost accounting deals with the internal aspect of business. As a result, cost accounting helps to improve the flaws of a company. Financial accounting on the other hand handles the external aspect of the company. How much profits the company makes, how much cash flow the company brings in, in a given year etc. As a result, the goodwill of a company depends on financial accounting.
- Cost accounting is used basically to reduce cost and to improve the efficiency of business processes. Cost accounting acts as a tool for management. On the other hand, financial accounting doesn’t concern itself about controlling anything; rather its objective is to create a true and fair picture of the financial affairs of the company.
- Cost accounting is a lot about knowing the pixel view of a business. On the contrary, financial accounting shows us the big picture.
- Cost accounting is not mandatory and applicable for all organizations. Only the organizations which are engaged in manufacturing activities are bound to report through cost accounting. On the other hand, financial accounting is mandatory for all organizations.
- Since cost accounting is used to control costs and take prudent management decisions, cost accounting is performed in every short interval. Financial accounting, on the other hand, is bound to report the financial affairs of the company at the end of the year.
- In cost accounting, estimation has a great value in determining and comparing the cost of sales per unit. In financial accounting, every transaction and reporting is based on actual data.
Cost Accounting vs Financial Accounting [Comparision Table]
|Basis for Comparison||Cost Accounting||Financial Accounting|
|1. Definition (Cost Accounting vs Financial Accounting)||Cost accounting is the art and science of applying the costing methods, techniques, and principles to the products, projects, and processes to improve the profitability and to reduce the overall cost of the business.||Financial accounting is the act of classifying, storing, recording, and analysing the financial transactions of the company through financial statements to improve the profitability and to maintain the transparency of the company.|
|2. Objective (Cost Accounting vs Financial Accounting)||The main objective of cost accounting is to find out per unit cost of every product, process, or a project.||The main objective of financial accounting is to reflect the accurate financial picture of an organization to the external stakeholders, toward whom the organization is responsible.|
|3. Scope (Cost Accounting vs Financial Accounting)||The scope of cost accounting revolves around management and its decision making processes. It is more of an internal score than outside reflection.||The scope of financial accounting is more pervasive; because it tries to disclose an accurate financial picture to its stakeholders.|
|4. Estimation (Cost Accounting vs Financial Accounting)||Cost accounting is based on the comparison between the actual transaction and the estimation of cost of the transaction.||In financial accounting, the recording is always done on the actual transactions only. There’s no place for estimation.|
|5. Particular period (Cost Accounting vs Financial Accounting)||Cost accounting isn’t done as per any particular period. Rather it’s calculated as per the requirement of the management decision making process.||Financial accounting is recorded at the end of a particular financial period. Generally, a financial period starts at 1st April of a year and ends at 31st March of the next year.|
|6. Reduction of cost (Cost Accounting vs Financial Accounting)||Cost accounting serves two purposes. Firstly, it ensures that cost of operations (or producing a product) is reduced by setting up an estimated cost for each unit of a product. Secondly, cost accounting reflects the true picture of operations.||Financial accounting on the other hand doesn’t concentrate on cost control; rather its only purpose is to disclose the right information in an accurate way.|
|7. Tools/Statements (Cost Accounting vs Financial Accounting)||There are mainly three things that cost accounting ascertains – the cost of sales of the product, how much margin the organization would add, and the selling price of the product. Of course, cost accounting is much more than that, but these are the essentials of cost accounting.||Financial accounting takes the help of journal, ledger, trail balance, and financial statements such as income statement, balance sheet, shareholders’ equity statement, and cash flow statement.|
|8. Measurement of efficiency (Cost Accounting vs Financial Accounting)||As cost accounting tries to find out the pixel view of operations, it is able to provide a lot of information regarding the loopholes of labours and other inputs and also offers valuable feedback to improve the efficiency of the inputs.||Financial accounting shows the big picture of a company; as a result, financial accounting isn’t able to improve the efficiency of the inputs.|
Conclusion – Cost Accounting vs Financial Accouting
From the above discussion, it’s clear that cost accounting vs financial accounting is quite different.
The organizations that are not performing cost accounting don’t get any benefits of cost accounting since they don’t have data points to look at each unit.
But the manufacturing organizations which are involved in cost accounting and financial accounting, data points of cost accounting help to create financial accounting at the end of the day. And they also get a comprehensive tool to look at their business internally and externally.