Definition of Cost Accounting
Cost accounting is the collection, processing and evaluation of operating data e.g., cost of products, operations, processes, jobs, quantities of materials consumed, labor time used etc. for internal planning and control as well as for external reporting.
How Does Cost Accounting Help in Better Control Over Cost?
Cost accounting helps in attaining the aim of controlling cost by using various techniques such as budgetary control, standard costing and inventory control. Each item of cost (viz. material, labor and expense) is budgeted at the beginning of the period and åctual expenses incurred are compared with the budget and any variance between targets and actual results are analyzed and where necessary, corrective actions are taken. This increases the efficiency of the enterprise.
Cost accounting calculates the cost by considering all factors that contribute to the production of the output, both manufacturing and administrative factors.
The objective of the cost accounting is to help the management in fixing the prices and controlling the cost of production. Basically cost accounting is for internal management, however, it also provides information for external reporting.
Production planning and scheduling, inventory planning and management, labor time and labor cost budgets are some of the areas where management is assisted by cost accounting. It also provides information to management regarding actual results, such as the output of various departments, actual labor cost, cost of materials in process etc.
Cost accounting collects data both in monetary and non-monetary terms. Then these are compared with pre-established standards and budgets to exercise management control over the operations.
The Scope of Cost Accounting
1. Determination and Analysis of Cost
The main objective of cost accounting is the determination of cost of products or services rendered which includes the collection and analysis of expenses, the measurement of production of different products at different stages of manufacturing and the linking up of production with the expenses.
Cost accounting records cost and income information for each department, process, job, sales territory in order to ascertain the cost and evaluate the operating efficiency of each division of the business enterprise.
2. Control of Costs
In the age of competition, the objective of business is to maintain costs at the lowest point with efficient operating conditions. It requires examination of each individual item of cost in the light of the services or benefits obtained to ensure maximum utilization of money expended or its recovery. This requires planning and use of the standard for each item of cost for locating deviations if any and taking remedial measures.
3.Proper Matching of Cost With Revenue
It prepares monthly or quarterly statements to reflect the cost and income data identified with the sale of that period.
4. Aids to Management
Cost accounting enables a business not only to ascertain what various jobs, products and services have cost to the business but also what they should have cost. It locates losses and wastages for taking corrective measures and to avoid them in the future.
Special cost studies and investigations that help management in determining policies and formulating plans for profitable operations are also a part of cost accounting.
Principles of Cost Accounting
The principles of cost accounting are as under:
1. The cost accounting system aims at working out the cost of production of goods and services soon on completion and not long after production.
2. It also aims at identifying all costs with individual products manufactured and sold or with services generated and sold. This process is composed of two features:
- Classifying costs as direct and indirect to individual products.
- Remainder of the costs are classified as direct and indirect to departments and from there costs are changed to products.
3. It adopts a number of cost classifications for managerial needs.
4. A number of costing methods and techniques are used for costing products, cost control and managerial decisions.
5. Only normal costs form part of the cost of production. Abnormal costs are considered losses.
6. Although cost accounting particularly the integrated system of accounting can ultimately produce financial statements (profit and loss account and balance sheet), its emphasis is on managerial accounting. It becomes a vehicle for producing accounting data which would assist management in the performance of its functions. It enforces accountability in its real meaning. Thus cost accounting is to be built around the organizational structure.
Costing vs Cost Accounting
it is abundantly clear that Cost Accounting provides the basis on which the costing is made possible. Cost Accounting provides the necessary cost data for the purpose of Costing. Without Cost Accounting Costing is not possible. A small manufacturer may be in a position to do costing but a large-scale manufacturer shall be quite unable to do so without the help of cost accounting.
Cost accounting is a broader term which assimilates in itself the functions of costing, which certainly is a narrower term. In a broader sense both the terms are used in the same manner meaning the same thing. Cost accounting makes a provision for analysis and classification of expenditure.
It then enables the management to ascertain the total as well as per unit cost of a particular unit of production. It also discloses the constituents of the total cost. The ascertainment of cost and the provision of unknowledge of constituents are the two broad objects of costing. Thus both the terms can and is used in the same sense.
Importance of Cost Accounting
Cost accounting assists the management in carrying out its day-to-day functions of control and formulation of business policies. The management comes to know the causes of losses and wastages. It is, in fact, an aid to managerial control. The importance of cost accounting may be studied under the following aids:
1. Costs: Classification and sub-division. Costs are classified and sub-divided in order to provide management every possible detail of expenditure incurred in producing a product or rendering a service. The details enable the management to eliminate or to reduce those activities from which little or no profit is obtained.
2. Cost Control: Material labour and overhead. The perpetual inventory system, setting up of labour efficiency standards, classification of overheads into fixed and variable and uncontrollable are a few of the methods which help the management in exercising effective control over the various costs and take suitable measures to do the needful.
3. Setting-up Standards for Measuring efficiency: Standards are set up and are used for measuring the efficiency not only of labour but all factors of production. Estimates and plans are provided. These are compared with actuals and deviations etc. are defected to take corrective measures.
4. Provision For Budgets etc. The estimates, plans, budgets and other aids are provided to the management to compare the results desired and actually achieved. Certainly, this not only helps in coordinating the efforts but helps in setting the targets and achieving what actually is desired to achieve.
5. Price Determination: An Aid. Units wise details of costs, their break. up, accuracy of computation and cost data made available by the costing department go a long way in determining the price of the product or services rendered.
6. Special Factors are specially taken care of and the management is kept posted with all developments including any factor which has arisen because of one reason or the other. This enables the management to guard the enterprise against any eventuality. And either the management is able to take effective measure to save itself from disaster or keep those factors away from its own establishment. Depression, seasonal fluctuations, idle time of labour and machine or a few of the special factors which have to be guarded against. Cost accounting keeps the management well informed on these counts.
7. Policies: Business and others. Cost accounting is not only an aid to the whole business and its various activities but also is helpful in arriving at a fruitful business policy and other policies on which depend on the future of the whole enterprise. Cost accounting seldom fails the management and consequently the enterprise. It is certainly a very important aid since it has become an essential tool of management. It serves management. It assists it in the execution of all the policies. It offers scope to make the policies etc. flexible so that the desired results may be achieved without any tangible trouble.
Why Is Cost Accounting Necessary?
The above discussions lead us to the conclusion that cost accounting is a systematic procedure of determining per unit cost. It serves, therefore, the purpose of cost ascertainment as well as cost const. It is necessary because of its advantages to the business enterprise and importance to the following few lines:
(i) It ascertains the costs of each product, process cost center and department.
(ii) It assists in cost classification and analysis.
(iii) It provides all details of all factors affecting the cost of the product or service.
(iv) It provides a system for cost control.
(v) It provides sufficient cost data to management for vital decisions to be taken by the management in the best interest of the enterprise as a whole.
(vi) It provides information to all interested parties, e.g., trade customers, banks, shareholders, association, Unions, Government, insurance companies, etc.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.