What is Cost accounting ?
What is Cost accounting?Importance and advantages Cost accounting and financial accounting
Introduction
Cost ascertainment, cost analysis and cost control are the
Meaning of cost accounting
Cost accounting is a branch of accounting that has evolved to overcome the limitation of financing accounting. It is the process of accounting for cost, which is concerned with the ascertainment, allocation, distribution and accounting aspect of cost. It is that branch of accounting, which deals with the classification, recording, allocation, stigmatization and reporting of current and perspectives costs. Actually, it is the formal mechanism by means of which costs of products and services are ascertained and controlled.
It is an interest reporting system that aims to assist the management for planning and decision making. It primarily emphasizes on cost and deals with collection, analysis, interpretation and presentation for managerial decision making on various business problems.
Cost accounting is more concerned with short-term planning and its reporting period is much lesser than financing accounting. It deals with historic data but it is also futuristic in approach. Cost accounting system cannot be installed without proper financial accounting system. Each organization can develop a costing system best system to its individual needs. In financial accounting the major emphasis is in cost classification based on type of transaction e.g. salaries, repairs, insurance, stores etc. but in cost accounting, the emphasis is laid on functions, activities, products and on internal planning and control and information needs of the organization.
"Cost accounting is a systematic set of procedures for recording and reporting measurements of the cost of manufacturing goods and performing services in the aggregate and in details."
- National association of accountants- USA
From the above definitions, it can be concluded that cost accounting is account ting for costs aimed at providing cost data, statements and reported for the purpose to assist the management in planning, decision making and controlling.Objectives and functions of cost accounting
The main objectives of cost accounting are mentioned below:
1. To ascertain cost: the main objective of cost accounting is to ascertain the cost of goods and services. The expenses that are incurred while producing goods or rendering services are called costs. Some examples of cost are material, labor and other direct and indirect expenses. Under cost accounting, cost are collected, classified and analyzed with the aim of finding out the total as well as per unit cost of goods, services, process, contract etc.
2. To analyses cost and loss: another objective of cost accounting is to analyze the cost of each activity. The analysis of cost is necessary to classify the cost into controllable or uncontrollable, relevant, profitable or unprofitable etc. similarly, under cost accounting, the effects of miscues of material, idle time breakdown or damage of machine on the cost is also analyzed.
3. to control cost: cost control is a technique that is used to minimize the cost of product and services without comparimision on the quality. Cost accounting aims at controlling the cost by using various techniques, such as standard costing and budgetary control.
4. To help in fixation of selling prices: another important objective of cost accounting is to help in fixation of selling price. The costs are accumulated, classified and analyzed to ascertain cost per unit. The selling price per unit is calculated by adding a certain profit on costing, output costing, service costing etc are used for determine the selling price.
5. To aid the management: cost accounting aims at assisting the management in planning and its implementation by providing necessary costing information that also enable the evaluation of the past activities as well as future planning.
Importance and advantages of cost accounting
The importance and advantages of cost accounting presented below:
1. Disclosed the operating of individual activity: cost accounting provides the costing information in term of product, department, process etc. in other words, it provides the costing information of each activities which helps to separate the profitable and non-profitable activities.
2. Helps in controlling cost: cost accounting helps in controlling cost by Appling some techniques such as standard costing and budgetary control this is done by comparing the actual cost with the standard or budgeted cost. The corrective actions are taken in any deviation exits.
3. Provides necessary cost information: it provides necessary cost information to the management for importations and controlling. Similarly it provides necessary costing information to the outsides such as government, tax authority, supplier, investors etc.
4. Guides in fixing selling price. It ascertains the total and per unit cost of production of goods and services that helps to fix the selling price as well. The selling price is fixed by adding profit with the total cost. It is very critical function since the height selling price may lead the low demand of the product, similarly the low selling price may result the loss.
5. Helps in increasing profit: it disclosed the profitable and non profitable activities that enable management to decide to eliminate or control unprofitable activities and expand or develop the profitable activities. This leads to the increase of profit. Similarly, it helps to introduce and implement different cost programs to increase profit.
6. Advantages to government: cost accounting is advantageous to the customers as well. The customers get the qualification good and services at reasonable price. This is due to the rational use of technology, material, labor and cost control and reduction programs.
7. Advantages to government: cost accounting helps to the government in many ways like. Determination of tax, formulation of policies regarding foreign trade, fixation of and control of price, settling minimum wages and labor disputes etc.
8. Provides reliable data for the comparison of cost: it provides reliable data and information which enable the comparison of cost between period, volume of output, departments and processes. Cost accounting provides standards which enable the comparison with actual for taking corrective actions.
9. Helps investors and financial institutions: it is also advantageous to investors and financial institutions since it discloses the profitable and financial position of the concern in which they intend to invest.
10. Beneficial to workers: it is beneficial to workers as well since it emphasizes the efficient utilization of labor and scientific system of wages payment.
Limitation of cost accounting
Besides a number of advantages, cost accounting suffers from some limitations. Some of than are mentioned below.
1. Lack of uniformity: cost accounting lacks a uniform procedure. It is possible that two equally competent cost accountants may arrive at different result from the same information. Keeping this limitation in view, all cost accounting result can be taken as mere estimates.
2. Conceptual diversity: there are a large number of conventions, estimations and flexible factors such as classification of cost into its elements, issue materials non average or standard price, apportionment of overhead expenses, arbitrary allocation of joint costs, division of overhead into fixed and variable costs, division of cost into normal and abnormal and controllable and non-controllable and adoption of marginal and standard costs due to which it becomes difficult to have exact costs. In such a context, the reliability of cost accounting might be low.
3. Costly: there are many formalities which are to be observed by a small and medium size concern due to which the establishment and running cost are so much that it becomes difficult for these concern to afford its cost. Thus it can be used only by big concern.
4. Ignorance of futuristic situation: the contribution of cost accounting for handling futuristic situation has not been must. For example, it has not evolved so for tool for handing inflationary situation.
5. Lack of double entry system: under cost accounting, double entry system is not adopted so, cost accounting does not help to check the arithmetical accuracy of the transaction and locate the errors.
6. Developing stage: cost accounting is in developing stage since its principles, concepts and conventions are not fully developed.
Limitations of financial accounting
Financial accounting suffers from a number of deficiencies which are as follows:
1. Disclose the overall result only: financial accounting disclose the overall result of a business. It fails to reveal the result of each department, process, products, jobs etc.
2. Based on historical information: financial account ting records the past transaction and prepares financial stalemates accordingly. So it is based on historical information. It is also called postmortem which does not have much importance.
3. Not helpful in price fixation: financial accounting does not provide proper systems of controlling various elements of cost like materials, labor and other expenses. Cost control procedure can be adopted by setting standards, but it lack in financial accounting.
4. Not control on cost: financial accounting does not provide proper system of controlling various elements of cost like materials, labor and other expenses. Cost control procedures can able to prepare tender or quotations.
5. No classification of cost: financial accounting does not classify into cost i.e. direct and indirect, fixed and variable, controllable, normal and abnormal etc. it only divides expenditures into two categories as capital and revenue.
6. Fails to offer a system of standards: financial accounting fails to measure the efficiency of material, labor and other resources as it does not offer any system of standard.
7. Fails to offer cost information: financial accounting does not provides cost information to the management to make plants and decisions as well as controlling the operations.
8. Fails to ascertain cost of products about losses: financial accounting fails to ascertain cost of products and services due to lack of cost information.
9. Fails to provide information about losses: financial accounting fails to provide information caused due to idle time, idle plant, defective metafiles etc.
10. No assistance in planning and decision-making: financial accounting system does not provide any guidance and assistance to the management in taking various decisions relating to the operations of an undertaking. It does not provide the required data and assistance for the purpose of making divisions on the above mentioned matters.
Cost accounting and financial accounting – a comparison
Different between cost accounting and financial accounting can be understood with the help of the following illustration:
Financial accounting records show an overall profitability of 20% on sales while cost accounting records show a profit of 39.4% AND 41.18% ON Products X and Z respectively while there is a loss of RS. 14000 (35%) on product Y. the cost records make it clear that a big part of the profit is being eaten away by product Y. if complete details are knows to the management, it may take necessary steps to make the product Y a profitable one. If it is not possible, the production of product Y may be stopped.
Methods of costing
Overall many years, various cost accounting method have evolved to record to record the manufacturing costs to suit particular industries, and it is the need for the organization to establish a suitable cost accounting system for their business to facilitate the recording and collection of costs, allocation, apportionment and absorption into products and services, analysis and control of costs etc. but whatever the costing method in used, the basic costing principles relating to collection, analysis, allocation, apportionment and absorption is used. The costing methods are broadly categorized into two:
• Specific order costing
• Continuous operation costing
Specific order costing
Specific order costing methods are used by business organization, which involved in make/assemble/ construct jobs or products to individual customer's specific orders. This is the category of basic costing methods application where the work consists of separate jobs. Batches of contracts each of which is authorized by a specific order. The specific order costing is further classified into (a) job costing (b) contract costing, and (c) batch costing.
Job costing
Job costing is the method of costing, which is applied to ascertain the cost of specific jobs o work-orders which are treated as contracts of small size. These jobs are generally not in similar nature and non-repetitive nature and may not be comparable with each other.
This method has the following main features:
i. Under this method, production is carried on by a manufacture against customer's order and not for own stock.
ii. Each job or work-orders is of a separate nature.
iii. The jobs or work-order are generally executed in factories, workshops and repair shop.
iv. Under this method, job or specific work-order is the units of costing.
v. In this method, the production and its requirement are determined first and then the expenses are ascertained in related to it.
This method is most suitable to such activities where work is done according to the customer's specifications. Examples are engineering works, plumbering works, printing press, automobile works, repair shops, electrical fittings, and decorating works etc.
Contract costing
Contract costing does not in principle differ from job costing. A contract is a big job while a job is a small contract. The term is usually applied where large-scale contracts are carried out. A contact is a job of large size, which may extend even beyond one accounting period. The person executing the contract is known as "contractor" and the person for whom it is executed is known as "contractee".
This method has the following main features:
i. Contacts are jobs of large sized and may continue over more than one accounting year.
ii. Contracts are executed as per the specification given by the contractee.
iii. Contracts are executed at contract site away from contractor's premises.
iv. Each contract is treated as a separate unit of cost for the purpose of cost ascertainment.
v. The contract is executed by the contractor for some agreed amount of consideration known as 'contract price'.
The presentation of costing information relating to contracts is made in the form of a separate contract account opened for each contract undertaken by the contractor. This method of costing is most suitable to building construction, civil engineering works, road and bridge construction etc.
Batch costing
It is a part of job costing and is applied to ascertain the cost of production in industries where production is carried on in batches. A batch may be defined as a group of specified number of similar products. Under this method, a batch is treated as one job and the cost of this complete batch is ascertained. Thus, in this method, the cost of a group of products is ascertained. The unit of cost is a batch of group of identical products, instead of a single job order or contact. This method of costing is mostly suitable to readymade garments, spare parts manufacture for motor cars, scooter, radios, watches etc., biscuit manufactures, toys making, canned products etc.
Continuous operation costing
Where organizations, which involve in mass production of products, through continues operations, which will then be sold from stock and will not be product to the specific requirements of the customers. The important feature of continuous operating costing is that, the process involves in production of identical units of output and total costs are divided by number of units produced to give the average cost per unit. He continuous operation scouting is classified as: (1) process costing (2) operation costing (3) unit or output costing, (4) service or operating costing and (5) multiple or composite costing.
Process costing
This method of costing is employed to ascertain the cost of production in industries where a product is passes through different processes or stages, each distinct and well-defined, before its completion. Under process costing, there is a finished product at each stage or process (which becomes the raw material of the next process until it reaches the final stage of competition) and this renders it necessary to know the cost of production at each stage.
This method has the following main features;
i. The production is continue and is carried on for own stock.
ii. The units manufactured and uniform and standardized.
iii. The finished product, before completion, has to pass through various process or stages, each being separate and well defined.
iv. The order of the sequence of process is specific and pre-determined.
v. The finished product of each process becomes the raw material of the next process except that of the last process which is transferred to the finished stock account.
In this method, a separate account is opened for each process and costing information presented in the form of process account which is debited with the cost incurred thereon. This method is generally employed in industries like food products, pants making soap making, oil refineries, distilleries, and chemical works etc.
Operation costing
Operating costing is a further refinement of process costing. The system is employed in industries where mass or repetitive production is carried out or where articles or components have to be stocked in semi-finished stage, to facilitate the execution of special order, or for convenience of issue or later operations. The procedure of costing is broadly the same as for convenience of issue or later operations. The process costing except that cost unit is an operation instead of a process. For example, the manufacturing of handles for bicycles involves a number of operations such as those of cutting steel sheets into proper strips, molding, machining and finally polishing. The cost of each one of these operation may be found out separately.
Units, output or single costing
Where the products can be expressed in identical quantities units and where manufacture is continues, this type of costing is applied. Cost statements or cost sheets are prepared under which the various items of expenses are classified and the total expenditure is divided by total quantity produced in order to arrive at per unit cost of production.
This method of costing is generally applied to industries where the following features are present:
i. The units of output are identical.
ii. The output or production is continuous.
iii. The units of output are natural.
iv. It is desirable to ascertain the cost per unit of output e.g., per ton, per unit, per kilogram, per meter etc.
The above-mentioned features are present in industries like collieries, brick works, flour mills, cement mills, paper mills, iron and steel mills, sugar mills etc. which are engaged in producing only one types of product or a few grades of the same product.
Service or operating costing
This method of costing applied to ascertain the cost of providing or operating a service. This method of costing is employed in those undertakings that are engaged in operating or providing services rather than in manufacturing tangible products.
These undertakings, adopting service or operating costing, generally have the following features:
i. These undertakings are engaged in rendering services of unique nature to their customers.
ii. These undertaking are required to invest a large proportion of their total capital in fixed assets e.g. buses, trucks.
iii. Motor Lorries, aircrafts, railway, etc.
The amount of working capital required to meet out the day-to-day expenses, is comparatively less. This method is applicable to road transport undertaking, airways, shipping companies' electricity companies, hospitals, cinemas, hotels, canteens, and water works etc. the presentation of costing information is made in the form of a statement knows as "operating cost sheet".
Multiple or composite costing
Multiple or composite costing is applied to ascertain the cost of complex products manufactured by a manufacturing concern where no single method of costing is applicable under this method, the total cost is ascertained by aggregating components cost, which are collected by both job costing and process costing.
Multiple costing is applied to industries in the production of bi-cycles, motor cycles, scooter, motorcars, radios, television, typewriter, accounting machines, engines and other complex products.
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