Introduction

CHAPTER 10

Cost Accou.nting

Cost Accounting is one of the important disciplines of accountancy to give proper information required to the management for effectively discharging its functions such as planning, organizing, controlling, directing, co-ordinating and decision making. In this regard Financial Accounting is concerned with record keeping directed towards the preparation of Profit and Loss Account and Balance Sheet. It provides information about the enterprise in a general way. Accordingly Financial Accounts are prepared as per the requirement of the Companies Act and Income Tax Act. The main purpose of financial accounting is to ascertain profit or loss of a concern as a whole for a particular period. Thus, financial accounting does not serve as the needs of management for effective control, determination of prices, making effective plan for future operations and formulating various policy decisions.

To overcome the limitations of the financial accounting, the cost accounting is a recent development born in response to the needs of management for detailed information about cost of a product or a unit of services. Every business firm is expected to make profit in the long run and, keep costs within control. Recently the Companies Act has made obligatory the keeping of cost records in some manufacturing companies. In essence, therefore Cost Accounting is now widely used by large manufacturing and non­manufacturing operations.

Definitions of Important Concepts

The definitions of the following important concepts of Cost Accountancy are given below :

(a) Cost (b) Costing (c) Cost Accounting (d) Cost Accountancy (e) Cost Control (0 Cost Reduction (g) Cost Allocation (h) Cost Absorption (i) Cost Audit G) Cost Unit (k) Cost Centre

(a) Cost: The word 'Cost' is used in a variety of ways. Cost may be defined as a total of all expenses incurred in a given thing. A I CPA defines cost as "the amount measured in money or cash expended or other property transferred, capital stock issued, services performed or a liability incurred in considerations of goods or services received or to be received."

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'Cost' is defined by W.M. Harper in the following words "Cost is the value of economic resources used as a result of producing or doing the thing cost."

(b) Costing: I C M A London has defined costing as "the technique and process of ascertaining costs." As a technique, it refers to costing as the body of principles and rules concerned with appropriate allocation of expenditure for the determination of cost of products and services.

(c) Cost Accounting: Cost accounting is the method of accounting for cost. The I C W A defines Cost Accounting as the technique and process of ascertainment of costs. Cost accounting begins with the recording of all income and expenditure, and ends with the presentation of statistical data.

(d) Cost Accountancy: According to the Chartered Institute of Management Accountants London, cost accountancy means "the application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and the ascertainment of profitability. It includes the presentation of information derived therefore for the purpose of managerial decision making. Thus, cost accountancy is the science, art and practice of a cost accountant."

(e) Cost Control: Cost control is the guidance and regulation by executive action of cost of operating an undertaking. It involves pre-determination of targeted costs, measuring the actual costs, investigating into the causes of variations and instituting the corrective action.

(1) Cost Reduction: The term 'cost reduction' refers to the achievement of real and permanent reduction in the unit of cost of goods manufactured or services rendered without impairing their suitability or diminution in the quality of product. Cost reduction involves saving in unit cost ; such saving is of permanent nature and the utility and quality of the goods and service:01'emain unaffected.

(g) Cost Allocation: Cost allocation is the allotment of whole item of cost to cost centres. The technique of charging the entire overhead expenses to a cost centre is known as Cost Allocation.

(h) Cost Absorption: The term 'Cost Absorption' refers to the process of absorption of all overhead costs allocated to or apportioned over particular cost centre or production department by the units produced.

(i) Cost Ascertainment: The term 'Cost Ascertainment' means to ascertain the cost of each product, process or operation and ensure that all the expenses have been absorbed in the cost of products. Cost Ascertainment is one of the important objectives of Cost Accounting.

(j) Cost Audit: I C M A defines 'Cost Audit' as a detailed examination or verification of cost accounts and check on the adherence to the cost accounting plan. The purpose of cost audit is to examine whether the methods laid down for ascertaining costs and other decisions are being properly implemented and whether the cost accounting plan is being adhered to or not. The purpose can be (i) Protective and (ii) Constructive. Protective purpose aims to examine that there is no undue wastage or losses and that the cost accounting system reflects the correct and realistic cost of production. Constructive purpose aims at providing the management with information useful in regulating production, choosing economic methods of operations, reducing the operational costs, etc. based on the findings during the course of cost audit.

(k) Cost Unit: The term 'Cost Unit' refers to a unit of product, service or time in relation to which costs may be ascertained. It is a unit of quantity in terms of which costs can be measured. Cost Unit may be selected on the basis of (a) Single and (b) Composite (or) Commonly used.

The following are some examples of Cost Units used in different industries:

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Name of Industry

Paper Steel Sugar Cement Textile (cloth) Transport Electricity Bricks

A Textbook of Financial Cost and Management Accounting

Cost Units used

Per Tonne (or) Per Kg Per Tonne Per Quintal Per Tonne Per Metre Passenger Kilometre Per Kilo Watt-hour Per 1000 bricks

Cost Centre

According to the Chartered Institute of Management Accountants, London, Cost Centre is defined as a location, person or items of equipment (or group of these) for which costs may be ascertained and used for purposes of cost control. In other words, cost centre is a part of an organization which includes location, processes, equipment, (or) machine centres, various departments, persons etc. in relation to which costs can be charged or ascertained.

Cost Centres can be classified into the following types :

(1) Personal Cost Centre: It consists of a person or group of persons, e.g., salesmen, Marketing Manager, etc.

(2) Impersonal Cost Centre: It is a Cost Centre which consists of a location or items of equipment.

(3) Operation Cost Centre: It consists of machines and/or persons carrying out similar operations.

(4) Process Cost Centre: It is a Cost Centre which consists of a specific process or a continuous sequence of operations.

Objectives of Cost Accounting

The following are the important objectives of Cost Accounting:

(1) Ascertainment of cost.

(2) Determination of selling price.

(3) Cost control and cost reduction.

(4) Ascertainment of profit of each activity.

(5) Assisting Management in decision making.

(6) Formulating business policy.

(7) Matching costs with revenue.

Distinction between Financial Accounting and Cost Accounting

The following are the differences between Financial Accounting and Cost Accounting:

(1) Purpose

Financial Accounting

It is prepared for providing information about the final results of the business activities as a whole for a particular period to its proprietors, outsiders etc.

Cost Accounting

The main purpose of Cost Accounting is to provide information to the management for the proper planning, control and decision making.

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Financial Accounting Cost Accounting

(2) Need Financial Accounts are maintained as per Cost accounts are maintained to to meet the the requirements of Companies Act and requirement of the Management. Income Tax Act.

(3) Recording Transactions are classified, recorded and In cost accounting, transactions are analysed subjectively. classified, recorded and analysed objectively

according to the purpose for which costs are incurred.

(4) Analysis of Profit Financial accounting reveals the profit of a Cost Accounting shows the profit made on business as a whole. each product, job or process.

(5) Accounting period Financial accounts are prepared for a Cost reports are prepared frequently and definite period. submitted to the management may be daily,

weekly, etc.

(6) Stock valuation In financial accounts, stocks are valued at Cost accounting stocks are valued at cost. cost price or market price whichever is less.

(7) Dealings Financial accounts deal with actual facts In cost account lays emphasis on both actual and figures. facts and estimates or predetermined cost.

(8) Relative Efficiency Financial accounts do not reveal the rp.lative Cost account provides information on the efficiency of each department or section. relative efficiencies of various plant and

Machinery.

Management Accounting

Management Accounting helps the management in effectively perfonning its functions of planning, organizing, controlling, co-ordinating and decision-making.

The Institute of Cost and Management Accountants London has defined Management Accounting as "the application of professional knowledge and skill in the preparation of accounting infonnation in such a way as to assist management in the fonnation of policies, and in the planning and control of the operations of the undertaking."

Cost Accounting'Vs Management Accounting

The following are the main distinctions between Cost Accounting and Management Accounting:

(1) Cost Accounting deals with cost ascertainment, cost allocation, cost apportionment and cost control. Management Accounting provides all accounting infonnations to the management for discharge of its functions effectively.

(2) Management Accounting has a wider scope as compared to cost accounting. Therefore Management Accounting uses more advanced techniques of Management reporting.

(3) Management Accounting deals with both Cost Accounting and Financial Accounting. But cost accounting deals with cost data.

(4) Standard Costing, Budgetary Control, Break-Even Analysis, Inventory Control etc. are the basic tools and techniques used in Cost Accounting. But in Management Accounting, fund flow analysis, cash flow analysis, ratio analysis etc. are the important tools used for analysis and interpretation of financial statements.

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Advantages of Cost Accounting

Cost Accounting helps the Management to ascertain the true cost of every operation, through setting objectives and standard of operation, comparison of actual performance with standard to reveal the discrepancies or Variances. If the variances are adverse, the management takes up corrective measure to eliminate variations. The following are the advantages of cost accounting to the management, to the employees, to the creditors, to the government and to the public:

Advantages to the Management

(1) Facilitates planning.

(2) Helps in formulating policies.

(3) Useful in setting up objectives and standards of performance.

(4) Facilitates cost comparison.

(5) Leads to effective cost control.

(6) Determines of selling price.

(7) Ascertains profit of each activity.

(8) Assists the Management in decision making.

(9) Facilitates cost reduction.

(10) Measures performance.

Advantages to the Employees

(1) Ensures fair incentive wage schemes.

(2) Facilitates job security, recognition and promotion.

(3) Useful in measuring operating efficiency of the employees.

Advantages to the Creditors

(1) Measures the financial strength and creditworthiness of the business.

(2) Attract investors for extending their credit facilities.

(3) Creates trustworthiness among the creditors, debentureholders, banks, etc.

Advantages to the Government

(1) It helps to formulate business policies and national plans for industrial development.

(2) It facilitates assessment of taxation, and establishment of indexes.

(3) It assists in effective utilization of resources, i.e., materials, labour and machines etc.

(4) It assists the government for cost reduction, price fixation, export and import and granting subsidy etc.

Advantages to the Public

(1) It helps in elimination of wastages and inefficiencies.

(2) It facilitates the consumers to pay fair price for products.

(3) It leads to progress of national economic growth.

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(4) Creates employment opportunities.

(5) Increases the living standards of the people.

Limitations of Cost Accounting

The following are some of the limitations of cost accounting :

(1) There is lack of uniformity in regard to its procedure and practices.

(2) Cost are classified and interpreted in such different manners that though given the same title, they are computed on a different basis.

(3) Lack of consistency becomes more acute when projections are made beyond the recorded cost data.

(4) Inherent limitations of cost accounting objections raised by different sections of business societies against the introduction of cost accounting.

(5) Cost accounting is unnecessary for recently established industries. And also modern methods of costing systems are not suitable for all types of industries.

(6) Cost accounting system involves considerable amount of expenditure at the installation stage. Thus costing system is not economical for a small concern.

(7) Cost accounting involves accounting procedures and record-keeping. These are far more detailed and difficult than those required in financial accounting.

Installation of Cost Accounting System

While installing a cost system, the cost accountant should consider the following factors :

(1) Objectives of Costing System: While installing a cost accounting system, it should be ensured that it will aid in ascertainment of cost, determination of selling price, cost control and cost reduction etc.

(2) Nature of Business: Cost Accounting system should be suited to the nature of products and business. The nature of product and business is essential to determine proper method of costing on the basis of types of product, methods and product life cycle, quantity, quality etc.

(3) Nature of Organization: It is essential to examine existing organization structure of the company before introducing the costing system. Since the system is to be designed to suit the organization it is necessary to ascertain the layout, nature and size of the organization, scope of authority and responsibility.

(4) Methods and Procedures: Before introducing the costing system, the Cost Accountant should carefully study the existing manufacturing procedures, processes, methods, system of wage payments, receipts and issue of materials. This will help him to select the proper method of costing.

(5) Communication: A good system of cost accounting will provide information which helps in decision making. Cost information should be made available promptly and regularly. It is necessary to examine the prompt reporting system.

(6) Standardization: The system should be introduced after a detailed study of the standardization. Standard Forms should be used in order to reduce clerical work to the minimum.

(7) Simplicity: The system to be adopted should be simple and easy to adopt to the changing requirement. The costing system should be capable of being understood by the operating personnel.

(8) Co-operation: There is need for co-operation and support of the various departments involved in the cost accounting process for being successfully implemented.

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(9) Reconciliation: Emphasis should be on whether separate set of cost and financial books are required or an integrated system has to be followed. This depends upon the nature and size of the industry. Where cost books are maintained independetly of financial records there must be provision for reconciliation between the cost and financial records.

Practical Difficulties in Installing Costing System

The following are the practical difficulties confronted in installing a costing system :

(1) Lack of top management support.

(2) Resistance from accounting departmental staff.

(3) Non co-operation from user departments.

(4) Shortage of trained staff in costing department.

(5) Heavy cost of installing the system.

Steps to Overcome Practical Difficulties

To overcome these difficulties, the steps required are given below:

(1) To sell the idea to top management to convince them of the utility of the system.

(2) Resistance and non co-operation can be overcome by behavioural approach to deal with the staff concerned effectively.

(3) Proper training should be given to the staff at each level.

(4) Regular meetings should be held with the cost accounting staff, user departments staff and top management to clarify points.

QUESTIONS:

1. What do you understand by Cost Accounting? 2. Define the terms Cost Centre and "Cost Unit." 3. What are the important objectives of Cost Accounting? 4. What are the differences between financial account and cost accounting? 5. Distinguish between cost accounting and management accounting. 6. What are the factors to be considered for installation of good costing system? 7. Describe the practical difficulties in installation of costing system. 8. Cost Accounting has become an essential tool of management. Give your comments on this statement. 9. Indicate the various advantages of Cost Accounting.

10. Define costing and discuss briefly its objects and advantages. 11. What are the limitations of cost accounting? 12. Write short notes on :

(a) Costing; (b) Cost Accountancy; (c) Cost Control; (d) Cost Reduction; (e) Cost Unit and Cost Centre.

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