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How Cost Accounting Works: A Complete Guide

Lauren DeBisschop
Apr 11, 2023

Cost accounting is a process that businesses of all sizes use to gather, analyze, and report on data related to producing and selling goods or services. This information plays an essential role in various financial management processes, helping businesses stay informed about their financial status. By tracking costs associated with every stage of production or service delivery, cost accounting provides valuable insights into how much it costs to make a product or deliver a service and how much profit is generated from each sale. In the following sections, we'll take a closer look at how cost accounting works and why it's beneficial for businesses to implement effective cost accounting practices.

Using Cost Accounting to Operate More Efficiently

Cost accounting is an effective accounting method that businesses can use to improve their efficiency and lower costs. While standard accounting methods may be sufficient for some businesses, cost accounting provides valuable insights that can help prevent businesses from exceeding their budgets and increase their overall efficiency.

One critical data point that cost accounting provides is labor costs. By tracking labor costs associated with every stage of production or service delivery, cost accounting can provide businesses with a deeper understanding of how much it costs to make a product or deliver a service. This information can be used to optimize staffing levels, improve scheduling and productivity, and reduce overall labor costs.

Moreover, cost accounting can help businesses monitor their financial performance and measure the return on investment (ROI) of various projects and initiatives. By understanding the costs associated with each project or initiative, businesses can make informed decisions that can improve their bottom line and overall financial health. This information can help businesses adjust pricing models, product mixes, and more, which can have a direct impact on their operations and profitability.

Cost Accounting Types and Methods

There are numerous types of costs associated with a business’s operations as well as multiple methods of cost accounting. Your business structure and production will determine which method will work best for your team.  

Types of Costs

  • Direct costs: Expenses that are directly attributable to the production of a specific good or service. These costs can be traced to a particular product or service and are necessary for its production. By understanding and tracking direct costs, businesses can make more informed decisions about pricing, production levels, and other aspects of their operations.
  • Indirect costs: Expenses that cannot be easily and directly traced to a specific product or service, such as rent, utilities, salaries of support staff, and other administrative expenses. Indirect costs are typically allocated to different products or services based on a predetermined cost allocation method, such as allocating based on the proportion of direct costs or using an activity-based costing system. Identifying and tracking indirect costs is important for businesses to accurately calculate the true cost of their products or services and make informed decisions about pricing and profitability.
  • Variable costs: Expenses that change in direct proportion to changes in production or sales volume. These costs are directly tied to the production or delivery of a specific product or service, and can include things like raw materials, packaging, and direct labor costs. As production or sales volume increases, so do variable costs, and as production or sales volume decreases, variable costs also decrease. By identifying and tracking variable costs, businesses can better understand the relationship between their costs and their production or sales volume and make more informed decisions about pricing and profitability.
  • Fixed costs: Expenses that do not change with changes in production or sales volume. These costs are typically associated with overhead expenses, such as rent, insurance, salaries of management, and other administrative expenses. Fixed costs are essential for the operation of a business and must be paid regardless of whether any products or services are produced or sold. By identifying and tracking fixed costs, businesses can gain a better understanding of their overall cost structure, and make more informed decisions about pricing, budgeting, and profitability.
  • Product costs: This refers to the total cost of producing a specific product or delivering a specific service. Product cost includes all direct costs (such as materials, labor, and overhead) as well as any indirect costs (such as rent, utilities, and administrative expenses) that are directly tied to the production or delivery of the product or service. By calculating the product cost, businesses can gain a better understanding of the true cost of their products or services, and make more informed decisions about pricing, profitability, and resource allocation.
  • Period costs: Expenses that are not directly tied to the production or delivery of a specific product or service. Instead, these costs are associated with a specific time period, such as a month or a year, and are typically considered to be overhead expenses. Examples of period costs include salaries of administrative staff, rent, utilities, and advertising expenses. By identifying and tracking period costs, businesses can gain a better understanding of their overall cost structure and profitability over time.

Methods of Cost Accounting

There are many different methods, but three of the main ones include:

  • Job order costing: The data collected in this method determines the cost of producing a specific job or product. This version is best used when products are produced on a job-by-job (or client-by-client) basis.  
  • Process costing: This method involves tracking costs at each stage of the process, making it ideal for companies that produce a good or service in a continuous manner. Then, the total is divided by the number of items produced during that timeframe, providing a cost per unit.  
  • Activity-based costing: This method is a comprehensive analysis of all costs associated with producing a product or service. It accounts for direct and indirect expenses, including the cost of materials and administrative overhead.

Applications of Cost Accounting

From manufacturing to healthcare, cost accounting plays a pivotal role in informing decision-making across industries. It is an essential tool for any business looking to remain competitive in today's economy.


Manufacturing companies can make informed decisions about their processes by determining the cost of production, including the expenses associated with raw materials, labor, and overhead. The data can help determine the most cost-effective methods of production, the profitability of certain goods, and appropriate pricing models. With the insights provided by cost accounting, manufacturers can ensure that their operations are efficient, sustainable, and profitable over the long term.


For healthcare organizations, cost accounting is used to determine the cost of providing medical services to patients. The data is used to identify areas where they can reduce expenses, optimize systems, and allocate resources effectively. Operational efficiency is improved with insights into areas of waste as well. By utilizing cost accounting, healthcare organizations can provide high-quality care to their patients while also managing costs effectively, which is critical for the long-term sustainability of the healthcare industry.


The cost of a construction project is constantly in flux. It is crucial for proper project and resource management for construction companies to accurately account for their materials, labor, and overhead expenses. Cost accounting data can help these companies optimize their inventory and reduce waste, as well as reduce labor costs where necessary. In addition, construction companies can ensure they are pricing their projects appropriately and are providing a fair market price to their customers.


Cost accounting provides a framework for analyzing and managing the costs associated with staffing agency operations, including marketing, recruiting, hiring, and more. This data is key in calculating the cost per hire and the cost of sales. By tracking these metrics, staffing agencies can identify areas where they may be overspending or where they could be more efficient in their processes. With cost data, agencies can accurately forecast and plan for the future.

Cost Accounting with Greenshades

Labor costs are a critical point of data for project and cost accounting. Manually calculating the hours an employee has spent on each job or working for a client is time-consuming and increases the risk of miscalculating expenses.  

Greenshades Payroll supports project accounting with custom fields. This method gives Greenshades Payroll clients the ability to break-out labor expenses into more granular details for accounting needs. During the payroll process, easily tie earnings to a location, project, client, and more to help you accurately track the true cost of the labor associated with a specific project.

Enjoy peace of mind with a simple workflow to review every detail of your pay run. Greenshades achieves accuracy with its payroll wizard - and it doesn't stop there. Get a demo today to see how you can expand your capabilities beyond payroll with the Greenshades Payroll, HR, and Tax solution.

Download More Information about Greenshades Custom Fields for Cost and Project Accounting

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