Cost accounting is the process of determining and accumulating the cost of product or activity. It is a process of accounting for the incurrence and the control of cost. It also covers classification, analysis, and interpretation of cost. In other words, it is a system of accounting, which provides the information about the ascertainment, and control of costs of products, or services. It measures the operating efficiency of the enterprise. It is an internal aspect of the organisation. Cost Accounting is accounting for cost aimed at providing cost data, statement and reports for the purpose of managerial decision making.
The Institute of Cost and Management Accounting, London defines “Cost accounting is the process of accounting from the point at which expenditure is incurred or committed to the establishment of its ultimate relationship with cost centres and cost units. In the widest usage, it embraces the preparation of statistical data, application of cost control methods and the ascertainment of profitability of activities carried out or planned”.
Costing includes “the techniques and processes of ascertaining costs.” The ‘Technique’ refers to principles which are applied for ascertaining costs of products, jobs, processes and services. The ‘process’ refers to day to day routine of determining costs within the method of costing adopted by a business enterprise.
Costing involves “the classifying, recording and appropriate allocation of expenditure for the determination of costs of products or services; the relation of these costs to sales value; and the ascertainment of profitability”.
The terms ‘costing’ and ‘cost accounting’ are many times used interchangeably. However, the scope of cost accounting is broader than that of costing.
Following functional activities are included in the scope of cost accounting:
1. Cost book-keeping: It involves maintaining complete record of all costs incurred from their incurrence to their charge to departments, products and services. Such recording is preferably done on the basis of double entry system.
2. Cost system: Systems and procedures are devised for proper accounting for costs.
3. Cost ascertainment: Ascertaining cost of products, processes, jobs, services, etc., is the important function of cost accounting. Cost ascertainment becomes the basis of managerial decision making such as pricing, planning and control.
4. Cost Analysis: It involves the process of finding out the causal factors of actual costs varying from the budgeted costs and fixation of responsibility for cost increases.
5. Cost comparisons: Cost accounting also includes comparisons between cost from alternative courses of action such as use of technology for production, cost of making different products and activities, and cost of same product/ service over a period of time.
6. Cost Control: Cost accounting is the utilisation of cost information for exercising control. It involves a detailed examination of each cost in the light of benefit derived from the incurrence of the cost. Thus, we can state that cost is analysed to know whether the current level of costs is satisfactory in the light of standards set in advance.
7. Cost Reports: Presentation of cost is the ultimate function of cost accounting. These reports are primarily for use by the management at different levels. Cost Reports form the basis for planning and control, performance appraisal and managerial decision making.
OBJECTIVES OF COST ACCOUNTING
There is a relationship among information needs of management, cost accounting objectives, and techniques and tools used for analysis in cost accounting.
Cost accounting has the following main objectives to serve:
1. Determining selling price
2. Controlling cost
3. Providing information for decision-making
4. Ascertaining costing profit
5. Facilitating preparation of financial and other statements
1. Determining selling price: The objective of determining the cost of products is of main importance in cost accounting. The total product cost and cost per unit of product are important in deciding selling price of product. Cost accounting provides information regarding the cost to make and sell product or services. Other factors such as the quality of product, the condition of the market, the area of distribution, the quantity which can be supplied etc., are also to be given consideration by the management before deciding the selling price, but the cost of product plays a major role.
2. Controlling cost: Cost accounting helps in attaining aim of controlling cost by using various techniques such as Budgetary Control, Standard costing, and inventory control. Each item of cost [viz. material, labour, and expense] is budgeted at the beginning of the period and actual expenses incurred are compared with the budget. This increases the efficiency of the enterprise.
3. Providing information for decision-making: Cost accounting helps the management in providing information for managerial decisions for formulating operative policies.
These policies relate to the following matters:
4. Ascertaining costing profit: Cost accounting helps in ascertaining the costing profit or loss of any activity on an objective basis by matching cost with the revenue of the activity.
5. Facilitating preparation of financial and other statements: Cost accounting helps to produce statements at short intervals as the management may require. The financial statements are prepared generally once a year or half year to meet the needs of the management. In order to operate the business at high efficiency, it is essential for management to have a review of production, sales and operating results. Cost accounting provides daily, weekly or monthly statements of units produced, accumulated cost with analysis. Cost accounting system provides immediate information regarding stock of raw material, semi finished and finished goods. This helps in preparation of financial statements.
TYPES OF COST ACCOUNTING
1. Standard Costing: Standard costing assigns "standard" costs, rather than actual costs, to its cost of goods sold (COGS) and inventory. The standard costs are based on an efficient use of labor and materials to produce the good or service under standard operating conditions, and they are essentially the budgeted amount. Even though standard costs are assigned to the goods, the company still has to pay actual costs. Assessing the difference between the standard (efficient) cost and actual cost incurred is called variance analysis.
If the variance analysis determines that actual costs are higher than expected, the variance is unfavorable. If it determines the actual costs are lower than expected, the variance is favorable.
Two factors can contribute to a favorable or unfavorable variance. There is the cost of the input, such as the cost of labor and materials. This is considered to be a rate variance. Additionally, there is the efficiency or quantity of the input used. This is considered to be a volume variance.
Example: XYZ company expected to produce 400 widgets in a period but ended up producing 500 widgets, the cost of materials would be higher due to the total quantity produced.
2. Activity-Based Costing: Activity-based costing (ABC) identifies overhead costs from each department and assigns them to specific cost objects, such as goods or services.
Example: Cost accountants using ABC might pass out a survey to production line employees who will then account for the amount of time they spend on different tasks. The cost of these specific activities are only assigned to the goods or services that used the activity. This gives management a better idea of where exactly time and money is being spent.
To illustrate this, assume a company produces both trinkets and widgets. The trinkets are very labor intensive and require quite a bit of hands-on effort from the production staff. The production of widgets is automated, and it mostly consists of putting the raw material in a machine and waiting many hours for the finished good. It would not make sense to use machine hours to allocate overhead to both items, because the trinkets hardly used any machine hours. Under ABC, the trinkets are assigned more overhead related to labor and the widgets are assigned more overhead related to machine use.
3. Lean Accounting: The main goal of lean accounting is to improve financial management practices within an organization. Lean accounting is an extension of the philosophy of lean manufacturing and production, which has the stated intention of minimizing waste while optimizing productivity.
For example, if an accounting department is able to cut down on wasted time, employees can focus that saved time more productively on value-added tasks.
When using lean accounting, traditional costing methods are replaced by value-based pricing and lean-focused performance measurements. Financial decision making is based on the impact on the company's total value stream profitability. Value streams are the profit centers of a company, which is any branch or division that directly adds to its bottom-line profitability.
4. Marginal Costing: Marginal costing (sometimes called cost-volume-profit analysis) is the impact on the cost of a product by adding one additional unit into production. It is useful for short-term economic decisions. Marginal costing can help management identify the impact of varying levels of costs and volume on operating profit. This type of analysis can be used by management to gain insight into potentially profitable new products, sales prices to establish for existing products, and the impact of marketing campaigns.
The break-even point, which is the production level where total revenue for a product equals total expense, is calculated as the total fixed costs of a company divided by its contribution margin. The contribution margin, calculated as the sales revenue minus variable costs, can also be calculated on a per unit basis in order to determine the extent to which a specific product contributes to the overall profit of the company.
IMPORTANCE OF COST ACCOUNTING
The limitation of financial accounting has made the management to realise the importance of cost accounting. The importance of cost accounting are as follows:
1. Importance to Management
Cost accounting provides invaluable help to management. It is difficult to indicate where the work of cost accountant ends and managerial control begins.
The advantages are as follows:
2. Importance to Employees
Worker and employees have an interest in which they are employed. An efficient costing system benefits employees through incentives plan in their enterprise, etc. As a result both the productivity and earning capacity increases.
3. Cost accounting and creditors
Suppliers, investor’s financial institution and other moneylenders have a stake in the success of the business concern and therefore are benefited by installation of an efficient costing system. They can base their judgement about the profitability and prospects of the enterprise upon the studies and reports submitted by the cost accountant.
4. Importance to National Economy
An efficient costing system benefits national economy by stepping up the government revenue by achieving higher production. The overall economic developments of a country take place due to efficiency of production.
5. Data Base for operating policy
Cost Accounting offers a thoroughly analysed cost data which forms the basis of formulating policy regarding day to day business, such as:
(a) Whether to make or buy decisions from outside?
(b) Whether to shut down or continue producing and selling at below cost?
(c) Whether to repair an old plant or to replace it?
LIMITATIONS OF COST ACCOUNTING
Like other branches of accounting, cost accounting is not an exact science but is an art which has developed through theories and accounting practices based on reasoning and common sense. These practices are not static but changing with time. Cost accounting lacks a uniform procedure. There is no stereotyped system of cost accounting applicable to all industries. There are widely recognised cost concepts but understood and applied differently by different industries. Cost accounting can be used only by big enterprises.
The limitations of cost accounting are as follows: