Cost accounting

Limitation of financial accounting (FA)

1. historical data

2. summarized result

3. does not satisfy the information needs

Accounting information is critical containing of a business organization, their

dependence on accounting information has widely increased and hence is recognized

as an essential resource for managing an organization

FA achieves the objectives of

a. identifying financial events and transaction that occurs in an organization

b. measures the value of such occurrence in terms of money

c. organizes the data into meaningful information

d. analyses and communication of information to as broad range of persons

within the organization and outside organization is enable

Limitation of FA

i. It provides only part data: FA provides out of data information to management.

The management is more interested in current data than part data. It is rightly

said that financial accounts provides only postmortem analysis of part activities

ii. it reveals only over all result for the business: fa does not provide data for each

and every product process department or operation separately instead it

provides the financial information in a summary form for the whole

organization

iii. it is stasis in nature: modern business is dynamic but financial accounts do not

incorporate the changes a that takes place within the business

iv. it fails to take into account the impact of price level changes : under fa asset

are shown at the actual or the historical cost consequently deprecation is also

charged on the actual cost their will distort the profit. In modern inflationary

condition the price level have significant impact over the financial statement

v. it fails to exercise control over resources ie labor material and other expenses,

as a result losses and wastage go uncheck under this system

vi. it does not provide basis for cost comparison , cost comparison over a period of

time are between 2 jobs or 2 operations is not feasible

vii. it fails to ascertain break even point ie the sales or output where the revenue

equals the cost

viii. possibility of manipulation of fa the chief form of manipulation fa are in the

area of valuation of inventory, provision of deprecation , creation of secretes

reserves

Definition of cost accounting

The charted institute of management account of U.K has defined costing as the

techniques and process of ascertaining cost.

Weldon has defined costing as classifying recording and appropriate allocation of

expenses for the determination of cost, the relation of these cost too sales value and

the ascertainment of the profitability.

Cost accounting and financial accounting comparison

F A C A

Purpose The main aim of FA is to prepare

P & L a/c and balance sheet to

reporting to shareholder and

outside agencies ie external

user

The main purpose of CA is to

provide detailed cost information

to management ie insider

Statutory

requirement

The FA are required to be

prepared according to the

requirements of companies act

and income tax

Maintenance of CA are voluntary

expect in certain industries

where it has been made

obligatory to keep cost recorded

under the companies act

Periodically

reporting

Financial reports are prepared

periodically usually on annual

basis

Cost reporting is a continuous

process at an interval of daily

weekly monthly instance etc

Control aspect FA emphasis on the recording of

financial transaction and does

not attach important to control

aspect

CA provides detailed system of

control with the help of special

techniques of like standard

costing and budgetary control

Historical and

pre determined

cost

FA exclusively concerned with

historical records; the historical

nature of FA can be understood

in the context of the purpose for

which it is designed

It is concerned not only with

historical cost but also with

predetermined cost because cost

accounting doesn’t end with

what happened in the past it

extends to planning and

improves performance in the

future

Format

presenting

information

FA has a single uniform format

of presenting information ie P &

L a/c balance sheet

CA has various forms of

presenting cost information

which are tailored to meet the

needs of management and thus

lacks in uniform format

Type of

transaction

recorded

FA records only transaction with

outside parties ie sales,

purchase receipt etc

CA records not only external

transaction but also internal and

interdependent transaction like

issue of materials by store

keeper to production department

analysis of cost

and profit

FA reveals the P & L of the

business as a whole for a period

it doesn’t show the fig of cost

and profit for the individual

products department and

process

CA shows detail cost and profit

for each product line department

process etc

Objectives and functions of cost accounting

1. ascertainment of cost :this is the primary objective accounting .cost

ascertainment is achieved by different techniques and system of costing which

are used under different circumstance

2. Control of cost: cost control aims at improving efficiency by controlling and

reducing the cost. This objective has become increasingly important because of

growing competition

3. determination of selling price: on the basis of cost information provided by cost

accounting selling price of product or serviced may be fixed in period of dippers

ion cost accounting guide in deciding the extent to which selling price may be

reduced to meet the situation

4. Guide to business policy: it aims at serving needs of management at conducting

the business with at most efficiency. Cost data provides guide lines for various

managerial decision like make or buy selling below cost, utilization of ideal

capacity, introduction of new product etc..

5. measuring and improving performance: ca measures efficiency by classifying and

analysis cost data and then suggest various steps in improving performance so

that profitability is increased

Cost: cost is the amount of resources given up in exchange for some goods or

services. Resources given up are money money’s equalient expressed in monitory

unit.

Institute of cost and work accounting in India (ICWAI)

Defines cost as the amount of expenses (actual and national) incurred or attributed

to a specified thing or activity

American accounting association (AAA)

Defines cost as a foregoing measured in monetary terms incurred or potentially to be

incurred to achieve a specific objective

Shilling law defined cost as “cost represents benefit given up to acquire goods or

service

Cost unit: ascertainment of cost is the central activity of the ca the ascertainment of

the cost necessities the determination of unit in terms of which cost can be

ascertained and expressed

The unit of product or service in relation to which cost are ascertained is known as a

cost unit. Cost unit varies from industry to industry and from concern to concern. A

no of cost units maybe used within an organization for different purpose. Cost unit is

the basis of measuring cost and making comparison between actual cost and

predetermined standards

The forms of ascertainment used as cost units are usually the units of physical

measurement like number, weight, area, length, value, time etc.. Cost unit is a

device for the purpose of breaking up or separating up into smaller sud-divisions,

these smaller sub-divisions are attributed to product or services to determine.

Product or service or costs of time spend for a particular job etc.

Advantages

a. Revel profitable and unprofitable activities: on this information management

may take step reduce or emulate wastage and ineffenciey occurring in the

form of ideal time, under utilization of planned capacity spoilage of material

etc.

b. helps in cost control by using of techniques of std costing and budgeting

control

c. helps in decision making: ie provides related information for decision such as

introduction of new products replacement of old machinery, make or buy etc

d. Guides in fixing selling price: cost is one of the most important factor to be

considered while fixing price especially at times of deprecation. The price may

have to be fixed below total cost.

e. Helps in inventory control: perpetual inventory is an integral part of ca and

helps in preparation of entire p&l a/c. cost accounting also uses inventory

control techniques like ABC analysis etc

f. Helps in cost reduction : ca helps in finding out new improved ways to reduce

cost through the introduction of cost reduction programme

g. Revels idle capacity: the concerned may not be working to full capacity due to

reasons sudden shortage of demand , machine breakdown or other bottle

neck (experiment) in production a cost accounting system can easily work out

the cost of idle capacity so that management can take immediately steps to

improve the position

h. Aids in formulating policies: it provides such information that enables

management to formulate pricing policies preparing estimates of contracts

and tenders

i. Prevent frauds and manipulation : cost audit system helps in preventing

manipulation and fraud and thus gives reliable cost data to management and

others

j. Check the accuracy of financial accounts: with the help of reconciliation

between financial accounting and ca at the end of the accounting period

Cost centre

Cost centre is the smallest segment of activity or area or responsibility for which

costs are accumulated cost centre is defined as by “CIMA” of UK as “a location

person or item of equipment (or group of these) for which cost may be ascertained

and used for the purpose of control” it may be a location ie a sales area, an item of

equipment ie a machinery or a delivery van, a person ie as sales man or a machine

operator or a group of these

The determined of a suitable cost centre is very important for ascertainment and

control of cost. It enables accumulation of all such causes at one place for which a

common base of recovery may be used.

Types of cost centre

i. Personnel cost centre: it consist of person or a group of persons

ii. Impersonal cost centre: it consists of locator or an items of equipment or a group

or a group of these

iii. Operation cost centre: it consists of those persons and 1 or machine carrying out

the same kind of operation

iv. Process cost centre: it is one which has a continues sequence of operation

v. Product cost centre: it refers to a centre through which a product passed and

generally corresponds to a product department. In such centre raw material are

converted into finished products eg: repairs-melting shop, welding shop.

vi. Service cost centre: it is a department which incurs cost not direct on making the

product these cost centre area ancillary to and render service to production cost

centre eg: store department repair shop canteen

Classification is the process of grouping like facts under a common destination on the

basis of similarities of nature attributes or relations.

Need for cost classification: arises due to use of cost data for a verity of purpose the

same cost data can’t serve all purpose equally hence cost must be arranged and

classified in such a way that they can be combined in different ways to serve

different purpose. The following are the list of purpose the following are the list of

purpose that cost classification serves

1. ascertainment of profits periodically: profit can be ascertained only when the

relevant revenue is compared with the relevant cost

2. preparation of budget ; the classification helps in preparation of budget for

instance when flexible budget are prepared for different levels of activity , the

fixed cost remains constant at all levels of activity were as variable cost varies

according to level of output

3. cost control: fixed cost are mostly uncontrollable and if at all any control can be

exercised it can be done by the top level management , variable cost on the other

hand are mostly controllable when cost are classified s controllable cost and

uncontrollable

4. fixed selling price: in case of classification for the purpose of fixing selling price

the information needed will vary with the situation in which selling price is fixed

(marginal costing)

5. Observation of overheads (indirect cost) by classifying cost into fixed and variable

separate rates of absorption of overheads may be used the under observation or

over absorption arising out of the overhead are different in nature and need

different managerial action.

6. Other uses while planning cap. Expenditure: effect of proposed project on fixed

and variable cost should be studied more over differential and comparative cost

analysis are bases on classification of cost as fixed or variable

Basis of classification (nature analytical classification)

a. Material cost: ICMA defines material cost as “the cost of commodities other

than fixed cost introduction into product or consumed in the operation of an

organization. material cost may be direct or indirect material, the cost of

material entering into becoming a constituent part of the product or saleable

service is known as direct material cost

b. labor cost : it is defined as “ the cost of remuneration for employees efforts

and skills applied directly to the product or saleable service” labor consist of

both direct and indirect labor cost the above mentioned direct labor cost

inclusive of the indirect labor cost constitute the total labor cost

c. expenses : expenses may relate to direct expenses or indirect expenses cost

other than wages material cost , good constitute expenses

On the basis of viability

a. fixed cost: a cost which accurse in relation to the passage of time and which

within certain output or turnover limits tense to be unaffected by flotation in

volume of output or turn over the following are characteristics of the fixed cost

total amount of fixed cost remains constant for varying levels of output

fixed cost per unit is indirectly proportionate to the output

control of fixed cost lies in the hands of top management rather than

the departmental heads

b. variable cost: a cost which is aggregate tends to vary indirect proposition to

changes in volume of output or turn over its characteristics are

the variable cost per unit remains constant

the total variable cost varies in direct proportion to output

it is easy to assign variable cost 2 product or department

Control of variable cost lies in the hands of departmental heads eg; direct

material cost direct labor cost etc..

c. semi variable cost : a cost containing both fixed and variable elements is a semi

variable cost and is partly effected by flotation in volume of output or turn over

eg: tele charges, rental based on min rent supervision charges, maintenance and

repair

On the basis of identifiably

a. direct cost: are those which may be conveniently identified with a particular cost

centre or cost unit

b. indirect cost: are those cost which are incurred for the benefit a no of cost centre

or cost unit

eg: rent of a building ,salaries of mgt etc

Indirect costs have to be apportioned on certain assumption as regards this volume.

On the basis of function

a. production cost: cost of fabrication assembling units of products

b. administration cost: sum of cost of general mgt ,secretarial accountable and

administrative services which can be directly related to production marketing

research and development function of enterprise

c. selling and distribution cost : the cost of seeking to create and stimulate demand

and of securing orders ie cost of efforts to find and retain customers .distribution

– maling the packed products available for dispatch ie facilities the movement of

goods into the hands of the purchases

d. finance cost; cost of external source of funds

e. r&d : cost of seeking new or improved products

On the basis of controllability

Cost are classified according to what they are influenced by the action of a given

member of the organization

a. controllable cost : are those costs which can be influenced by the action of

specified members of the organization ie cost which are at least partly within the

control of mgt controllable cost generally include all direct cost and ae

controllable by the person responsible for the cost centre(production manager)

b. uncontrollable cost : are those which cant be influenced by the action of a

specified members of the organization fixed cost are uncontrollable cost

On the basis of time

a. Historical cost: Costs which are ascertained after been incurred ie such cost cost

are available only when the production has already been done. Their

characteristics

they are based on recorded facts

they can be verified and they are always supported by evidence of their

occurrence

they are mostly objectives because they related to happening which have

already taken place

b. Pre determined cost: such cost are estimated cost ie computed in advance of

production taking into consideration the pervious.. cost and the factors efficiently

such cost pre determined cost which will result in the identification of a variance

which helps the mgt in the purpose of control

On the basis of planning

Budget and STD cost furnish information to mgt and helps in planning and control

a. Budget cost represent : an estimate of expenditure for different phase of business

operations such as mfting, administration ,R&D etc which are co-coordinated in a

foremen work for a period of time in future eg raw material cost budget, labor

cost budget , cost of production budget mfting overheads budget administration

overhead budget etc

b. Standard cost: is defined as the predetermined cost based on a technical

estimate for material for material, labor and overhead for a selected period of

time and for prescribed set working conditions.

Cost sheet is a statement designed to show the output of a particular period along

with break up of cost the data incorporated in cost sheet are collected from various

statements of accounts which have been written in cost a/c on a day to day bases or

regular records CIMA defines cost sheet as document which provides for assembly of

the detailed cost of a cost centre or a cost unit.

A cost sheet may be prepared on a weekly, quiterally, monthly or yearly bases

Methods of costing

Specific order costing Operation costing

Job order costing Single /operation/output

Contract costing Operating costing

Batch costing Process costing

Multiple

Departmental

Specific order costing is defined as the category of basic costing method applicable

were work consist of separate contracts, job or batches each of which is authorized

by a special order or contract this method is adopted in made –to-order, type of

products which depends entirely on specification of customers as such there is known

standardization in production process for want of uniformity

Job order costing:

Is defined as that form of specific order costing which applies were work is

undertaken to customers requirement

Work is carried out within a factor or work shop were each job moves through

operations as a continuously identifiable unit

Building repair carried out in customer premises also constitute job costing

Costing for each job is dissimilar in nature & is identified separately by a job order no

Profit or loss is ascertained for each job separately

Eg ; interior deco, repair work shop , printing press etc..

Contract costing:

A work usually a constructional nature and is that form of specific order costing for

which customer requirements are taken and each order is off a long duration

Work is performed at the premises of the contractee

Most of the expenses are chargeable are direct in nature

Eg: building, road, dams, bridge etc...

Batch costing:

Is defined as that form of specific order costing which applies were similar articles are

manufactured in batches either for sale or for use within the under taking

It is similar to job costing

A convenient batch of production is rated as a job

Eg: bakery, hardware like bolts scores &Pharma industries

Operation costing

Is defined as basic costing method applicable were stdised goods or services result

from a sequence or repetitive and more less continuous operation or process to

which cost are charged before doing average over the units produced during the

period

Single output/unit costing: it is a method of costing by the unit of production where

manufacturing is continues & the units are identified. In some case the units may

differ I size, shape and quality. This method is called single costing as only a single

type of product is manufacturing

Eg; brick making industry, textile mills, paper mill, flour mills, quarries and collieries

Process costing: is that form of operation costing which applies where stdized goods

are produced. It is that method of costing where cost is ascertained at every stage of

the process

Features:

Out put of one process is passed as input of the subsequent process unit

production is complete

The cost of every process is transferred to the subsequent process

The process industries incase normal and abnormal losses usually

In a majority of process industries by products are obtained in addition to the

main the product

The cost of semi-finished goods are generally expressed in terms of fully

finished goods and this process is called equivalent production

Eg : sugar industry, breweries petroleum , paints

Service or operating costing: it is applicable where stdized service are provided either

by an undertaking or by a service cost centre

Features:

They render uniform service to all those who depends on it

It involves heavy cap. Expenses in the mfting and supply of service

The cost of production is classified into fixed and variable as economy of

operation affect the service cost unit

They make use of composite unit to express the cost per unit

Eg ; transport undertaking, service supplier supply’s of gas, electricity water, canteen

hospital service library etc..

Departmental costing: under this method of costing the cost incurred in mft of

particular department is ascertained

The two main reasons being

To control the cost of a dept eg :a dispensary belonging to a factory or cost of

running a research department

To charge the cost of a dept to the finished product eg: charging the cost of

maintained dept to the production dept.

Multiple costing/hybrid costing: it is used in those industries which ascertain various

component parts

Eg; automobiles industry, aero planes, refrigerator industry etc.