Understanding the difference between Cost and Financial Accounting is difficult for new accounting and business students and practitioners. Although the two fields appear similar since both revolves around finance and money matters, the differences lie in the goals, audiences, and techniques used.
Organizations require the accounting discipline because it is the language of accounting and business; it allows analysts and advisors within the organization to consider the recorded and analyzed financial data in business decision-making. However, the discipline of accounting has two branches within it — Cost Accounting and Financial Accounting — that serve the business for different purposes.
What is Financial Accounting?
Financial accounting involves capturing, classifying, and reporting a business’s financial transactions. Financial accounting’s purpose is to communicate to interested stakeholders, including potential investors, shareholders, regulators, and creditors, the organization’s profitability and the financial position for a particular period.
In preparing financial statements, it focuses on:
- Trading and Profit & Loss Account (to ascertain profit or loss).
- Balance Sheet (to indicate the financial position of the firm).
- Cash Flow Statement (to record inflow and outflow of cash).
In general, Financial Accounting responds to the question: “How much profit did the business make and what is its financial condition?”
Example:
Consider a manufacturing firm which wants to determine the total profit it made during the last financial year. It will refer to the Profit & Loss Account and other financial statements prepared under the principles of financial accounting.
What is Cost Accounting?
Cost Accounting, on the contrary, is more of internal accounting. It focuses on identifying, recording, and analyzing all costs associated with the production of a good or provision of a service. Its primary purpose is to assist the management in controlling costs, improving efficiency, and making rational operational decisions.
Cost accounting provides insight for inquiries such as: “How much does it cost to create a single unit?” “Which of the departments or processes is the most cost-effective?”
For instance, a manufacturing company may inquire how much it costs to produce a single chair, for which cost accounting provides data including raw materials, labor, factory overhead, and other costs incurred during the production phase.
Core Purpose and Objective
| Basis of Difference | Financial Accounting | Cost Accounting |
|---|---|---|
| Objective | To determine the overall profit or loss and financial position of the business. | To determine the cost of production, control expenses, and help in decision-making. |
| Primary Users | External parties such as investors, creditors, government authorities. | Internal management for planning and cost control. |
| Time Orientation | Historical — focuses on past financial performance. | Present and future-oriented — used for controlling and planning future operations. |
This table gives a snapshot of how both systems serve different yet complementary purposes within the same organization.
Scope and Coverage
The scope of financial accounting, while broad, standardized, and standardized includes the recording of all financial transactions in accordance with accounting principles such as GAAP or IFRS and the compilation of final accounts.
Evaluating the analytical scope of the different branches of accounting, one may contrast cost accounting and management accounting. In particular, cost accounting concentrates on the study of cost behavior, allocation, and control.
To illustrate, suppose financial accounting contains a portion that states your company has made a production expense of 10,00,000. In that case, cost accounting refines this assessment and states that 6,00,000, 2,50,000, and 1,50,000 were respectively used for materials, labor, and overheads.
Financial accounting will produce summarized information such as the profit, assets, liabilities, and equity.
Cost accounting, on the other hand, will provide specific information such as the cost per product, the cost per process, or the cost per job.
Consider an example of a company that produces two types of products where financial accounting will combine all the costs, but for cost accounting, it will compute the cost of production for Product A and Product B separately to determine which one is more profitable.
Legal Requirements
One of the differences in cost versus financial accounting is the need for it to be done legally. All companies must do financial accounting as it is legally and regulation required.
Except in specific industries where cost audits are mandated, cost accounting remains optional. Its primary function serves internal management. The periodic evaluation of a business’s financial performance determines the necessity of detailed cost records. Cost records, however, are of little value to the organization.
Reporting and Periodicity
At the end of a financial period, financial statements serve specific purposes and are generated in line with periodic assessments. Cost accounting, however, is more frequent, as management is required to have timely relevant information to adjust expenses and implement change. Cost accounting serves this function.
Consider a situation where departmental labor expenses suddenly escalate. Cost accounting reports will identify the cost overrun and empower management to rectify the situation.
Focus and Orientation
Cost accounting revolves around inputs and the cost of specific resources, whereas financial accounting concentrates on the financial performance of the organization and overall business results.
Focus and Orientation
Financial accounting focuses on results, while cost accounting focuses on processes.
| Aspect | Financial Accounting | Cost Accounting |
|---|---|---|
| Focus | Overall financial result | Cost of individual units or processes |
| Orientation | Accuracy and compliance | Efficiency and cost control |
| Decision Support | Helps in external financial decisions | Helps in internal managerial decisions |
Thus, while financial accounting shows the final score, cost accounting tells you how to improve the score.
Users and Their Needs
The information needs of users of financial accounting include:
Profitability for investors.
Solvency for creditors.
Compliance for state authorities.
However, the primary focus of cost accounting is:
Managers who design and oversee the control of production costs.
Department heads who audit the efficacy of the units.
Internal staff who are responsible for day-to-day operational decisions.
Both systems are, by nature, different, yet they are two sides of the same coin, with one facilitating external reporting and the other bolstering internal management.
Control and Decision-Making
Cost accounting reflects management performance and shows how, and in which areas, costs can be contained. For example, cost accounting can show where a process is wasting costly inputs and where inefficiencies lie.
In contrast, financial accounting provides the summary results, and it does not focus on the cause of the results.
Practical Case:
Consider, for example, a furniture company that identifies a 15% decline in profit in the company’s financial accounts. The management, in reviewing the cost records, indicates that the increased cost was driven by wood price and labor overtime, which then inform corrective actions, such as improving scheduling of workers or relocating wood suppliers.
This example illustrates how both accounting systems can be integrated for enhanced decision-making.
Format and Flexibility
Financial accounting must be practiced according to a set legal framework and standardized documents. All businesses must issue statements in a fixed format to follow for easy comparisons and audits.
Cost accounting is more adaptable, however. Every business is free to formulate their cost accounting system according to the organization’s offerings and their specific production processes and management needs. This is the reason two firms within the same market can adopt disparate cost accounting methods.
Also Check: Understanding Financial Statements: Final Accounts, Cash Flow vs Fund Flow, and Real Case Studies
Quantitative and Qualitative Aspects
Financial accounting captures transactions in monetary terms only and ignores all qualitative factors. Out of the many, some factors not included in the records are employee morale, production efficiency, and machine downtime.
Cost accounting, on the contrary, often captures qualitative factors in addition to the quantitative ones. It records in and analyzes outputs, machine hours, labor, and efficiency and wastage metrics to identify performance improvement opportunities.
Summary: Key Differences Between Cost and Financial Accounting
| Basis | Financial Accounting | Cost Accounting |
|---|---|---|
| Nature | Deals with recording and reporting of financial data. | Deals with cost computation, analysis, and control. |
| Type of Data | Historical and overall. | Analytical and specific. |
| Legal Requirement | Mandatory for all companies. | Optional (except where cost audit is required). |
| Time Period | Usually yearly. | Usually monthly or as required. |
| Users | External parties. | Internal management. |
| Flexibility | Rigid and standardized. | Flexible and adaptable. |
| Output | Financial Statements. | Cost Reports and Statements. |
Interrelationship Between Cost and Financial Accounting
Despite the aforementioned disparities, it is critical to highlight the interdependence of the two systems. Cost accounting does not work in isolation since financial accounting provides total expenses and other basic information. Cost accounting also seeks to adjust the financial figures that are reported.
Most businesses today employ integrated accounting systems, where both cost and financial information are maintained in a unified set of books. This approach is designed to eliminate duplication and promote seamless coordination.
Conclusion
To conclude, cost accounting and financial accounting serve different purposes, but are equally necessary components of the bookkeeping system of a business.
To outside stakeholders, financial accounting shows the business’s financial position truly and fairly.
To management, cost accounting helps manage eficciency, control expenses, and make operational decisions.
For students pursuing their degrees in the BBA or any branch of the commerce stream, learning this distinction is not merely an issue of passing exams, but rather a matter of developing a managerial disposition. The ability to read financial accounts and analyze cost accounts is the springboard for making informed and optimal business decisions.
FAQs: Difference Between Cost and Financial Accounting
What is the difference between cost accounting and financial accounting?
The difference is that financial accounting is concerned with documenting the overall financial performance for outside parties, whereas cost accounting is concerned with evaluating the costs of production for management purposes.
Why is cost accounting not a legal requirement?
This is due to the fact that it is intended for internal purposes. It aids management in decision making, but it is not necessary for statutory reporting.
Can a firm utilize both cost and financial accounting simultaneously?
Yes, several firms utilize integrated accounting systems in which financial and cost data are recorded concurrently to mitigate redundancy.
Which accounting is more useful for management decisions?
Cost accounting is more useful for daily management decisions as it aids in detailed analysis regarding the control of costs and operational efficiency.
Is financial accounting historical or future-oriented?
Primarily historical. Financial accounting involves documenting and reporting activities that the business has previously undertaken.
👨💼 Author: BBAProject Editorial Team
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