Chapter 1 Cost Accounting
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[A] Financial Accounting
Introduction:
- Financial Accounting is concerned with providing accounting information to external user.
- Financial Accounting is oriented towards the preparation of financial statement which summarize the result of operation for selected period of time and show the financial position of the business at particular dates.
Objective
- Provides accounting information to users for help in decision making.
- F.A. process`s end product: Financial Statement
- Financial Statement Includes: P & l A/c, Balance Sheet, Cash Flow Statement.
Accounting System
- Double Entry System: For Technique {I, M, R, C}
- GAAP Generally Accepted Accounting Principles: R, C, S, A, C.
Measurment Unit
- Business Transaction (Self) + Monetary Terms
User of Financial Accounting Information
- Internal User`s:
- External User's:
Limitation of Financial Accounting
1. Not provide detailed cost information for different Department process, jobs, products etcetera
2. Not set up proper system of controlling materials and supplies which lead to losses on account of scrap, theft, defective etcetera
3. Not provide help in analysis of worker and employee performances because we don`t records wages and salaries as different jobs, products etcetera
4. Difficult to know the behavior of cost because in F.A. expenses aren`t classified as variable, function etcetera
5. Not possess an adequate system of standards to evaluate performance of worker, department, product etcetera
6. F.A. contains historical cost. Historical Cost is not a reliable basis for predicting future earnings, solvency etcetera
7. Not provide cost data to determine the price.
8. Not provide necessary information to management in taking important decision. Like: Business Expansion, starting new or dropped or improved the product etcetera
[B] Cost Accounting
Meaning & Definition
Cost
- Cost is the amount of resource given up in exchange of some goods or services. It can be expressed as a noun as well as a verb.
- As a Noun: It can be defined as the amount of expenditure actual or nominal incurred on or attributable to a specified article, product or activity.
- As a Verb: It can be as an action to ascertain the cost of a specified thing or activity.
Costing
- “Costing is the defined as 'the technique and process of ascertaining cost.'” I.C.M.A England
Cost Accounting
- Cost accounting is defined as “the process of accounting for cost which begins with the recording of income and expenditure or the bases on which they are calculated and ends with the preparation of periodical statements and reports for ascertaining and controlling cost.”
- This is a practical usage of theoretical knowledge.
Cost Accountancy
- Cost Accountancy has been defined as “The application of costing and cost accounting principles, method and technique to the science, art and practice of cost control and the ascertainment of profitability. It includes the presentation of information derived there from, for the purpose of managerial decision making.” I.C.M.A England
- its scope is very wide. It including – Costing, Cost Accounting, Cost Control, Cost Audit.
Cost Control
- Cost Control is the guidance and regulation by executive action of the cost of operating an undertaking.” I.C.M.A England
- Steps of Cost Controls:
1. Set up targets Standard Cost.
2. Measure periodically Actual Cost.
3. Compare Standards Cost and Actual Cost and Find its variance.
4. Analysis the Variance: Find Causes.
5. Take Corrective Action to eliminate the Variation.
Cost Audit
- Cost Audit is defined as “The verification of the correctness of cost accounts and of the adherence to the cost accounting plan.
Objective of Cost Accounting
1. Ascertainment of cost or To Determine Product Cost
2. Determination of Selling Price and Profitability:
- Basis for price fixation and rate negotiation.
3. Cost Control
4. Cost Reduction
- It may be defined as “The achievement of real and permanent reduction in the unit cost of goods and services without impairing their suitability for the use intended or diminution in the quality of the product.
- It is an approach of management where-
Cost of an object is believed to have a further reduction or No Cost is as termed as lowest and Every Possibility of cost reduction is explored.
- Assumption Involved in definition: -
1. There is a saving in Unit Cost.
2. Such Saving in Permanent Nature.
3. The Utility and Quantity of the goods or services remain unaffected, if not improved.
5. Assisting Management in Decision Making
- In planning, Implementation, measuring, controlling and evaluating of various activities.
Differnce Between Cost Control & Cost Reduction
: Cost Control and Cost Reduction differ primarily in their goals and duration. Cost Control is a preventive function focused on the past and present, aiming to maintain costs according to established standards and stopping once a target is achieved. In contrast, Cost Reduction is a corrective, continuous process focused on the present and future that seeks to constantly improve and lower all existing cost standards, regardless of existing conditions.
Scope of Cost Accounting
- Costing- Techniques and Process of determine cost.
- Cost Accounting – Accounting for Cost.
- Cost Analysis- Finding out the factor responsible for variance in actual cost from the budget cost.
- Cost Comparison- Involved in alternative course of action.
- Cost Control- Detailed examination of each cost.
- Cost Report- Ultimate Function.
- Statutory Compliance
Advantages of Cost Accounting
1. Reveles types of Activity- Profitability and Unprofitable departments, jobs, Product etcetera
2. Reducing Cost- All times of cost can be analyzed to minimum the losses and wastages {Production and Activity}.
3. Cost Controlled- Cost Controlled and Profit Increased.
4. Inventory Control
5. Computation of Selling Price
6. Helps in Management in negotion- Labor, Government etcetera
7. Decision Making- Product can be made or buy, Product can be continuous or drop, Machine/Assets are leased or buy etcetera
8. Help in avoid lose- Like: low demand, Seasonal Demand, Change in Tech, Competitive Condition etcetera
9. More accurate and reliable F.A. can be prepared
10. An adequate C.A. system ensures maximum utilization of resources so we can achieve goals of getting higher earnings and maximize the profit.
Limitation of Cost Accounting
1. Expensive- C.A. treated as investment and benefit derived from the system excepted the amount spent on it.
2. Unnecessity- Some people argue because duplication of work. But in competitive market we need it.
3. Inapplicability- Different situations require different type of cost analysis.
4. Lack of Support of Top Management
5. Problem of Staff-
- Trained Costing Staff.
- May not co-operate and assistance the additional work.
6. Variation in F.A. and C.A. Results- Preparation of Reconciliation Account.
7. No replacement of Financial Accounting
[C] Management Accounting
Management Accounting deals with providing information including Financial Accounting information to managers for their uses in Planning, Decision Making, Performance, Evaluation, Control, Management as costs and cost determination of Financial Accounting.
M.A. contains report prepared to fulfill the needs of management.
According to cima, U.K “M.A. is an integral part of management concerned with Identifying, presenting and interpretating information used for: -
- Formulating Strategy,
- Planning and Controlling,
- Decision Making,
- Optimizing uses of Resources,
- Disclosure of Shareholders and other external to the entity,
- Disclosure to Employees and
- Safeguarding Assets.''
Role of Management Accountant: - It is an accountant who participate in all accounting work within the organization, including maintaining the accounting records, preparing Financial Statement, preparing many specialized managerial reports and statements, generally information for different level of management, coordinating budgeting, accounting and reporting function.
It plays vital role in helping managers.
Differnce between F.A. and C.A. and M.A.
Financial Accounting and Cost Accountig
Table summary: Financial Accounting and Cost Accounting differ primarily in their objectives and standardization. Financial Accounting focuses on reporting the overall financial performance of an entity for both internal and external users using a set format and GAAP principles based on historical data. In contrast, Cost Accounting is used for internal cost control and decision making, utilizing both historical and pre-determined costs without a set format or GAAP requirements. Key operational differences include Financial Accounting's use of a double entry system to record commercial transactions in monetary terms, while Cost Accounting focuses on production-related expenses for specific cost objects like jobs or processes, measuring them in units such as money or hours as the situation requires.
Cost Accounting and Management Accounting
: Table summary: Cost Accounting and Management Accounting differ primarily in scope and purpose. Cost Accounting focuses on the quantitative record of product and service costs, using past and present data and following specific principles and procedures since the Industrial Revolution. In contrast, Management Accounting has a wider scope, incorporating both quantitative and qualitative aspects for budgeting, taxation, and planning to provide information for management coordination. While Cost Accounting is centered on cost ascertainment, Management Accounting focuses on projecting future figures to meet the needs of the modern business world and does not follow specific rules and regulations.
[D] Costing
We learn the following content-
- Method of Costing:
- Costing has referred to the technique and process to ascertaining cost.
- To ascertaining cost there are two methods.
- Job Costing
- Process Costing
- All other methods of costing are only variants of the above two method: -
Table summary: Job costing and process costing a divided into several specific methods. Job costing includes Batch Costing, Contract Costing or Terminal Costing, and Multiple Costing or Compound Costing. Process costing comprises Unit or Single Output Costing, Operating or Service Costing, Operation Costing, and Department Costing.
- Types or Technique of Costing:
- The term “Types /Technique” Refer to: -
- The manner of ascertain cost of job, process etcetera
- Also Indicate: What type of cost are being ascertained such as Historical Cost or Standard Cost.
- Type
- Marginal / Variable / Differential Costing
- Absorption / Full / Conventional Costing
- Direct Costing
- Uniform Costing
- Budgeting Costing
- System of Costing:
- The Term “Costing System” refers to: - An accounting system followed to
- to accumulate cost,
- to ascertain cost of products or job,
- to prepare cost information using some procedures and principle for recording of cost data.
- Costing System also divided into two categories both have some variants: -
- Job Order Costing System
- Process Costing System
- System of Costing: -
- Standard Costing
- Historical / Actual Costing
- Estimated Costing
Terms of Costing
1. Job Costing
- It is used in those business concern: -
- Where production is carried out as per specific order and Customer Specification.
- Each job is Separate and Distinct from the other jobs.
- Eg House Building, Ship Building, Toy Making, Machinery Production and Repair.
2. Batch Costing
- Used: A group of Identical or Similar Products.
- Each Batch of Product is unit of Cost for which costs are accumulated.
- Eg Medicine, Toys, Components
3. Contract / Terminal Costing
- Based on the Principle of Job Costing.
- The contract becomes the cost of Unit for which Relevant Costs are accumulated.
- Difference between Job and Contract
Table summary: Methods of classification for jobs and contracts based on size and location. Small jobs and small contracts are characterized by work performed inside a factory, such as table or jewelry making. Conversely, big jobs and big contracts are characterized by work performed outside a factory, such as house or ship building.
4. Compound / Multiple Costing
- Used: Industries where production`s Nature in Complex.
- Cost are Accumulated:
- Different Components making the final product and
- The tootled to ascertain the total cost of product.
5. Process Costing
- Where Used:
- Industries where production is done continuously.
- Eg Paper, Chemicals, Crude Oil etcetera
- Ascertain Cost: Difficult to traces the cost of specific unit and the total cost is averaged for the number of units manufactured.
- Sometimes, Total CPU is ascertained: -
- At each stage of production for control process.
6. Unit / Single Output Costing
- Where Used:
- Singke Item is Produced and
- The final production is Composed of homo-jee-nee-us Unit or
- Product can be 1, 2, 3…...more. But with variation only in Size, Shape and Quantity.
- Eg Milk, Ores, Bricks etcetera
- CPU: Total Cost divided by Total Number of Units Manufactured
7. Operating / Service Costing
- Where used: Organization which only render service and do not manufacture any physical item. Eg Transport, Power House, Universities etcetera
- Cost Unit: Depending upon the Nature of Service being rendered. Eg Per km, Per tone Miles, Per Electric Unit, Per Student etcetera
8. Operation Costing
- Where Used: Industries where process consists of distinct operations.
- Ascertainment of Cost: Each Operation rather than the Process.
- Assumption: Output is achieved through a Number of Different Operation.
- It offers better control and facilities Like- Computation of unit operation cost at the end of each product
9. Departmental Costing
- In case, there are number of departments in a factory,
- To ascertain the cost [ The objective of department costing]: Output of each Dept. separately
10. Marginal / Variable / Differential Costing
- In this technique cost is Separate between Fixed Cost and Variable Cost
- In this technique Cost of Product or Chargeable Expenses Only Variable Cost
- Fixed Cost: Written off against the profits in the period in which they arise.
- Help in Study of effect in Profit due to change in volume or type of products.
11. Absorption / Full / Conventional Costing
- In this technique cost is Separate between Fixed Cost and Variable Cost
- In this technique Cost of Product or Chargeable Expenses Both Variable and Fixed Cost
- Method Process To determine the total unit cost
- S-1 First Accumulated: Direct Cost
- S-2 Share of the Overheads [Factory, Office, S&D]: Levied on the appropriate base.
- In this technique, Cost is not separated for the purpose Cost Ascertainment, Analysis and Presentation and because of this it has limited Application.
12. Direct Costing
- In this technique, Cost is separate between Direct Cost and Indirect Cost.
- In this Technique: -
- Direct Cost: Cost of Product / Chargeable Expenses.
- Indirect Cost: Written off against the profits in the period in which they arise.
13. Uniform Costing
- It is not a technique of Costing, it is an attempt: -By a serval Organization to use similar Costing Principle and/or Practice.
14. Budgeting Costing
- It is the System of Management and Accounting in which
- All operations are Forecasted and Planned so far as possible ahead of,
- The Actual Results compared with the forecasted and planned one.
- It is technique of cost applied to the
- Control of Total Expenditure [Materials, Wages, Overheads]
- By Comparing Actual Performance with Planned Performance.
15. Standard Costing
- It is determined and used and then compared with the actual costs to determine the extent of variance. So that remedial action can be taken.
- It is Pre-determined Cost in Conformity with the most effective operation and use of the resources within the firm.
16. Historical / Actual Costing
- The Process of their Accumulation and Cost Ascertainment are set out on an actual cost or historical basis.
- It is the system of costing under which costs are determined after they have been incurred.
17. Estimated Costing
- In this Costing System Costs are developed from Projection using Average of Past Data regarding Performance.
- Not helpful for Management because not scientifically predetermined costs.
- Emphasis on: Actual Cost with which it is compared At the end of Accounting Period.
- Revised Based on: Actual Cost condition which are expected to continue during the next accounting period.
[E] Cost Accounting System
Mean
A cost accounting system is system that –
- Accumulate cost,
- Assign them to cost objects, that is Product, Job etcetera
- Reports Cost Information.
Assist Management
- Planning and Control of business operations.
- Analyzing product profitability, and
- Accomplishing business objectives, through Optimum Utilization of available resources.
The underlying Principles, Procedure and Objective of all costing system are the same but the application of these principles and methods may vary with the circumstances.
Factor Influencing the Cost Accounting System
- Size and Lay Out- Business grow- costing information increase
- Raw Materials- Degree of waste, spoilage influence- Designing of the C.A.S
- Nature and Number of Product-
- One Product: All costs are direct.
- 2 or more Product: cost data become complex.
- Manufacturing Process- It includes: - like Production [lay out, arrangements, scheduling, control methods], Plant & Machinery Capacity, Inspection and Testing of Materials etcetera
- Managerial Requirements- System should reveal the trouble spots and area so that remedies action can be taken.
- Comparability- Self cost data and industry cost data.
- Organizational Structure- The C.A.S must correspond to the organization authorities or division. So that individual person can be held accountable for the costs incurred in their respective department.
- External Factors- They have great influence on the frequency of volume and structure of the C.A.S.
- Staff Efficiency- Staff- Competent, qualified enough to proceeds the required cost information.
Essintiol Feature of Cost Accounting System
- Basis of Accumulating Cost
- Relationship with Financial Accounting
- Full Costing or Marginal Costing
- Basis of Product Cost which system of costing
Difference in installation of a Costing System
- Opposition from the existing staff
- Shortage of Trained Manpower
- Error in Measuring Requirements
- Non-Cooperation from Management
[F] Others
Cost Centre
- Cost Centre
- A cost center is an organizational segment area of function for which it is desirable accumulate cost. But not to generate revenue.
- It is charged with all the cost that relate to it.
- England Terminology: it is a location, person or item of equipment or graph of these for which costs may be ascertained and used for the purposed of control.
- Type of Cost Centre: A cost center consists of
- Personal Cost Center: Person or Group of persons like- salesmen, watchmen, machine operators.
- Impersonal Cost Center: location or an item or group of these like- department, area, machine, delivery van.
- Operation Cost Center: the machine and/or process carrying out similar operation.
- Process Cost Center: a specific process or a continues sequence of operations.
- Production Cost Center: where actual production work take place. In a manufacturing concern.
- Service Cost Center: which serve as ancillary or rendered services to a production cost center. In a manufacturing concern.
Cost Object
- It is anything for which a separate measurement of cost required.
- Like: -
- Product smart phone, book
- Service utility bill payment facility
- Project metro rail project
- Activity quality inspection of materials, placing of orders
- Process crude oil refines
- Department sales, safety, manufacture
- It remains in nucleus of cost classification and analysis of the cost behavior.
Cost Drivers
- It is a factor or variable which effect level of cost.
- It is an activity which is responsible for cost incurrence.
- An activity may be an event, task or unit of work etcetera
- Eg Machine Set-up, Numbers of Test Performed, Hour Spent on Machine.
- cima “Cost Driver as a 'factor influencing the level of cost' often used in the context of activity-based costing to Denote the Factor which links activity resource consumption to Product Outputs, for example the number of purchase order would be a cost driver for procurement cost.”
Cost Unit
- I.C.W.A, England “It is a unit of a product, service or time or combination of this relation to which cost may be ascertained or expressed.”
- A Batch which consists of a group of identical items and maintains its identity through one or more stages of production may also be considered as a Cost Unit.”
- Cost Unit: Physical Measurement like- numbers, weight, area, volume, length, time and value etcetera
।Table summary: Cost units for various industries and undertakings. Electricity is measured per KWH, bricks per 1000 bricks, hotels per room per day, banks per department, workshops per job, and buses per passenger KM.