Unit - 1 : Introduction To Cost Accounting

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Unit - 1 : Introduction to Cost AccountingStructure of 31.141.15ObjectivesIntroductionBranches of AccountingEmergence of Cost AccountingNatureAdvantagesImportanceInstallation of Cost Accounting SystemEssential of a Good Cost Accounting SystemMethodsTechniquesCost Accounting vs. Financial AccountingLimitations of Cost AccountingSummarySelf Assessment QuestionsReference Books1.0ObjectivesAfter completing this unit, you will be able to: 1.1To assertion and control cost.Determining selling price.Facilitating preparation of financial and other statements.To reduce cost.To provide base for operating policy.IntroductionIn the initial stages cost accounting was merely considered to be a technique for ascertainment of costof products or services on the basis of historical data. In course of time due to competitive nature ofthe market, it was realized that ascertainment of cost is not as important as controlling costs. Hence, costaccounting started to be considered more as a technique for cost control a s compared to cost ascertainment.Due to technological development in all fields, now cost reduction has also come within the ambit of costaccounting. Cost accounting is thus concerned with recording, classifying and summarizing costs fordetermination of costs of products or services, planning, controlling and reducing such costs and furnishingof information to management for decision making.Meaning and Definitions of Cost Accounting“Cost accounting is a quantitative method that accumulates, classifies, summarizes and interprets informationfor three major purposes: (in) Operational planning and control ;( ii) Special decision; and (iii) Productdecision.” -Charles T. Horngren1

“Cost accounting is the process of accounting for costs from the point at which the expenditure is incurredof committed to the establishment of its ultimate relationship with cost units. In its widest sense, it embracesthe preparation of statistical data, the application of cost control methods and the ascertainment of theprofitability of the activities carried out or planned is defined as the application of accounting and costingprinciples, methods and techniques in the ascertainment of costs and the analysis of saving and/or excess ascompared with previous experience or with standards.” – Institute of Cost and ManagementAccountants of London“Cost accounting is defined as the application of costing and cost accounting principles, methods andtechniques to the science, art and practice of cost control and the ascertainment of profitability. It includesthe presentation of information derived therefore for the purposes of managerial decision making. –WheldonCost accounting thus provides information to the management for decision of all sorts. It serves multiplepurposes on account of which it is generally indistinguishable from management accounting or so-calledinternal accounting. Wilmot has summarized the nature of cost accounting as “the analysing, recording,standardizing, forecasting, comparing, reporting and recommending” and the role of a cost account as thatof “a historian, news agent and rophet”.1.2Branches of AccountingThere are seven branches of accounting:a)Financial Accounting: This is called original accounting, which is mainly confined to the preparationof financial statement for the various concern parties and financial institutions.b)Cost Accounting: The process of accounting for cost which begins with the recording of incomeand expenditure or the bases on which they are calculated and ends with the preparation of periodicalsstatements and reports for ascertaining and controlling cost.c)Management Accounting: Management accounting is a distinctive form of resource managementwhich facilitates management’s ‘decision making’ by producing information for managers withinorganization.d)Inflation Accounting: This accounting system do not consider the cost constant at every timebecause the price of a commodity change with time to inflation and decline purchasing power ofmoney.e)Social Accounting: This deals with the application of double entry system of book keeping tosocio-economic analysis at the preparation, estimation and interpretation of nation and internationalincome and balance sheet.f)Value –Added Accounting: In this system income is measured by the value added by a firm in aparticular period. It is the difference between the value of the product and the cost of raw material,stores and any brought out component used for production.g)Human Resource Accounting: Human Resource accounting is the measurement of the cost andvalue of people for the organization or it is the process of identifying and measuring data abouthuman resources and communicating this information to interested parties.1.3Emergence of Cost AccountingThe Institute of Cost and Works Accountants of India (ICWAI) was established as a company limited byguarantee for the development of cost accounting in India. The main purpose of this to develop the cost2

accounting as a profession. The maintenance of cost accounting records became mandatory since 1965,after the addition of Sec.209 (1) (d) in the companies act 1956.The Institute of Cost and Works Accountants of India has recently issued cost accounting standard (CAS)1 to 4 also to understand the subject in a better manner as follows :CAS 1CAS 2CAS 3CAS 41.4-Classification of costCapacity determinationAllocation and apportionment of overheadCost of production for captive consumptionNatureCost accounting is a practice of cost control which is as follows:(a)Cost accounting is a branch of systematic knowledge that is a discipline by itself. It consist its ownprinciples, concepts and conventions which may vary from industry to industry.(b)Cost accounting is a science and arts both. It is science because it is a body of systematic knowledgerelating to a wide variety of subject and an art because without the efficiency and experience of costauditor it is not possible to use costing techniques efficiently.1.5AdvantagesA good system of costing is the technique of controlling the expenditure and helps bringing economy inproduction, so it serves the needs of a large section of people in the following ways.(a)Benefits to the Management: The information revealed by cost accounting aims at mainly assistingthe management in decision making and optimizing profits. Besides this there are certain advantagesof cost accounting to the management i.e. it helps in price fixation, in revealing profitable andunprofitable activities, idle capacity, in controlling cost and also helps in inventory control.(b)Benefits to the Employees: Cost accounting introduces wage scheme, bonus to the efficient &sincere employees which in turn increasing productivity, profitability and lowering cost.(c)Benefits to Creditors: The better management of finance through cost accounting leads to timelydebt servicing by company in the form of repayment of loan and payment of interest. To stay andgrow in competition and for judging soundness of present and perspective borrower and costreports give better picture of efficiency profit prospectus and capacity.(d)Benefits to the Government: Cost accounting enables the Govt. to prepare plans for economicdevelopment of the country, to make policies regarding taxation, excise duty, export, price, ceiling,granting subsidy etc.(e)Benefits to Consumers/Public: Cost accounting helps consumers in getting goods of betterquality at reasonable price.1.6ImportanceCost accounting gives information and reports to the management in the following ways:(a)Control of Material Cost –Cost of material is a major portion of the total cost of a product. It canbe controlled by regular supply of material and spares for production, maintaining optimum level offunds in stocks of materials and stores.3

(b)Control of Labour Cost: If workers complete their work within the specified time cost of labourcan be controlled.(c)Control of Overheads: By keeping a strict check over various overheads such as factory,administrative and selling & distribution, this can be controlled.(d)Measuring Efficiency: Cost accounting provides information regarding standards and actualperformance of the concern activity for measuring efficiency.(e)Budgeting: The preparation of the budget is the function of costing department and budgeting isdone to ensure that the practicable course of action can be chalked out and the actual performcorresponds with the estimated or budgeted performance.(f)Price Determination: On behalf of cost accounting information, management is enable to fixremunerative selling price for various items of products and services in different circumstances.(g)Expansion: The management may be able to formulate its approach to expansion on the basis ofestimates of production of various levels.1.7Installation of Cost Accounting SystemIt is essential to undertake a preliminary investigation installing a suitable system of cost accounting to knowthe feasibility of installing cost accounting system to such business.(a)Essential Conditions: The following conditions are essential for successful functioning of the costingsystem:(i.) Material control system should be very efficient.(ii.) The role of cost accounting must be clear.(iii.) The methods of wage payment must be sound and well designed.(iv.) The cost report should be printed forms to facilitate quick compilation.(v.) The cost and financial accounts must be integrated so as to facilitate reconciliation of profit.(b)Essential Factors for Installing a Cost Accounting System: The following essential factors areto be considered before installing a cost accounting system :(i) Nature of Industry –There is no technique or method of costing that can be applied universally.The nature of business should be considered while applying the costing techniques.(ii) Background of Business Unit –The back ground of business unit includes its existence,position, rate of growth, policy and philosophy of management. It serves as a basis for designing thecost accounts in respect of necessity, simplicity and investment involved in installing cost account.(iii) Selling & Distribution Method –The warehousing facility, external transport, market researchand other promotion measures, terms of sale and promotion of orders from customers are to beconsidered with regard to distribution process.(iv) Flexibility and Uniformity – The cost accounting system to be install must be flexible anduniform in operation and must be capable of adoption to changing conditions and facilitates interfirm comparison among various firms belonging to the same industry.(v) Product Range – Range of product must be analyzed in terms of size, models, fashions, areaof market and competitors to determine the method of costing to be selected.(vi) Organizational Factors – Size and type of organization, levels of management, extent ofdelegation and responsibility, extent of departmentalization, availability of modem office equipments4

and number of managerial and supervisory staff are to be considered while installing cost accounting.(vii) Area of Control-It must be given top most priority for exercising control over materials whenmaterial control occupies significant are of control.(viii) Reporting and Use of Electronic Data Processing- The reports of cost data must befrequent and promptitude, while installing cost accounting system. In modern ere use of electronicdata processing equipments and computers has become a common practice.(c)Procedure for Installation(i.) Nature of Business: Nature of the business of organization like capacity of plant, nature ofmaterial and labour, and various processes etc. should be considered before installation of costingsystem.(ii.) Determination of Cost Centers: Nature and no. of cost centers required should be decidedto control cost.(iii.) Determination of Process: Suitable system or process should be adopted according to thesize of business and nature of product.(iv.) Nature and Quality of Product: Quality of product, time consumed, and process used etc.should be considered while installing a costing system.(v.) Determination of Extent and Way to Control: Extent and way to over material, labour andover head should be determination.(vi.) Arrangement for Flow of Cost Data: Proper arrangement should be made for the informationrelated to cost.(vii.) Forms: Standardized forms should be used by all foreman and workers.(viii.) Records to be Maintained: Complete and accurate records should be maintained to carefullywork out.1.8Essential of a Good Cost Accounting SystemA good cost accounting should possess the following essential features:i)It should be simple, practical and capable of meeting the business concern requirements.ii)Accurate data should be used by cost accounting system; otherwise it may distort the output of thesystem.iii)To develop a good system of cost accounting necessary co-operation and participation of executivesfrom various departments of the business is needed.iv)The cost of installing and operating the system should be result oriented.v)It should not sacrifice the utility by introducing unnecessary details.vi)For the introduction of the system a carefully phased programmed should be prepared by usingnetwork analysis.vii)Management should have faith on costing system and works as a helping hand for its developmentand success.1.9MethodsDepending upon the nature of the business and the types of its products, numbers of methods of costascertainment are used in practice. The methods of costing are as follows:5

a) Job Costing: In this system the cost of each job is ascertained separately which is suitable in allcases where work is undertaken on receiving a customer’s order. Like a printing press, motor workshop etc.b) Batch Costing: It is considered as the extension of job costing. It represents a number of smallorders passed through the factory in batch. Each batch here is treated as a separate unit of cost.c)Contract Costing: It is suitable for the firms which are engaged in the work of construction ofbridges, roads, buildings etc.d) Single or Output Costing: It is used in the business where a standard production is turned out andit is desired to find the cost of a basic unit of production.e) Process Costing: It is a method of costing used to ascertain the cost of a product which maypasses through various processes before completion.f)Operating Costing: The cost of providing a service is known as operating cost and the methodsto ascertain the cost of such services is known as operating costing.g) Multiple Costing: In multiple costing, a combination of two or more methods of costing is used inconjunction to determine the cost of final product. This method is used by the industries wheredifferent components are separately manufactured and subsequently assembled into the finishedproduct. For e.g.: Motor car, Television, Ships etc.1.10 TechniquesFor ascertaining cost, following techniques of costing are usually used:a)Uniform Costing: The practice in which common methods of costing for different undertakings inthe same industry are used is known as uniform costing.b)Historical Costing: In this technique, ascertainment of cost is done after they have been incurredbut the utility of this technique is limited.c)Direct Costing: The practice of charging all direct costs to operations, processes or productsleaving all indirect costs to be written off against profit’s in which they arise are called as directcosting.d)Absorption Costing: In this all costs, both variable and fixed are charged to production, operationsor processes.e)Marginal Costing: The method of ascertaining marginal cost by differentiating between fixed andvariable costs. This technique is used to ascertain effect of changes in volume or type of output overthe profits.f)Standard Costing: The preparation of standard costs and applying them to measure the variationsfrom actual cost and analyzing the causes of variations with a view to maintain maximum efficiencyin production is known as standard costing.g)Activity Based Costing: ABC is a system that focuses on activities as fundamental cost objectsand utilizes the cost of these activities as building blocks or compiling the costs of other cost objects.6

1.11 Cost Accounting vs. Financial AccountingBasis1)PurposeCost AccountingIts main purpose to guidethe management for properplanning, controlling anddecision-making etc.Financial AccountingIt reveals the final results duringthe particular period for everyconcern.2)CoverageIt deals with expenses relatedto or identified with products.3)BasisThis deals with estimated andactual data both.4)ScopeIt is related to a particularThis deals with wholeorganization connected withmanufacturing and also otheractivities or areas.This deals only with the actualfinancial transactions andfigures and not on estimation.It includes all commercialproduct or service.5)Parties Involved6)Final Statement7)Valuation of his deals with internaltranslations betweendepartments within theorganisation.Only one statement is preparedi.e. statement of cost.Stock is valued at costIt does not consider onlyhistorical records but alsopredetermined cost.It is clearly classifies the costinto fixed and variable cost.Generally these accounts arekept to meet managementrequirements. Now it hasbecome obligatory.translation of organisationfor a particularperiod of time.This concern with externalparties as well as externaltransactions.Profit & Loss A/c and balancesheet both are prepared.Market value or costwhichever is lower isconsidered as the value ofstock.It is related to the historicalrecords.In this cost is not classifiedinto fixed and variable cost.It is required by companiesact, Income Tax Act, etc. tokeep these accounts.1.12 Limitations of Cost AccountingThese are the following reasons for which cost accounting is criticized by the different sections of society:a)Not Reliable: Cost Accounting is based on estimates and so it is not reliable.7

b)Failure of the System: Cost Accounting system has failed to produce desired results in manyconcerns. Thus it could be said that this system is at fault.c)Unnecessary: it is not necessary in Business concern as it involves duplication of work.d)Inapplicability: Modern methods of cost accounting are not applicable to every type ofindustries.e)Expenses: It is expensive because double set of account books has to be maintained and itsintroduction involves considerable amount of expenditure.1.13 SummaryThe techniques and process of accounting for cost begins with recording of Revenue and expenditureand the basis on which they are calculated and it also includes the presentation of information in theform of periodical statements and reports for the purpose of managerial decision – making. CostAccounts are key to economy in manufacturing and are indispensable to the intelligent and economicalmanagement of the factory. Thus it has come on essential tool of management.1.14 Self Assessment Questions1.“Cost Accounting System is neither unnecessary nor expensive, rather it is profitableinvestment”, Comment.2.Discuss the characteristics of an ideal system of Cost Accounting and differentiate betweencost accounting and financial accounting.3.Explain different ‘Methods’ and ‘Techniques’ of costing.1.15 Reference Books-Agrawal, Shah, Mendiratta, Agarwal, Sharma, Tailor — Cost and Management Accounting( Malik and Co.)-Jain, Khandelwal, Pareek — Cost Accounting (Ajmera Book depot, Jaipur)-Oswal, Maheshwari, Modi — Cost accounting. Cost Accounting ( RBD, Jaipur)-Agrawal, Jain, Sharma, Shah, Mangal — Cost Accounting ( RBD, Jaipur)8

Unit - 2 : Basic Cost ConceptsStructure of tionClassification of CostsCost ConceptsComponents of Total CostCost SheetSummarySelf Assessment QuestionsReference Books2.0ObjectivesAfter c

“Cost accounting is a quantitative method that accumulates, classifies, summarizes and interprets information for three major purposes: (in) Operational planning and control ;( ii) Special decision; and (iii) Product decision.” -Charles T. Horngren. 2 “Cost accounting is the process of accounting for costs from the point at which the expenditure is incurred of committed to the .

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