Cost Accounting - an overview

Cost accounting is the art or process of recording, analyzing and classifying of expenditure for the purpose of product costing or service costing, ascertainment of profitability, operational planning and cost control.

Cost accounting is a forward looking approach which is related to the recording, analyzing and classifying of expenditure with the object of ascertaining the total and per unit cost of a product or service.

Cost accounting is an internal aspect of the organization which measures the operational efficiency of an enterprise and assists the management to maintain costs at the lowest point consistent with the efficient operating conditions.

Standard costing, budgetary control and marginal costing are some of the dynamic techniques of cost accounting.

Management Accounting

Management Accounting is the presentation of accounting information in such a way as to assist management in the creation of policy and the day to day operation of an undertaking.

It relates to the use of financial and cost data for the purpose of evaluating the performance of the business.

Need for Cost Accounting or Limitations of Financial Accounting

Financial accounting, which is historical in nature, is mainly concerned with the recording of day to day business transactions. It is simply a post mortem of the past events. Financial accounting suffers from the following limitations.

A) No provision for material control: Financial accounts do not contain detailed particulars of materials consumed in a manufacturing concern.

The financial accounts record the value of opening and closing stocks and the cost of raw materials purchased, they are silent as to quantity of the various items of raw material issued to different departments or jobs and the price at which they have been issued.

Therefore, the cost of raw material consumed for the manufacture of a particular unit of output cannot be ascertained from financial accounts

B) Non-availability of detailed particulars about labour cost: Financial accounts contain the record of the total wages paid to the workers during a specified period but they are silent as to number of workers employed, number of workers engaged on different jobs or in different departments, number of hours worked by each worker , rate of wages, total wages paid job wise, product wise or department wise.

No distinction is made between the wages of efficient and inefficient workers. As such it becomes difficult to ascertain as to whether the increase in the wage rates of workers or increase in the number of workers has led to a corresponding increase in the quantity of output or not.

` C) Classification of Accounts in a

general manner: Under financial accounting system, accounts to be prepared are classified into personal, real and nominal accounts. Such a classification of accounts does not help in ascertaining the cost of production – product wise, job wise, department wise, work order wise etc.

D) No classification of costs into direct and indirect items: In financial accounts prepared under the financial accounting system, costs are not classified as to direct and indirect items and are not assigned or allocated to each product at each stage of production or to each department or process.

E) Ascertainment of true cost of production not possible.

F) No record for wastages. G) No provision for a system of

standards.

H) No assistance in fixation of selling price and calculation of tender price: Financial accounting system fails to supply data regarding the true or exact cost of production on account of which the manufacturer finds himself unable to fix a competitive selling price for his products.

Many a time, a manufacturer or a contractor has to submit quotations or tender to a prospective customer for the supply of a large quantity of a product at some further date or for the execution of a contract. The quotation price or the tender price should be competitive. A competitive quotation price or tender price can be determined with reference to the past cost data and changes anticipated over the previous cost levels. Financial accounting system does not supply data relating to true cost of production.

i) No assistance in cost control: In financial accounts costs and expenses are recorded only after these have been actually incurred or spent.

Financial accounts do not have any technique to check the reasonableness of any cost or expenditure.

F.A do not help in fixing the responsibility on any individual for any wastage or excessive cost

J) Financial accounts deal only with the over all profitability of the business concern: Financial accounts of a business concern are so designed as to disclose the overall profit or loss of the business concern for a specified period.

Financial accounts do not deal with the product wise, job wise, process wise, department wise profitability of the business.

Hence, the unprofitable activities of the business are not disclosed and the necessary steps cannot be taken to make them profitable or to discontinue them

K) No provision for comparison of costs: Financial Accounts do not provide data for the comparison of the costing results of a particular period with that of other periods of operation of the same business concern or with that of other concerns in the same line of industry.

L) No assistance in Planning and Decision-making: The management may require information for the following purposes. Determination of sales required to

earn desired profits. Manufacture or buy decision Determination of Break even point,

Margin of safety Operate or shut down decision Ascertainment of the effect of changes

in selling price on profits.

Definition of Cost Accountancy According to Harold J Wheldon “Costing

is the classifying, recording, and appropriate allocation of expenditure for the determination of the cost of products or services; and for the presentation of suitably arranged data for purposes of control and guidance of the management. It includes the ascertainment of the cost of every order, job, contract, process, service or unit as may be appropriate. It deals with the cost of production, selling, distribution.”

8 features of Cost Accountancy

1) It is a special branch of accountancy dealing with the ascertainment of cost of products and services.

2) Cost accountancy is both a science and an art.

3) It follows the same double entry system.

4) It involves classification, analysis, recording and ascertainment of costs.

5) It determines the total and per unit cost of products and services.

6) It provides data for fixing the selling price of products and services and for determining the quotation price or tender price.

7) It provides data to the management for exercising effective control over costs.

8) Helpful in forward planning and decision making process.

Scope of Cost Accountancy 1) Costing: It refers to the

techniques and processes of ascertaining costs. It involves classification, analysis and appropriate allocation of expenditure incurred in respect of a product or service.

Thus costing consists of the principles, rules and methods which are used for determining the costs of products or services.

2) Cost Accounting: Cost accounting is the science which records and determines scientifically the accurate cost of manufacture or service per unit. It controls and guides the persons involved in the organization of production.

Thus, cost accounting is the formal mechanism by which cost data are provided for ascertaining and controlling the costs of products or services

3) Cost Control: Cost control is the guidance and regulation, by executive action, of the costs of operating an undertaking.

Cost control involves the setting up of targets for expenses and production performance, measurement of actuals, comparison of actuals with targets to ascertain variances, analysis of variances and taking corrective action to eliminate variances.

4) Budgetary control: It is a system whereby the budgets are used as a means of planning and controlling costs.

Budgetary control involves the establishment of budgets for each section of the organization, measurement of the actual performances and their comparison with budgeted performance to determine the deviations, the ascertainment of reasons for such deviations and taking suitable action to remedy the defects.

5) Cost Audit: It is the verification of the correctness of cost accounts and a check on the adherence to the cost accounting plan.

The purpose of the cost audit is to ensure that the figures as shown by cost accounts are correct and that cost accounts, cost centres and cost units have been properly charged

Objectives of Cost Accounting The primary objective of cost accounting

is to find out the cost of unit production of a commodity or service.

According to J.R. Batliboi “ The main objective of cost accounts, irrespective of the branch of industry to which they are applied should always be to express faithfully and accurately the true costs”.

1) To study, analyze and classify the cost of production.

2) To ascertain the total and per unit cost of the commodity produced, work performed and service rendered.

3) To ascertain the profitability of different products, jobs or work orders.

4) To provide means to measure the efficiency of labour.

5) To exercise effective control over wastage and loss of materials during production.

6) To exercise effective control on the idle time of workers and machines.

7) To provide statistical data for the purpose of submitting quotations and tenders

8) To provide for cost control through budgetary control and standard costing system.

Methods of Costing. Different methods of costing are

applied for ascertaining unit cost in different industries based on the nature of operation and unit of finished product involved.

All these methods have the same general principles but they differ in the methods used in collecting and presenting cost data are concerned.

Basically there are two methods of costing ie Job Costing and Process Costing.

Job costing is applied to special order type of industry which is devoted to the execution of specific orders such as printing press, ship building, road construction etc.

The main objective of job costing is to ascertain the cost and profit or loss in respect of each job, contract or project undertaken.

Process costing is applied to mass production type of industry engaged in the continuous production of uniform standard products such as chemicals, oil, cement, cloth, yarn, mining etc,

The main objective of process costing is to ascertain the cost of process or operation involved in converting raw materials in to finished products.

The different methods of costing, which represent finer divisions of these two basic methods are

1) Single costing or Unit costing: