What is Cost Accounting?

Cost accounting vs financial accounting
The building blocks

Cost accounting works out what it costs you to make a product, finish a job or serve a client, so you can set prices, control spending and see which work makes money. It traces direct costs, such as materials and the labor on a job, and assigns a share of overhead, such as rent and software. Unlike the financial statements you file or show a lender, it's for your own decisions.

Billed publishes this page. The definitions below come from the open textbook Principles of Accounting, Volume 2: Managerial Accounting (OpenStax): sections 1.2, 2.2, 4.1, 4.2 and 6.1, all opened on October 29, 2026. This is general information, not accounting or tax advice; ask your accountant where judgment is needed.

Cost accounting vs financial accounting

OpenStax treats cost accounting as another name for managerial accounting: "Also known as management accounting or cost accounting, managerial accounting provides information to managers and other users within the company in order to make more informed decisions."

The difference from financial accounting is who the information is for and which rules apply:

Financial accounting reports to people outside the business. OpenStax says it "is governed by rules set out by the Financial Accounting Standards Board (FASB)", and that its reports are used "primarily by external users, including the creditors, tax authorities and regulators, investors, customers, competitors, and others outside the company".
Cost (managerial) accounting is "gathered and reported for a more specific purpose for internal users", such as owners and managers. You choose the detail and the format.

The building blocks

Three kinds of product cost. OpenStax: "The three general categories of costs included in manufacturing processes are direct materials, direct labor, and overhead." It notes that "some service industries do not have direct material costs", so a service business may have only direct labor and overhead.

Direct materials: materials that go into a specific job or product, such as lumber for a build.
Direct labor: the hours worked on that job, at the cost of the person doing them.
Overhead: costs that support the work but aren't traced to one job, such as rent, insurance, equipment and admin. See overhead cost.

How costs behave. OpenStax defines the two main patterns:

"A fixed cost is an unavoidable operating expense that does not change in total over the short term, even if a business experiences variation in its level of activity."
"A variable cost is one that varies in direct proportion to the level of activity within the business."

Knowing which costs are fixed and which vary with the work feeds into contribution margin and break-even thinking.

Job costing vs process costing

OpenStax describes the two main systems:

Job order costing "is an accounting system that traces the individual costs directly to a final job or service, instead of to the production department. It is used when goods are made to order or when individual costs are easy to trace to individual jobs".
Process costing "is used when the manufacturing process is continuous", and "costs are accounted for by the production process or production department instead of by the product or by the job."

A contractor, a designer or a consultant who quotes each job fits job costing. A business making large runs of identical items fits process costing. A third method, activity-based costing, assigns overhead by the activities that cause it.

Assigning overhead with one rate

Job costing needs a way to add overhead to each job before the year's actual overhead is known. OpenStax: "A predetermined overhead rate is calculated at the start of the accounting period by dividing the estimated manufacturing overhead by the estimated activity base." It names direct labor hours, direct labor costs and machine hours as examples of an activity base.

Worked example: costing one job

The business and figures here are a sample, invented for this example.

A small joinery workshop expects $48,000 of overhead for the year (rent, insurance, tools, admin) and 2,400 hours of direct labor.

Overhead rate: $48,000 ÷ 2,400 hours = $20 per direct labor hour.
Job 117, a built-in bookcase:
- direct materials: $1,800;
- direct labor: 40 hours × $35 an hour = $1,400;
- overhead applied: 40 hours × $20 = $800.
Total job cost: $1,800 + $1,400 + $800 = $4,000.
Price and profit: the workshop quoted $5,500, so the job's profit is $5,500 − $4,000 = $1,500, a margin of $1,500 ÷ $5,500 = 27.3% (rounded).
What the overhead line shows: costing only materials and labor ($3,200) would have made the job look $800 more profitable than it was. Priced at $3,500 on that basis, the job would have lost $500 once its $800 share of overhead is counted ($3,500 − $4,000 = −$500).

At year end, compare the overhead you applied to jobs with the overhead you actually spent, and adjust next year's rate. Ask your accountant how any difference is treated in your books.

Using the results

Pricing: quote from full job cost, including overhead, not from materials and labor alone.
Estimates vs actuals: after each job, compare the hours and materials you estimated with what was used, and update your rates.
Which work pays: total profit by job type or client over a quarter to see where margin comes from.
Cost control: watch the costs that vary with the work separately from fixed costs, since they respond to different decisions.

Where Billed fits

Billed publishes this page. Its time tracking page says you can "Log time for each task as you work, and see how much time goes into each project", which gives you the direct labor hours for a job. Its expense tracking page says an expense in Billed records "who you paid, when, how much and which category it belongs to, with the receipt attached to the same entry", which gives you the materials and other direct costs. The job-cost calculation itself, as in the example above, is something you do from those records, yourself or with your accountant.

When this guide isn't for you

This page covers cost accounting for small businesses that price by job or product. If you manufacture in volume, carry significant inventory, or need inventory costs for financial statements or tax returns, work with an accountant on the costing method and its tax treatment.

Frequently Asked Questions

What is the difference between cost accounting and financial accounting?

Financial accounting reports to people outside the business, such as lenders, investors and tax authorities, and follows set standards. Cost accounting, which OpenStax treats as managerial accounting, produces information for owners and managers, in whatever detail helps them price and control costs.

What are the three main types of product cost?

Direct materials, direct labor and overhead. OpenStax notes that some service businesses have no direct material costs, so their job costs are direct labor plus a share of overhead.

What is the difference between job costing and process costing?

Job costing traces costs to each individual job or order, which suits work made to order. Process costing accounts for costs by production process or department, which suits continuous production of identical items.

How do I add overhead to a job?

Use a predetermined overhead rate: divide your estimated overhead for the period by an estimated activity base, such as direct labor hours, and apply that rate to the hours each job uses. At period end, compare applied and actual overhead and adjust the rate.

Does a small service business need cost accounting?

It helps if you quote by job or project. Knowing each job's direct labor and its share of overhead shows whether your prices cover your costs, even if you keep the calculation in a spreadsheet.

Was this article helpful?

What Is Cost Accounting? A Simple Guide for Small Business