Cost accounting is the branch concerned with measuring, accumulating and analysing the cost of products, services and activities, in order to value inventory, determine profitability, support decisions and control costs.
1 Where it sits between the two branches
Cost accounting
Measures, accumulates and analyses cost
→ to financial
Inventory valuation and cost of sales in the statements
→ to managerial
Pricing, decisions, budgeting and control
One source of data feeding two destinations that differ in purpose and form
| Branch | Its core question | Bound by standards? |
|---|---|---|
| Financial accounting | What is the result for the period and the position of the business? | Yes |
| Cost accounting | What does the product, service or activity cost? | Partly — in what concerns inventory valuation |
| Managerial accounting | What do we decide on that basis? | No |
2 The objectives of cost accounting
- Valuing inventory and determining cost of goods sold in the financial statements.
- Determining the profitability of each product, service, customer or sales channel separately.
- Supporting pricing by revealing the minimum acceptable price and the real profit margin.
- Controlling costs by comparing what was spent with the standard and analysing the differences.
- Planning resources and building budgets on genuine cost data.
3 The cost unit and the cost centre
| Concept | Definition | Examples |
|---|---|---|
| Cost unit | The unit to which cost is attributed | A tonne of steel · a consulting hour · a square metre · a student in a class |
| Cost centre | A location or department where costs are accumulated before being charged on | A production line · a warehouse · a maintenance department |
| Cost object | Anything whose cost we want to know | A product · a project · a customer · a branch |
Choosing the cost unit
It must be measurable and meaningful for the activity. A cement plant measures in tonnes, a hospital by case or bed-day, a transport company by kilometre or by trip. Choosing a unit that does not express the activity makes every number after it worthless.
4 Cost accounting in services
Many people think it is only for factories. In reality service businesses need it more, because most of their costs are indirect and there is no tangible product to measure.
A consulting firm has 5 consultants at an annual cost of SAR 1,500,000, with indirect expenses of SAR 600,000. Expected billable hours are 6,000 per year.
| Total costs | 2,100,000 |
| Billable hours | 6,000 |
| Cost per hour | SAR 350 |
The benefit: any quote below SAR 350 an hour means a loss — unless there is a clear strategic reason. Many firms price by instinct and then wonder why they are not profitable despite being busy.
Mind the non-billable hours
If you divide by total working hours instead of billable hours, you end up with an hourly cost far below the truth — one of the best-known mistakes in pricing services.
Lesson summary
- Cost accounting measures, accumulates and analyses the cost of products, services and activities.
- It feeds financial accounting with inventory valuation, and managerial accounting with decision information.
- Its objectives: inventory valuation, profitability, pricing, control and planning.
- The cost unit must be measurable and expressive of the activity.
- Service businesses need it as much as factories, or more.
5 Test yourself
Three quick questions
Choose the answer you think is correct — the result appears immediately.
1. What is the most suitable cost unit for a road transport company?
The cost unit expresses the output of the activity itself, and transport is measured by distance, load or trip.
2. Which output of cost accounting goes straight into the financial statements?
Inventory valuation and cost of sales are line items in the statements; the rest are internal management reports.
3. A firm computed its hourly cost over total working hours instead of billable hours. The result:
Dividing the cost over more hours lowers the apparent hourly cost, so work gets priced below what it costs.