COST - Himpub

Cost Accounting1.2Cost account ing is a branch of accounting which specialises in the ascertainment of cost ofproducts and services. It is for use by management. It has been explained in detail in this book.Management account ing is the modern concept of accounts as a tool of management. It isconcerned with all such accounting information that is useful to management.COST ACCOUNTINGCost account ing has primarily developed to meet t he needs of management . Profit and LossAccount and Balance Sheet are present ed to management by t he financial account ant . But modernmanagement needs much more det ailed informat ion t han supplied by t hese financial st at ements. Costaccount ing provides det ailed cost informat ion to various levels of management for efficient performanceof t heir funct ions. The informat ion supplied by cost account ing acts as a tool of management formaking opt imum use of scarce resources and ult imat ely add to t he profit abilit y of business.Meaning of Costing, Cost Accounting and Cost AccountancyCost i ng. The t erms ‘costing’ and ‘cost accounting’ are oft en used int erchangeably. The Chart eredInst it ut e of Management Account ants (CIMA) of UK has defined cost ing as, “the techniques andprocesses of ascertaining costs”. Wheldon* has defined cost ing as, “the classifying, recording andappropriate allocation of expenditure for the determination of costs, the relation of these costs to salesvalue and the ascertainment of profitability’.” Thus, cost ing simply means cost finding by any process ort echnique. It consists of principles and rules which are used for det ermining:(a) t he cost of manufact uring a product ; e.g., motor car, furnit ure, chemical, st eel, paper, etc. and(b) t he cost of providing a service; e.g., elect ricit y, t ransport , educat ion, etc.Cost Account i ng. Cost account ing is a formal syst em of account ing for costs in t he books ofaccount by means of which costs of products and services are ascertained and cont rolled. An authoritat ivedefinit ion of cost account ing has been given by CIMA of UK as follows: “Cost accounting is the processof accounting for costs from the point at which expenditure is incurred or committed to the establishmentof’ its ultimate relationship with cost centres and cost units. In its widest usage, it embraces thepreparation of statistical data, the application of cost control methods and ascertainment of profitabilityof activities carried out or planned.”Cost i ng and Cost Account i ng— Dif f erence. Though t he t erms ‘cost ing’ and ‘cost account ing’ areint erchangeably used, t here is a difference bet ween t he t wo. Cost ing is simply det ermining costs byusing any met hod like arit hmet ic process, memorandum st at ements, etc. Cost Account ing, on t he ot herhand, denot es t he formal account ing mechanism by means of which costs are ascert ained by recordingt hem in t he books of account . In simple words, cost ing means finding out t he cost of product orservice by any t echnique or met hod, cost account ing means cost ing using double ent ry syst em.Cost Account ancy. Cost account ancy is a very wide t erm. It means and includes t he principles,convent ions, t echniques and syst ems which are employed in a business to plan and cont rol t heut ilisat ion of its resources. It is defined by CIMA of UK, as “the application of costing and costaccounting principles, methods and techniques to the science, art and practice of cost control and theascertainment of profitability. It includes the presentation of information derived therefrom for thepurposes of managerial decision-making.” Cost account ancy is t hus t he science, art and practice of acost account ant .Scope. Cost account ancy is a wide t erm and includes cost ing, cost account ing, cost cont rol andcost audit .

Introduction1.3Cost cont rol involves est ablishing pre-det ermined st andards of cost for different elements i.e.material, labour and overhead. These st andard costs are t hen compared wit h act ual costs and differencesbet ween t he t wo are analysed and t he necessary correct ive act ion is t aken.Cost audit is t he applicat ion of auding principles and procedures in t he field of cost account ing. Itis defined by CIMA, London as “verificat ion of cost accounts and a check on t he adherence to t he costaccount ing plan.”OBJECTIVES AND FUNCTIONS OF COST ACCOUNTINGThe main object ives of cost account ing are as follows:1. Ascert ai nment of cost . This is t he primary object ive of cost account ing. In ot her words, t hebasic objective of cost accounting is to ascert ain t he cost of products and services. For cost ascertainmentdifferent t echniques and syst ems of cost ing are used in different indust ries.2. Cont rol and reduct i on of cost . Cost account ing aims at improving efficiency by cont rolling andreducing cost . This object ive is becoming increasingly import ant because of growing compet it ion.3. Gui de t o busi ness poli cy. Cost account ing aims at serving t he needs of management inconduct ing t he business wit h ut most efficiency. Cost dat a provide guidelines for various managerialdecisions like make or buy, selling below cost , ut ilisat ion of idle plant capacit y, int roduct ion of a newproduct , etc.4. Det ermi nat i on of selli ng pri ce. Cost account ing provides cost informat ion on t he basisof which selling prices of products or services may be fixed. In periods of depression, cost accountingguides in deciding t he ext ent to which t he selling prices may be reduced to meet t he sit uat ion.5. Measuri ng and i mprovi ng perf ormance. Cost account ing measures efficiency by classifyingand analysing cost dat a and t hen suggest various st eps in improving performance so t hat profit abilityis increased.In order to realise t hese object ives, t he dat a provided by cost account ing may have to be reclassified, re-organised and supplement ed by ot her relevant business dat a from outside t he formal costaccount ing syst em.COST ACCOUNTING AND FINANCIAL ACCOUNTING — COMPARISONBot h cost account ing and financial account ing are concerned wit h syst emat ic recording andpresent at ion of financial dat a. The t wo syst ems rest on t he same principles concerning debit and creditand have t he same sources of recording t he t ransact ions. But cost account ing is much more det ailedt han financial account ing. This is because in financial account ing profit or loss is ascert ained for t hebusiness as a whole whereas in cost account ing det ailed cost and profit dat a for various parts ofbusiness like depart ments. products, etc., are shown. This is explained in t he following example :Suppose a company is manufact uring t hree products — A, B and C. Under financial account ing andcost account ing t he following t ypes of st at ements are prepared.Under Fi nanci al Account i ng. A Profit and Loss Account is prepared to comput e profit as shownbelow (dat a is assumed):* Cost Accounting and Costing Methods — — Wheldon.

Cost Accounting1.4Prof i t and Loss Account f or t he year endi ng 31st March, 2013 75,00020,00025,00030,0001,50,000To MaterialsTo WagesTo Other expensesTo Profit (Balancing figure) 1,50,000By Sales1,50,000This st at ement shows t hat tot al profit is 30,000 but it does not disclose t he det ails of profit / lossof each of products A, B and C in t he tot al profit . This is revealed by cost account ing.Under Cost Account i ng. A det ailed st at ement is prepared as follows : (Dat a of above Profit andLoss Account wit h furt her assumpt ions).St at ement of Cost and Prof i t f or t he year endi ng 31st March, 2013Total MaterialsWagesOther expensesTotal costSalesProfit/ Loss ct A Product B Product C �) 4,000In cost accounts, det ailed costs are compiled for each product so t hat cost and profit on eachproduct can be known. In t he above St at ement of Cost and Profit , it can be seen t hat tot al profit is 30,000 i.e. t he same amount as in financial Profit and Loss Account . In addit ion, cost accounts showt hat in t he tot al profit of 30,000, Product A is cont ribut ing 26,000 and Product B 8,000, whereasProduct C is showing a loss of 4,000. When management gets t his informat ion, it should invest igat eto find out t he reasons of loss in Product C. If Product C cannot be made profit able, its product ionshould be stopped to improve t he overall profit pict ure of t he company. However, t his t ypes ofinformat ion is not revealed by financial account ing.The mai n poi nt s of di f f erence bet ween Cost Account ing and Financial Account ing areexplained below:BasisFinancial AccountingCost Accounting1. PurposeThe main purpose of Financial accounting isto prepare Profit and Loss Account andBalance Sheet for reporting to owners orshareholders and other outside agencies, i,e.,external users.The mai n purpose of costaccounting is to provide detailedcost information to management,i.e., internal users.2. StatutoryrequirementsThese accounts are obligatory to be prepared Maintenance of these accounts isaccording to t he legal requi rements of vol unt ary except i n cert ai nCompanies Act and Income Tax Act.industries where it has been madeobligatory to keep cost recordsunder the Companies Act.

Introduction1.53. Analysis of costand profitFinancial accounts reveal the profit or loss ofthe business as a whole for a particular period.It does not show the figures of cost and profitfor indivi dual products, depart ments andprocesses.4. Periodicity ofreportingFinancial reports (Profit and Loss Account and Cost report ing is a cont inuousBalance Sheet ) are prepared periodically, process and may be on dail y,usually on an annual basis.weekly, monthly basis, etc.5. Control aspectIt lays emphasis on the recording of financial It provides for a detailed system oftransactions and does not attach importance controls with the help of certainto control aspect.special techniques like standardcosting and budgetary control.Cost accounts show the detailedcost and profi t dat a for eachproduct line, department, process,etc.6. Historical and pre- It i s concerned almost excl usi vely wit hdetermined costshistorical records. The historical nature offinancial accounting can be easily understoodin the context of the purposes for which itwas designed.It is concerned not only wit hhistorical costs but also with predetermined costs. This is becausecost accounting does not end withwhat has happened in the past. Itextends to plans and policies toimprove performance in the future.7. Format ofpresentinginformationFinancial accounting has a single uniformformat of presenting information, i.e., Profitand Loss Account, Balance Sheet and Cash FlowStatement.Cost accounting has varied formsof present ing cost i nformat i onwhich are t ailored to meet t heneeds of management and thuslacks a uniform format.8. Types oftransactionsrecordedFinancial accounting records only externaltransactions like sales, purchases, receipts, etc.,with outside parties. It does not record internaltransactions.Cost accounting not only recordsext ernal t ransact i ons but alsoi nt ernal or i nt er-depart ment altransactions like issue of materialsby st ore-keeper t o product iondepartments.9. Types ofstatementspreparedFinancial accounting prepares general purposestatements like Profit and Loss Account andBalance Sheet. That is to say that financialaccounting must produce information that isused by many classes of people, none of whomhave explicitly defined informational needs.Cost accounting generates specialpurpose statements and reports likeReport on Loss of Materials, IdleTime Report, Variance Report, etc.Cost accounting identifies the user,discusses his problems and needsand provides tailored information.APPLICATION OF COST ACCOUNTINGCost account ing is generally considered as being applicable only to manufact uring concerns. This isnot so. Its applicat ions are in fact much wider. All t ypes of act ivit ies, manufact uring and nonmanufact uring, in which costs are incurred and monet ary value is involved, should consider t he use ofcost account ing. Wholesale and ret ail business, banking and insurance companies, railways, airways,

Cost Accounting1.6shipping and road t ransport companies, hot els, hospit als, schools, colleges, universit ies, farming andcinema houses, all may employ cost account ing t echniques to operat e efficient ly. It is only a mat t er ofrecognit ion by t he management of t he applicabilit y of t hese cost ing concepts and t echniques in t heirown fields of endeavour.ADVANTAGES OF COST ACCOUNTINGFinancial account ing has cert ain limit at ions which have given rise to cost account ing. In ot herwords, t he emergence of cost account ing is because of t he limit at ions of financial account ing. Costaccount ing has many advant ages but t he ext ent of t he advant ages obt ained will depend upon t heefficiency wit h which cost syst em is inst alled and also t he ext ent to which t he management is preparedto accept t he syst em.The principal advant ages of cost account ing are as follows:Advantages to Management1. Reveals prof i t able and unprof i t able act i vi t i es. A syst em of cost account ing reveals profit ableand unprofit able act ivit ies. On t his informat ion, management may t ake st eps to reduce or eliminat ewast ages and inefficiencies occurring in any form such as idle t ime, under-ut ilisat ion of plant capacit y,spoilage of mat erials, etc.2. Helps i n cost cont rol. Cost account ing helps in cont rolling costs wit h special t echniques likest andard cost ing and budget ary cont rol.3. Helps i n deci si on maki ng. It supplies suit able cost dat a and ot her relat ed informat ion formanagerial decision-making, such as int roduct ion of a new product line, det ermining export price ofproducts, make or buy a component , etc.4. Gui des i n f i xi ng selli ng pri ces. Cost is one of t he most import ant factors to be consideredwhile fixing prices. A syst em of cost account ing guides t he management in t he fixat ion of sellingprices, part icularly during depression period when prices may have to be fixed below cost .5. Helps i n i nvent ory cont rol. Perpet ual inventory syst em, which is an int egral part of costaccount ing. helps in t he preparat ion of int erim profit and loss account . Ot her inventory cont rolt echniques like ABC analysis, level set t ing, etc., are also used in cost account ing.6. Ai ds i n f ormulat i ng poli ci es. Cost ing provides such informat ion as enables t he management toformulat e product ion and pricing policies and preparing est imat es of cont racts and t enders.7. Helps i n cost reduct i on. It helps in t he int roduct ion of a cost reduct ion programme andfinding out new and improved ways to reduce costs.8. Reveals i dle capaci t y. A concern may not be working to full capacit y due to reasons such asshort age of demand, machine breakdown or ot her bot t lenecks in product ion. A cost account ing syst emcan easily work out t he cost of idle capacit y so t hat management may t ake immediat e st eps to improvet he posit ion.9. Checks t he accuracy of f i nanci al account s. Cost account ing provides a reliable check on t heaccuracy of financial accounts wit h t he help of reconciliat ion bet ween t he t wo at t he end of t heaccount ing period.10. Prevent s f rauds and mani pulat i on. Cost audit syst em, which is a part of cost account ancy,helps in preventing manipulat ion and frauds and t hus reliable cost dat a can be furnished to managementand ot hers.

Introduction1.7Advantages to WorkersWorkers are benefit ed by int roduct ion of incent ive plans of wage payment which is an int egral partof a cost syst em. This results not only in higher product ivit y but also higher earnings for workers.Advantages to SocietyAn efficient cost syst em is bound to lower t he cost of product ion. The benefits of cost reduct ionand cost cont rol accrue to t he public at large in t he form of lower prices of products and services.Advantages to Government Agencies and OthersA cost syst em produces ready figures for use by government , wage t ribunals, t rade unions, etc., foruse in problems like price fixing, wage level fixat ion, set t lement of indust rial disput es, etc.LIMITATIONS OR OBJECTIONS AGAINST COST ACCOUNTINGDespit e t he fact t hat t he development of cost account ing is one of t he most significantst eps to improve performance, cert ain object ions are raised against its int roduct ion. These are asfollows:1. I t i s unnecessary. It is argued t hat maint enance of cost records is not necessary and involvesduplicat ion of work. It is based on t he premise t hat a good number of concerns are funct ioningprosperously wit hout any syst em of cost ing. This may be t rue, but in t he present world of compet it ion,to conduct a business wit h ut most efficiency, t he management needs to know det ailed cost informat ionfor its decision-making. Only a cost account ing syst em can serve t his need of t he management and t hushelp in t he more efficient conduct of a business.2. I t i s expensi ve. It is point ed out t hat inst allat ion of a cost ing syst em is quit e expensive whichonly large concerns can afford. It is also argued t hat inst allat ion of t he syst em will involve additionalexpendit ure which will lead to a diminut ion of profits. In t his respect , it may be said t hat a cost ingsyst em should be t reat ed as an invest ment and t he benefits derived from t he syst em must exceed t heamount spent on it . It should not prove a burden on t he finances of t he company.3. I t i s i nappli cable. Anot her argument somet imes put forward is t hat modern met hods of cost ingare not applicable to many t ypes of indust ry. This plea is not very apt . The fault lies in an at t empt toint roduce a readymade cost ing syst em in a firm. A cost ing syst em must be specially designed to meett he needs of a business. Only t hen t he syst em will work successfully and achieve t he object ives forwhich it is introduced. In fact, applications of costing are very wide. All types of act ivit ies, manufacturingand non-manufact uring, should consider t he use of cost account ing.4. I t i s a f ai lure. The failure of a cost ing syst em in some concerns is quot ed as an argumentagainst its int roduct ion in ot her undert akings. This is a very fallacious argument . If a syst em does notproduce t he desired results, it is wrong to jump to t he conclusion t hat t he syst em is at fault . Thereasons for its failure should be probed. In order to make t he syst em a success, t he ut ilit y of t hesyst em should be explained and t he cooperat ion of t he employees should be sought by convincingt hem t hat t he syst em is for t he bet t erment of all.INSTALLATION OF A COSTING SYSTEMThere cannot be a readymade cost ing syst em for every undert aking. In order to meet t he specialneeds of a business, a cost ing syst em has to be specially devised to

Cost Accounting 1.2 Objectives and Functions of Cost Accounting 1.3 Cost Accounting and Financial Accounting — Comparison 1.3 Application of Cost Accounting 1.5 Advantages of Cost Accounting 1.6 Limitations or Objections Against cost Accounting 1.7 Installation of a costing system 1.7 Concept of Cost 1.9 Cost Centre 1.10 Cost Unit 1.11 Cost .File Size: 1MB