Concept of cost accounting
There are three
branches of accounting. i.e Financial Accounting cost accounting and management
accounting. Cost accounting is one of the branches of accounting, which has
been developed due to the limitation of financial accounting. Financial accounting
communicates economic information of an organization as a whole and that is
used for external reporting purposes. The reporting of financial accounting may
not be sufficient for internal reporting i.e for the formulation of policy and
strategy, decision making, and control.
According to
C.Gilespie “cost accounting is a set of producers for determining the cost of a
product and various activities involved in its manufacture and sales and for
planning and measuring performance.
FEATURES OF COST ACCOUNTING
The following are the
main features of cost accounting
o Nature: Cost accounting is a
branch of accounting. It is concerned with recording and reporting costs of
output to the firm’s management.
o Objective: Its main objectives
are to accumulate costs of output, job, process, unit, and department and
report them for different uses.
o Status: It is complementary
to financial accounting as it provides cost data of different kinds of stock
for preparing financial statements.
o Basis: It is the basis for a
cost estimate, cost control, and price determination of output.
o Usefulness: It is useful for
decision making and performance evaluation as it uses absorption or valuation
costing techniques in preparing income statements.
Objectives of cost
accounting
There can be several
objectives of cost accounting. However, the following are its important
objectives:
To ascertain cost:
The important
objective of cost accounting is to ascertain the cost of a product or services
or jobs. Ascertainment of cost is the process of determining cost after they
have been incurred. Generally, there are two methods for determining the cost
of i.e job costing and process costing. Due to the difference in the nature of the
activity of the industry, different methods of the cost may be applied.
To control cost:
The objectives of cost
accounting are to control the cost by using various techniques such as standard
costing, inventory control, marginal costing, etc.
To provide information
for decision making:
Cost accounting is the
formal system of accounting and provides information for various managerial
decisions like
i.
Whether to accept or reject the offer
ii.
Whether to make or buy a product
iii. Whether to continue or
replace the existing machine. Whether to drop or continue the product or
services
To fix the selling
price:
Cost accounting can
provide detailed information about the cost of a product or service to
determine the selling price.
To ascertain costing
profit or loss:
Cost accounting
ascertains the total cost and total revenue of every product or service or job
and calculates profit or loss by comparing it with revenue and cost.
To provide information
in preparation of financial statements:
Inventory should be
valued for the preparation of financial statements by comparing cost price and
market price.
Importance and
advantages of cost accounting
Cost accounting
provides immense advantages to a firm. It also can be explained in terms of
importance:
Helping in
ascertaining of cost:
Cost accounting uses
different methods of costing such as job costing, process costing, etc.
applying this costing method cost of each product, process, or job is
ascertained.
Helps in inventory
control:
It helps in inventory
control using various techniques like ABC analysis, economic order quantity, stock
level, etc.
Helps in the measurement
of efficiency:
It helps in the measurement
of efficiency of operations through the establishment of standards and various
analyses.
Helps in preparation
of budget:
It helps in the preparation
of various budgets such as sales budget, production budget, material purchase
budget, flexible budget, etc.
LIMITATIONS OF COST
ACCOUNTING
Cost accounting also
suffers from a number of limitations such as follows:
o Unnecessary: It is unnecessary
because it involves duplication of work, many good enterprises are functioning
without any costing system.
o Expensive: It is expensive
because the installation of a cost accounting system involves additional costs.
o Inapplicable to many
industries: It is inapplicable to many industries. A single costing
system may not be applicable to all industries because the costing system may
be specially designed to meet the need for a specific industry.
o Lack of uniform
procedure: it
is possible that two equally competent cost accounts may arrive at the different
results from the same information.
o The result shown by
cost and financial accounting may not be equal to each other: In cost accounting
certain incomes such as interest, dividend, share transfer fee, etc. are not
recorded and certain expenses such interest paid, dividend, loss on the sale of
fixed assets are not shown but these items are shown in financial accounting.
MEANING OF FINANCIAL
ACCOUNTING
Business firms for
earning profit perform business activities. Each business activity involves
financial transactions. Such financial transaction needs proper recording and
systematic classification and analysis to know profit or loss and financial position
usually at the end of each year. Financial accounting is the account, which
keeps records of the financial transaction. It shows profit or loss and
financial position at the end of each year.
In other words,
financial accounting is an art of recording, classifying, and summarizing the
financial transactions of a firm in such a manner that its profit or loss and
financial position are ascertained at the end year an communicated to the user.
OBJECTIVES OF
FINANCIAL ACCOUNTING
The main objectives of
financial accounting are;
To keep a systematic
record of the financial transaction:
The main objective of
financial accounting is to record the financial transaction of business in
systematically and scientific order. The need to record due to the limited memory
power of human beings.
To disclose the result
of the operation of the business organization:
Profit is the main
motive of every firm. Everyone related to the firm is keen to know its profit
or loss at the end of each year. It is also one of the important objectives of
financial accounting.
To show financial
position:
The firm is not only
keen to know its profit or loss at the end of each year, but also its financial
health on that date. The firm’s financial health is judged on the basis of
financial position.
To protect assets and
properties:
Financial accounting
not only keeps records of all assets and properties acquired by the firm but
also records of their use and transfer from one place to another. Recording of
the firm’s assets and properties and their audit helps to protect from misuse
and misappropriation.
Limitations of
financial accounting
Financial accounting
also suffers from limitations. Some notable ones are as follows:
No detailed cost
information:
Financial accounting
does not provide detailed cost information for different departments,
processes, products, jobs, different services, and functions. But, financial
accounting does not make evaluation performances of units, departments, and
processes.
No classification and
analysis of cost:
Segregation of costs
by nature and behavior are essential for controlling cost and identifying responsibilities.
Financial accounting does not segregate cost in terms of behavior such as
variable or fixed costs, nor does it classify in terms of nature such as direct
and indirect costs.
No price
determination:
Every firm must
determine the prices of its outputs in order to sell them. But, financial
accounting does not determine the selling prices of the firm's output.
No use of standards:
It does not provide
any standard costing to measure the efficiency in the use of material, labor,
and expenses.
No control over cost:
No information over the
loss of productivity:
Historical data:
DIFFERENCE BETWEEN
FINANCIAL ACCOUNTING AND COST ACCOUNTING
|
COST
ACCOUNTING |
FINANCIAL
ACCOUNTING |
|
The
main objective of cost accounting is to record and report the costs of output. |
The
main objectives of financial accounting are to report financial results in
terms of profit or loss and the financial position of a firm. |
|
Cost accounting segregates costs
into fixed and variable portions. |
Financial accounting does not
segregate costs into fixed and variable portions. |
|
Its
user is mainly managers who use the cost data for their decision making
purpose. |
Its
users are owners, managers, creditors, employees, workers, consumers, and
government. |
|
It is voluntarily required for the
firm to keep cost accounts. |
It is legally required for the firm
to maintain financial accounts. |
|
It
is primarily applied in manufacturing concerns. |
It
is generally applied to all types of business concerns. |
|
It values inventory on a cost
basis. |
It values inventory based either
on cost or market price whichever is low. |
METHODS OF ACCOUNTING
Methods of costing are
the procedures of ascertaining costs of output, process, or operation. Since
the nature of industry differs from one another, the methods of costing also
differ. Important methods of costing are as follows:
1. Job order costing: This method is
used to gathers and accumulates costs for each job order or work order received
from customers. Since each job order is specific and terminates after it is completed,
therefore all costs that are incurred in the job or order are accumulated after
its termination.
2. Process costing: The costing method
that ascertains the cost of each process or stage of producing output is called
process costing. Under this method, a separate account is opened for each
process to which all costs incurred thereon are charged.
3. Service costing: The method of
costing which is used for ascertaining the costs of service rendered is known
as service costs. Under this method, the cost per unit of service rendered such
as cost per passenger kilometer, cost per ton kilometer, cost per kilowatt, or
cost per patient day is determined. Therefore, this method is popular in
industries and institutions that provide services instead of manufacturing
products.
4. Contract
costing: This costing refers to the form of specific order costing, which
applies, where work is undertaken to customer requirements and each order is a long
duration as compared to job order costing. A job, which is big and spreads over
long periods of time is known as a contract. The method of costing which is
used in a contract is called contract costing. This method is used by builders,
civil engineering contractors, and construction firms.
5. Batch costing: A batch consists of
a lot of common units. Therefore, a number of identical units/articles
manufactured on a lot basis are called a batch. The Uniform size of the product
is produced in each batch. The costing method used to determine the cost of
products produced on lot wise basis is called batch costing.
6. Multiple costing: An ascertainment
of cost of the product by using more than one costing method is defined as multiple
costing. It is also called composite costing. It is adopted in those industries
where several components are used to produce a final product.
CONCEPT OF COST
Cost is a frequently
used word. Since all use the word cost as per their own need and purpose,
therefore the meaning of cost differs depending upon the need and purpose. An
accountant, economist, engineer, and a manager define it according to their
need. Therefore, it is not easy to define the term “cost”. However, in simple
words, the cost is defined as an amount of money spent on obtaining anything,
goods, or service. Cost is a resource foregone or sacrifice in monetary terms,
to achieve particular objectives.
According to the U.S.A.,
it is defined as an exchange price, the foregoing, a sacrifice made to source
some benefits.
CONCEPT OF COSTING
The process of fixing
costs of activity is defined as costing. The activity refers to the manufacture
of products/articles or services rendered, or function performed. Each activity
needs cost. The procedure applied to ascertain the unit cost of product or
service is costing. So, costing comprises of collection, classification, and
analysis of cost for ascertaining the unit cost of products and services.
Manufacturing and service industries follow costing to ascertain the cost of
products or services.
According to W.H.
Wheldon, costing is the classifying, recording, and appropriate allocation of
expenditure for the determination of the costs of products or services, and for
the presentation of suitability arranged data for purpose of control and
guidance of management.
Classification of
costs
Classification of cost
refers to the division of cost on the basis of characteristics of costs. it is
concerned with dividing costs into different types. it is fact grouping of cost
according to their common characteristics. A suitable classification of cost is
important to identify cost by product, process, or operation. The cost can
mainly be classified on the following bases:
1. Element/Nature
2. Functions or activities
3. Variability or behavior
4. Controllability
Elements/ Nature
The cost of the product
of an industry comprises of material cost, labor cost, and expenses. Therefore,
cost appears into material cost, labor cost, expenses under the classification of
costs based or physical characteristics. The cost has three main elements such
as raw materials, labor, and other expenses. It can be classified into
materials, labor, and expenses based on physical characteristics.
Material cost
Material cost represents
the total costs of the main raw materials, components, consumable stores, and
packing materials. Materials cost also includes import duties, dock charges,
transport cost, storing cost receiving and inspection cost, and other costs
associated with the materials purchased.
Labor cost
Labor cost is the
total of wages incurred for the effort or services made by laborers in the
productions of goods and services. Therefore, wages paid to the workers are
termed as labor costs.
Expenses
Expenses are the total
costs incurred for production, administration, and selling and distributing
operations. Such expenses include the cost of drawing, cost of special tools,
cost of trial production, royalties, rent, lighting, and welfare expenses.
All three elements of
cost can further be divided or grouped into two types based on their nature such
as direct and indirect costs.
Direct costs
Direct costs are those
materials, labor, and other expenses that can easily be attributed or
identified with a unit of product, process, or operation. The cost of raw
materials, productive labor, and carriage of materials paid are examples of
direct costs. The total direct cost is termed as prime cost.
Indirect costs
Indirect costs are
those types of costs, which cannot easily be attributed to or identified with a
unit of product, process, or operation. Therefore, the total costs of indirect
materials, indirect labor, and indirect expenses are referred to as indirect
costs. They are also called overhead costs. Examples of indirect costs are
repair charges, salaries, rent, telephone, and water.
Direct materials cost:
The cost of materials
having a physical identity with the end product is defined as direct materials
cost. The main raw materials and necessary components are a few examples of
direct materials.
Indirect materials
cost:
Materials are not used
as inputs of the product are called indirect materials. The cost of materials
incurred for the repair of a machine used for printing of textbooks is defined
as indirect materials cost.
Direct labor cost:
Labour or wages
incurred for the operative workers engaged in the production process are
categorized as direct labor costs. Wages paid to the workers involved in
production and handling materials, workers engaged in productive operation by
way of supervision and maintenance, etc are direct labor costs.
Indirect labor cost:
Smooth operation of an
organization needs the operation of the accounting department, marketing
department, and internal transport also besides the production department.
Indirect labor costs mean salary paid to staff.
Direct expenses: Direct expenses
are charged directly to a finished product like direct materials cost. It is also
called designed chargeable expenses. These include special layout costs,
drawing and design charges, royalties, and so on.
Indirect expenses:
The cost which is not
directly connected with the finished product but occurs on account of operation
is termed as indirect expenses. Indirect expenses are also more frequently
called on cost or overheads and include expenses such as canteen expenses,
lighting, heating charge, rent, insurance, and so on.
Components of indirect
materials:
Production supplies
and consumable stores, greases, waste, Non-durable tools and equipment,
maintenance material and supplies, inspection, and testing materials.
Components of indirect
labor:
Managerial salary,
supervisory salary, foremen salary, clerical salary, general labor, unallocated
times wages, overtime wages, and so on.
Components of indirect
expenses:
Factory rent,
electricity, lighting, conveyance and traveling, postage and telegrams,
insurance, depreciation of plants and machinery.
Functions or
activities
The classification of
costs based on functions like manufacturing, administrative, selling and
distribution is called functional classification. The functional classification
of cost focuses on different activities and segregate costs accordingly.
Production (manufacturing) and non-production (non-manufacturing) costs are the
division of the major costs made after prime cost under this classification.
Prime cost is known as
Basic, Flat, or Direct cost comprises direct material, direct labor, direct
expenses. They are attributable to and are identified to particularly finished
goods.
Production Cost
Production cost is the
sum of the cost incurred for realizing finished goods. It includes direct
material cost and conversion cost needed to convert such direct material into
finished goods. So, it is the sum of Prime cost plus manufacturing expenses or
factory overhead or works overhead. It is also called manufacturing cost or
factory cost or work cost.
Manufacturing expenses
include indirect materials, indirect labor, and indirect expenses associated
with manufacturing operations. Conversion cost includes direct labor cost and
manufacturing expenses need to convert input material into finished goods.
Process cost
Production costs
depending upon the stage of production operation can be categorized into
different costs. The output of one process becomes the input cost of the immediate
next process. Costs of each individual process are collected separately and are
term as cleaning process cost, cooking process cost, and so on. Each process
cost is divided by the number of units produced by the same process. It goes on
cumulating and total manufacturing cost equals the sum of all costs accumulated
at the final process. The cost so accumulated is divided but the number of
units produced to ascertain cost per unit of finished goods.
Components of
manufacturing overheads:
Work manager’s salary,
factory supervisory salary, Foremen salary, Work Clerks’ salaries, Provident
fund contribution of factory employees, Leave and holiday wages of factory
employees, Unallocated time wages, overtime wages, Production supplies and
consumable stores, Non-durable tools and equipment, Maintenance material and
supplies, Greases, Waste, Inspection and testing materials, Inspection and
testing labor, Repairs of maintenance of factory plant and equipment,
Depreciation of factory plant and machinery, Factory rent, Factory electricity,
Factory lighting, Factory insurance.
Non-Production cost
Non-production cost
refers to the expenses incurred for running administrative and selling and
distribution works. So, the non-production cost is known as operation cost or
non-manufacturing cost that includes administrative overhead and selling and
distribution overheads. Such costs keep no direct link with production
operation therefore defined as non-production cost.
However, the cost of
production comprises manufacturing cost and administrative expenses.
Administrative
overheads
The expenses incurred
for administrative work like planning, coordinating, directing, controlling,
are called administrative overheads. It is also called office cost.
Components of
administrative overheads:
Director's fees,
office rent, rates and taxes, office repairs and maintenance general and
miscellaneous, executive salary, staff salary telephone charges, postage and
telegrams, printing and stationery, electricity, audit fee, office insurance, and
so on.
Selling and
distribution expenses
The expenses paid for
selling and distribution of finished goods are called selling and distribution
overheads. It can be categorized into selling overheads and distribution
overheads.
Selling overheads
The expenses incurred
for selling finished goods to customers are termed as selling expenses.
Components of selling
overheads:
Cost of catalogs/price
lists, salaries of sales staff, Salesman’s commission, Training of salesmen,
Travelling expenses of sales representatives, Commission, rent of sales office
and showrooms, Warehouse expenses, Provident fund, Entertainment and treatment
to customers, Samples products, Bad debts and collection charges, Neon light
posts, Customers’ service, and service after-sales.
DISTRIBUTION
OVERHEADS:
The expenses
associated with transporting finished goods from warehouse to sales depot,
showroom, and customers are termed as distribution overheads.
Components of
distribution overheads:
Packing expenses,
Freight outwards, Loading and unloading, Depreciation of delivery vans,
Insurance outward.
Total Cost includes
the cost of production plus a reasonable proportion of selling and distribution
expenses. It is normally called the cost of sales or selling costs.
Variability or Behaviour
Knowledge of
variability or behavior of cost is essential for decision making and forecasting
of cost. This helps to study how costs react with volume changes. Management
needs to identify costs from their behavior to formulate forward planning and
select a profitable course of action.
Variable Cost
The cost which changes
proportionality with the volume of output or services is called variable costs.
They increase or decrease in total amount with the increase or decrease in
volume of output. However, the per-unit variable cost is constant. Variable
manufacturing costs are also called product cost and include direct material,
direct labor, and fluctuating indirect materials, labor, and manufacturing
overheads.
Fixed Cost
The cost that does not
change with output is cost. It remains fixed for a stipulated period and
specific capacity output. A fixed cost is called constant or capacity cost. It
is also called create cost as it remains unchanged for a stipulated period.
Fixed cost in total amount remains constant whereas the fixed cost per unit
changes inversely with output changes. Therefore, an increase in output
decreases fixed cost per unit, and a decrease in output increases fixed cost
per unit. For example depreciation, rent and salaries.
Semi-variable cost
Those cost which do
not change proportionately like variable costs but their increase will be less
than proportionate unlike the variable costs is termed as semi-variable cost. Examples
of semi-variable costs are the salary of supervisors, traveling salesman
salary, repair and maintenance costs, etc. such costs contain fixed and
variable portions. So, semi-variable cost is also called mixed costs.
Step-fixed costs
(semi-fixed/ moving fixed costs)
Fixed costs are fixed
either to a capacity volume or to a period of time. Therefore, change in
capacity volume or lapses of time create change in fixed cost. It will
change by the original amount remaining constant for the specific relevant
range. Changes take the shape of steps at the different levels so it is called
the step fixed cost. Repairs and maintenance cost; depreciation of additional
machine purchases are some examples of step fixed costs.
Controllability
Controllability may be
defined in terms of change or alternation of costs. Effective cost control
requires knowledge of cost controllability. A sharp division of cost into
controllable and uncontrollable cost is a relative one and is influenced by the
action of a person at the management hierarchy. The term controllable cost
should not be used as synonymous with variable cost and direct costs. Knowledge
of the controllability of cost is important to control cost.
Cost under
controllability may be categorized into controllable and uncontrollable costs.
Controllable cost:
The cost subject to
control or substantial influence of a particular manager or individual is
called controllable cost. In controllable cost, the cost can be changed or
altered by the action of specific managers. Example; direct materials, direct
labor, other overheads such as indirect labor, factory supplies, cutting tools,
power costs, repair, and maintenance, etc are controllable costs.
Uncontrollable costs:
Costs that are not
subject to influence by the action of the manager are called uncontrollable
costs. These costs remain unchanged or unaltered. Example: managerial salaries,
staff salaries, depreciation after the purchase of equipment, rent. Some costs
may be controllable in the short run but not in the long run.
Reviewed by Bijay Munikar
on
March 15, 2021
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