2 COST ACCOUNTING

2. Standard costing: Here, costs are predetermined. Actual costs are compared with predetermined standard
costs and variances are analysed to obtain maximum efficiency.
3. Marginal costing: It refers to the segregation of costs into fixed and variable. Only variable costs are charged
to products or services. Fixed costs are charged to profit and loss account.
Cost accounting differs from costing; however, both are used interchangeably. Cost accounting is a specialised
branch of accounting which involves classification, recording, analysing, standardising, comparing, reporting and
recommending. The terminology of CIMA defines cost accounting as “the establishment of budgets, standard
costs, and actual costs of operations, processes, activities or products; and the analysis of variances, profitability
or the social use of funds”.

1.2 OBJECTIVES OF COST ACCOUNTING

The main objectives of cost accounting are:
1. To determine the cost of a product, process or service
2. To analyse, classify and record all expenditures with respect to the cost of product, process or service in order
to determine its cost
3. To provide necessary information to the management in time
4. To provide data needed for periodical preparation of profit and loss account and balance sheets
5. To serve as a guide by providing actual data for comparison
6. To facilitate price fixation and offering quotations
7. To assist budgetary control
8. To assist cost control and cost reduction
9. To record the relative production results in each unit of plant to examine efficiency
10. To provide the basis for production planning and for avoiding wastages of materials and stores
11. To provide data for different periods and various volumes of output for effective planning and future expan-
sion of business
12. To provide the basis for making decisions such as:
(a) To shut down or operate
(b) To make or buy
(c) To continue with existing plant/machinery or to replace it
(d) To determine cost–volume–profit relationship
13. To assist the management in devising suitable policy decisions in other key areas

1.3 ADVANTAGES OF COST ACCOUNTING

1. Helps in adverse periods: Cost accounting helps in the periods of economic recession, trade depression and
trade competition. In such periods, the management should concentrate on measures to be taken to minimize
loss. While taking decision during such periods, cost accounting extends a helping hand to the management
to resolve crisis.
2. Price fixation, Floating tenders, Quotations etc.: Cost records play a vital role in fixing the price of a prod-
uct, service or process. Cost accounting facilitates such task.
3. Makes estimates: Proper cost-accounting records provide the basis to prepare estimates and tenders.
4. Eliminates wastages: Cost of the article or process at each and every stage can be determined with the help
of cost records, thereby minimizing wastages that occur.
5. Maximizes profit: Cost accounting helps in maximizing profit, choosing apt approach for its production.
Non-profitable lines may be avoided.
6. Facilitates comparison: Cost records provide data to compare different periods, which in turn helps the man-
agement to take future course of action promptly.
7. Preparation of final accounts: Cost records provide the necessary accounting information for the preparation
of profit and loss account and balance sheet at specified periods promptly.

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 COST ACCOUNTING—AN OVERVIEW 3

8. Inventory control: Costing helps to a great extent with respect to control of stock of raw materials, work-in-
progress and finished goods.
9. Increasing productivity: Productivity of material and labour is inevitable for any organization to attain
growth and expansion. Costing helps in these areas to increase productivity.
10. Enhancing efficiency: As costs are determined at each stage, wastages can be detected and remedial measures
can be taken without delay; efficiency of an organization is enhanced, which in turn maximizes the profitability.
11. Boon to creditors: Costing records serve as a reliable and authentic document by which creditors (investors,
banks and money-lending institutions etc.) can repose faith on business organizations and extend advances
without any hesitation and with confidence.
12. Beneficial to employees: Costing records are easily accessible and transparent to employees because of
which they are benefitted monetarily by way of incentive, bonus etc. This strengthens the cordial relationship
between the employer and employee, and industrial peace environment prevails.
13. Boost to national economy: Prosperity in industrial sector will reflect in the general economy of any nation
by way of increased revenue to the government. Better system of cost accounting paves the way to achieve
higher GDP growth of the nation.

1.4 COST ACCOUNTING AND OTHER BRANCHES OF ACCOUNTING

Accounting is classified into:
1. Financial accounting and
2. Management accounting
First, we shall look into the relationship between cost accounting and financial accounting. Notwithstanding the
fact that both are concerned with systematic recording and presentation of data based on the same records and on
the same principles of debit and credit rules, they differ widely in the aspects shown in Table 1.1.

Table 1.1 Differences between Financial Accounting and Cost Accounting

Basis of Distinction Financial Accounting Cost Accounting
1. Aim Financial accounting Cost accounting aims at strengthening the
aims at strengthening the interests of the management for proper planning, opera-
business, proprietors and all others tion, control and decision-making.
associated with it.
2. Statutory requirement These accounts have to comply with Cost accounts have to comply with the
statutory requirements such as company requirements of management. Of late,
act and income tax act. certain industries have to meet the require-
ments of company act (only obligatory).
3. Emphasis This emphasizes the measurement of Cost accounting emphasizes ascertainment
profitability. of costs.
4. Profit analysis This analyses accounts and discloses the This discloses profit made on each product,
profit of the firm as a whole. process, job or service.
5. Nature of recording Transactions are recorded, classified and Transactions are recorded and analysed in
transactions analysed in a subject manner, i.e., an objective manner, i.e., according to the
according to the nature of expenditure. purpose for which costs are incurred.
6. Facts and estimates Financial accounts deal mainly with facts Cost accounting deals with facts and figures
and figures only. besides estimates.
7. Valuation of stock Stocks are valued at cost or market price Stocks are valued at cost price.
whichever is less.
8. Nature of report of Costs are reported in aggregate in financial Costs are broken into unit basis in cost
costs accounts. accounting.
9. Relative efficiency This does not provide information on the Cost accounting provides information on
relative efficiency of workers, plant, relative efficiency of workers, plant and
machinery etc. machinery.
(Continued)

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 4 COST ACCOUNTING

Table 1.1 (Continued )

Basis of Distinction Financial Accounting Cost Accounting
10. Type of transactions Financial accounts are concerned with Cost accounts are concerned with internal
and basis external transactions, which form the basis transactions, which do not form the basis of
of payment or receipt of cash. payment or receipt of cash.
11. Periodicity of report Financial statements are prepared and Cost reports are prepared and reported
reported only at specified period, usually most frequently, whenever management
once in a year. requires it.
12. Degree of accuracy Financial statements are more accurate as These are comparatively less accurate as
they are subject to scrutiny by statutory they are intended mainly for the
authorities. management.
13. Classification Financial accounts do not classify accounts, In cost accounting, they are classified prop-
expenses etc. erly and analysed perfectly.
14. Information Proper and adequate information on Proper and adequate information on each
each aspect of business is not provided to and every aspect of business is provided to
outsiders, though it extends information outsiders.
to outsiders.

1.4.1 Cost Accounting and Management Accounting

Some accounting professionals are of the view that cost accounting is a branch of management accounting. Such
a close relationship exists between the two categories of accounting. Both are internal to the organization. Both
have the same objectives—for instance, both assist management in its functions of planning, controlling and
decision-making. Both use more or less similar techniques such as marginal costing and budgetary control. But
cost accounting and management accounting differ in certain areas. The main points of distinction between cost
accounting and management accounting are shown in Table 1.2.
Table 1.2 Difference between Cost Accounting and Management Accounting

Basis of Distinction Cost Accounting Management Accounting

1. Objective Cost accounting is concerned with the This is mainly concerned with (i) the impact
ascertainment, allocation, distribution and (ii) effect aspects of costs.
accounting aspects of costs.
2. Hierarchy level In an organization, cost accountant is Management accountant is placed at a higher
placed at a lower hierarchy level than hierarchy level than cost accountant.
management accountant.
3. Accounting data Cost accounting data are generally derived Management accounting data are derived
by using management accounting from cost accounts and financial accounts.
techniques.
4. Relevance and Relevance and objectivity of data is not Relevance and objectivity of data is higher
objectivity higher in cost accounting compared to than cost accounting.
management accounting.
5. Usage of tools Tools and techniques used in cost account- A wide range of tools and techniques are used
and techniques ing are limited such as standard costing, such as ratio analysis, cash flow in addition to
budgetary control, break-even analysis. tools and techniques used in cost accounting.
6. Period of Cost account is generally concerned with Management account is concerned both with
planning short-term planning. short-term and with long-term planning.
7. Evaluation of It is mainly concerned with assisting in It is concerned with both assisting manage-
performance management functions and in the ment in its functions and in evaluating the
evaluation of performance. performance of the management.
8. Approach Cost accounting is generally historical It is generally futuristic in its approach.
in its approach. It projects the past.
9. Inclusion of other Cost accounting does not include financial It includes cost accounting as well as tax
branches of accounting. accounting and tax accounting. accounting.

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 COST ACCOUNTING—AN OVERVIEW 5

1.5 CONCEPTS OF COST

It is difficult to define the term “cost”. The term “cost” is ambiguous and uncertain. In general, cost means the
amount of resource used in exchange for goods or services. The resources used shall be money or money’s worth,
which is usually expressed in monetary units. The terminology of CIMA defines cost as “the amount of expenditure
(actual or motional) incurred on, or attributable to, a specified thing or activity”. It may also be defined as Cost
is a foregoing, measured in monetary terms, incurred or potentially to be incurred to achieve a specific objective.
A cost has to be looked in relation to (i) the nature of business (ii) purpose, (iii) different conditions and (iv) the
context in which it is used.
As already said, cost is measured in terms of money. However, costs which do not give rise to actual cash outlay,
namely, imputed (actual) or notional cost, are to be considered while decision-making. But these are not available
from accounting records—for instance, interest on capital invested by the owner in the firm in notional cost.
1. Nature of business: A cost has to be studied in relation to its nature of business. For example, a manufactur-
ing organization is interested in knowing the cost per unit of its product, whereas the organizations rendering
services such as electricity and transport are interested in ascertaining The costs of services they undertook.
The cost per unit can be easily ascertained by dividing the total expenditure by number of units produced or
quantum of services rendered. This is relatively easy if the organization produces only a single product. But if
more than one product is produced, other factors have to be considered for determining the cost.
2. Purpose: A cost has to be studied in relation to its purpose. For example, the purpose is fixation of selling price
cost. All items of expenditure relating to production, administration and selling will have to be included. But if
the purpose is valuation of inventories, only cost of production will have to be taken into account. Hence, the
concept of cost varies according to the purpose. It differs from purpose to purpose and has different denotations.
3. Conditions: A cost has to be ascertained under different conditions also. For instance, while dealing with
inventory, work-in-progress is valued at factory cost, whereas stock of finished goods is valued at production
cost. Different conditions lead to different modes of valuation of cost. Concept of cost varies thus.
4. Context: The term “cost” may not stand on its own and has to be qualified. It is a generic term. It is generally
used to include all the various types of costs. However, when the term is used specifically, it is always modified
with reference to the context costed by such descriptions as prime cost, fixed cost, variable cost, opportunity
cost and sunk cost. Each such modification implies a certain attribute which is important in computing and
measuring the cost.
Concept of cost is not precise and cannot be pinpointed. It is ever-widening. It has its own terminology. Hence,
different costs are to be used for different purposes.

1.6 CLASSIFICATION OF COSTS

Costs may be classified on different bases. They can be classified as follows:
1. By time (historical, predetermined)
2. By nature of elements (material, labour, overhead)
3. By association (product or period)
4. By traceability (direct, indirect)
5. By changes in activities or volume (fixed, variable, semi-variable)
6. By function (manufacturing, administration, selling, research and development)
7. Controllability (controllable, non-controllable)
8. Analytical and decision-making (marginal, uniform, opportunity, sunk, differential etc.)
9. By nature of expense (capital, revenue)
10. Miscellaneous (conversion, traceable, normal, total)
1.6.1 Classification on the Basis of Time
Costs can be classified into historical costs and predetermined costs.
1. Historical costs: Historical costs are determined after they are incurred actually. When production is com-
pleted, i.e., products reached their final stage of finished status, costs are available and on that basis costs

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