Cost Accounting is an 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.
It is a forward looking approach which is related to the recording, analyzing and classifying of expenditure with the objective of ascertaining the total and per unit cost of product or service.
ACCORDING TO ICMA (Institute of Cost and Management Accountants)
“Cost accounting is the process of accounting for cost from the point at which expenditure is incurred or committed to the establishment of its ultimate relationship with cost centers and cost units. In its widest usage, it embraces the preparation of statistical data, the application of cost control methods and ascertainment of the profitability of activities carried out or planned.”
ACCORDING TO RN CARTER
“It is a system of recording in accounts the materials used and labor employed in the manufacture of certain commodity or on a particular job.”
ACCORDING TO GORDON SHILLINGLAW
“Cost Accounting is defined as the body of concepts, methods and procedures used to measure, analyze or estimate the costs, profitability and performance of individual products, departments and other segments of a company’s operations, for either internal or external use or both and to report on these questions to the interested parties.”
ACCORDING TO THE HORTON AND MASON
“Cost Accounting is a method of recording accurately the facts of manufacture or other undertakings in such a way that necessary information thereon maybe available in the form required at the earliest possible moment.”
Thus costs accounting refers to that branch of accounting that:
- Deals with Costing i.e. the techniques and process of ascertaining costs.
- Helps in Analyzing and classification of costs on varied basis.
- Is internal accounting to the organizations.
- Assists the management in controlling the costs.
NEED FOR COST ACCOUNTING
Cost accounting is the branch of the accounting. As accounting is associated with recording only day-to-day transactions, it fails to report any data regarding the cost incurred in producing any unit of commodity. Thus, to provide the detailed view of the cost incurring in various activities, processes, or jobs; cost accounting has been emerged. The need for emergence of cost accounting can be explained with the help of the following points:
LACK OF PROVISION FOR MATERIAL CONTROL
The traditional accounting provides the amount of opening stock and closing stock of materials and the cost of the materials consumed by preparing manufacturing and trading account. But it fails to provide the information about
- How much units are issued to various departments?
- What is the value of raw materials used in the production process?
- How much cost has incurred in each process individually?
All these questions can be answered by preparing the cost accounting records.
NO DETAILED INFORMATION ABOUT LABOR COST
Labor is an integral part of the business. The success of the business depends highly upon the efficiency and inefficiency of the labor. Financial accounting records the total amount of wages or salaries provided to the labor and nothing more than that in the accounting records. It fails to provide the following information:
- How many workers are employed in the organization?
- How many workers are efficient or inefficient?
- How many workers are employed on various jobs, processes etc.?
- What are the varied rates of wages and salaries paid to various categories of labor?
- What is the number of working hours of the labor?
All this detailed can be getting from the cost accounting. This has led to the emergence of cost accounting.
IRRELEVANCE OF CLASSIFICATION OF ACCOUNTS IN GENERAL MANNER
The financial accounting classifies the accounts into three parts on traditional basis: Real accounts, personal accounts and nominal accounts. And on modern basis, the accounts are classified into five categories such as asset account, capital account, liability account, expense account and income account.
This classification is of no use in determining the cost unit-wise, job-wise, process-wise, batch-wise. Thus the need for cost accounting emerges.
IMPROPER CLASSIFICATION OF COSTS
There is no proper classification of costs in the traditional accounting. There was no record of direct cost, indirect cost or overheads, material cost, labor cost etc. the information regarding these costs can be made available to the management by preparing the cost accounts. This makes the task of cost control easier. Thus, it was necessary to emerge cost accounting as separate branch.
CANNOT ASCERTAIN TRUE COST OF PRODUCTION
The true cost of production can be ascertained by taking into consideration the cost of raw materials consumed, cost of labor, cost of normal or abnormal loss, cost of various operations, and cost of each process. However, the financial accounting records cost of materials consumed which does not provide the clear view of the each element of cost. This can only be ascertained by following the cost accounting.
LACK OF SYSTEM OF STANDARDS
To accomplish a goal, the standards should be set in advance. In accounting, the standards are set regarding the overall performance of the business concern. No target is set regarding
- How many units are to be produced?
- What will be estimated hours of working?
- The standard cost involved in each task?
Only the cost accounting facilitates the setting of targets for such issues and analyzing the deviations and then taking steps to correct them.
NO RECORDS FOR WASTAGES
Cost accounting is needed to take into account the records regarding the wastage of materials, man-hours, and machine-hours taking place during the course of production. These wastages are not recorded and communicated by preparing the financial accounts like trading account, profit and loss account and balance sheet.
LACK OF ASSISTANCE IN COST CONTROL
Financial accounting has no system of cost control. It records the expenses when they have already been incurred. So it was just a post-mortem analysis of the records. There is no system to fix the responsibility for not achieving the set standards. So cost accounting is needed to provide a framework for cost control. This is facilitated by the cost accounting through the use of its tools and techniques of marginal costing, break-even analysis, standard costing and variance analysis and budgetary control etc.
NO ASSISTANCE IN DECISION MAKING OR PLANNING
Financial accounting system does not provide any information or guidance to take the decisions regarding the following issues:
- Evaluation of profitability of alternative methods of production.
- Open or shut down decisions.
- Continue or discontinue any product line or product category.
- Manufacture or buy decision.
- Determination of break-even point and margin of safety etc.
This can be made possible only with the help of cost accounting.
ADVANTAGES OF COST ACCOUNTING
Cost Accounting system renders invaluable services to the manufacturers, management, employees, investors, consumers and government. The various advantages of cost accounting are as follows:
ASCERTAINMENT OF COST
The sphere of cost accounting comprises cost ascertainment firstly. Cost ascertainment means determining the cost incurred in producing any product. The cost ascertainment includes:
- Collection of expenses
- Analysis of expenses
- Measurement of production
The cost may be ascertained by following ways:
Activity Based Costing in which each activity is taken as fundamental cost object.
Unit costing which is adopted to ascertain the total cost and also per unit cost by making a detailed analysis of different elements of cost.
Job Costing method as per which costs is ascertained for the particular job or work.
Batch Costing which is used when products are produced in batches and cost is ascertained for each batch separately.
Contract Costing is a method of cost ascertainment of a particular contract which is non-recurring in nature. The person executing the contract is known as ‘contractor’ and the person with whom the contract is executed is known as the ‘Contractee’.
Process Costing is a method employed to ascertain the cost of production in industries where a product passes through different processes or stages.
Operation Costing represents the costing in which each cost of each operation involved in an activity is ascertained separately.
Composite Costing is applied to ascertain the cost of complex products manufactured by the manufacturing concerns where no single method of ascertaining cost can be applied.
Departmental Costing is adopted where the factory is divided into several departments and it is desired to ascertain the cost of each department than the whole concern collectively.
DISCLOSURE OF PROFITABLE AND UNPROFITABLE ACTIVITIES
The accounting records prepared on the basis of cost accountancy discloses the cost incurred of each job, process or operation. It provides the data to make a decision regarding the profitable and unprofitable activities of the concern. This information provides a base to make a decision regarding which activity is to be contracted or eliminated and which activity is to be expanded.
HELPS IN FIXATION OF SELLING PRICE
Cost accounting provides all the details regarding the actual cost incurred in the production of the commodity. It provides the businessman with the sound basis for fixing the selling price of the commodity. This protects the businessman from taking the wrong decision of charging fewer prices and incurring losses.
CALCULATION OF TENDER OR QUOTATION PRICE
Tenders or quotations are made to provide the rate which will be charged to supply the manufactured goods in future times. The cost data provides a useful base to set the tender price. If the tenders are based on the actual cost data, they are bound to be competitive and sure to be accepted by the prospective customer.
DISCLOSES THE COMPONENTS OF COSTS
To manufacture a product, the cost is incurred on material, labor and overheads. Cost accounting records
- Wage rate payable to efficient or inefficient employees
- Material ordering costs
- Material carrying costs
- Overtime cost, etc
All this minute information assist the manufacturer to ascertain the importance of each element of cost and determining where there is greater scope for the economy.
The accounting records of cost of one year can be compared with the records of another year. The cost accounting system provides the reliable information to compare the costs of different periods, for different volumes of output, in different departments or processes and in different establishments.
HELPS IN COST CONTROL
Cost control is the guidance and regulation of the costs by the administration and management authorities. It guides the organization to achieve the target of the undertaking for a given period. Cost control involves the following steps:
- Setting up the targets for expenses and production performance
- Measurement of the actual performance
- Comparison of the actual performance with the standard performance
- Finding out deviations, if any
- Taking corrective actions to remove all the deviations.
Cost control is done by following the various techniques:
Marginal Costing: It is a technique of cost accounting which pays attention to the behavior of costs with changes in the volume of the output.
Budgetary Control: It involves the establishment of budgets relating to the responsibilities of the executives to the requirements of the policy and the continuous comparison of the actual with the budgeted results, either to secure by individual action of that policy or to provide a basis for its revision.
Standard Costing: Standard costing discloses the cost of deviations from standards and classifies these as to their causes, so that management is immediately informed of the sphere of operations in which remedial action is necessary.
Variance Analysis: Variance analysis is a process of analyzing variances by sub-dividing the total variance in such a way that the management can assign the responsibility for off production performance. The main cost variances are: direct material variance, direct labor cost variance and overhead variance.
HELPFUL IN PLANNING AND DECISION MAKING
The various cost records maintained under the cost accounting system provide valuable information for the purpose of future planning and for decision making. The costing records assist the management in making the following decisions:
- Manufacture or buy decision.
- Selection of the profitable product mix
- Operate or shut down decisions
- Selection of profitable method of production
- Fixation of the selling price.
CHECK ON THE ACCURACY OF FINANCIAL ACCOUNTS
Cost Accounting system provides an independent and most reliable check on the accuracy of financial accounts by means of reconciliation of profits as shown by cost accounts and financial accounts.
LIMITATIONS OF COST ACCOUNTING
If the cost accounting system is not used with proper care and caution, then it proves to be unnecessary. So, some objections are raised against the use of the cost accounting which is as follows:
NOT AN EXACT SCIENCE
Cost accounting is not an exact science. Although it has its own body of knowledge, principles, tools and techniques, yet it is not as rigid as other sciences like physics, chemistry, biology etc. The cost accounting has emerged due to the limitations of financial accounting. The principles and theories developed in the light of convention and basic principles are not static but changing with the passage of time. This makes the cost accounting an inexact science.
NO UNIFORM PROCEDURES AND METHODS
There are numerous tools and techniques of the cost accounting. Various organizations employ various techniques and the results are different. This proves to a serious limitation of cost accounting as this makes the results incomparable.
There are large number of conventions and flexible factors such as
- Classification of cost into its elements.
- Issue materials on average or standard price.
- Apportionment of overheads expenses.
- Arbitrary allocation of joint costs.
- Division of overhead into fixed and variable costs.
- Division of cost into normal and abnormal cost.
- Division of costs into controllable and uncontrollable costs.
- Adoption of marginal or standard costs.
All this make the calculation of actual cost very difficult. It proves as the serious limitation of cost accounting.
The maintenance of cost accounting records is optional. There is no legal obligation to prepare the cost accounts. At the same time, for the preparation of cost accounting records, the cost and work accountants are required which proves to a costly affair for the business. So, the cost accounting system can be adopted or installed in large business organizations only.
LACK OF DOUBLE ENTRY SYSTEM
Under cost accounting, a double entry system is not completely followed. So it is not possible to check the arithmetical accuracy of the transactions and locate the errors.
NOT AN INDEPENDENT BRANCH
Cost accounting is not an independent branch. It depends largely upon the financial accounting for all the information and data. Also it takes the help of management accounting tools and techniques to provide the useful information to serve the interests of the management. This makes the cost accounting dependent which proves as its limitation.
DOES NOT DEPICT THE FINANCIAL POSITION OF CONCERN
Cost accounting is associated with cost ascertainment, cost recording and cost control. It provides no information regarding the liquidity, solvency and profitability position of the concern. This makes it an incomplete accounting.
What is cost accounting? Why is it necessary? (Note: Write the need of cost accounting in necessity.)
Explain the objectives (need) and advantages of cost accounting?