Traditionally, cost accounting is considered as the technique and process of ascertaining costs of a given thing. In sixties, the definition of cost accounting was modified as ‘the application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and ascertainment of profitability of goods, or services’. It includes the presentation of information derived therefrom for the purpose of managerial decision making. It clearly emphasises the importance of cost accountancy achieved during the period by using cost concepts in more and more areas and helping management to arrive at good
Cost and Management Accounting business decisions. Today, the scope of cost accounting has enlarged to such an extent that it now refers to the collection and providing all sorts of information that assists the executives in fulfilling the organisational goals. Modern cost accounting is being termed as management accounting, since managers being the primary user of accounting information are increasingly using the data provided by the accounts, setting objectives and controlling the operations of the business.
Accounting is a very old profession. Financial accounting is in use with the dawn of civilisation. As soon as counting and arithmetic started, and the use of money replaced the barter system, the financial accounting emerged in some form or other. However, cost accounting is traceable to the earlier part of the seventeenth century. The earliest reference of cost accounting can be found in Robert Loder’s farm accounts 1610–20. However, the industrial revolution in the 18th century brought about extensive mechanisation of production system resulting in large scale production.
Some sporadic efforts were made in U. K. and U. S. A. to install factory cost systems as far back as 1805. But the concept of prime cost was used around 1875 by some industrialists. Between 1885 and 1901, a number of publications from London and New York explained the cost of manufacture, the distribution of establishment charges, the commercial organisation of the factories, factory accounts – their principles and practices, and finally a complete text book on Cost Accounting Theory and Practice was published by J. L. Nicholson from New York in 1913.
The cost accounting concepts advanced further with the beginning of the First World War. The ‘cost plus’ concept was introduced during the war time in order to avoid delay in executing urgent supplies. The contracts were entered on the basis that the supplier would be reimbursed the cost ‘plus’ a fixed percentage to cover administration and other overhead expenses and profit. Immediately, two things happened. One, a demand for qualified persons to calculate cost and two, deliberation of cost concepts for identifying the items or elements that enter the cost.
The profession of cost accountancy got a real boost-up. More and more people got interested in the profession. In 1919, the Institute of Cost and Works Accountants was established in U. K. , which is now known as the Chartered Institute of Management Accountants (CIMA) at London. Simultaneously, in U. S. A. the National Association of Cost Accountants, which is now known as the National Association of Accountants, was also established at New York. Under the leadership of these two institutes, the profession and the concepts of cost accounting developed significantly.
Before the Second World War, the mechanism of standard cost accounting, budgetary control, flexible budgeting and direct costing became known in the U. S. A. and U. K. In India, prior to independence, there were a few cost Accountants, and they were qualified mainly from l. C. M. A. (now CIMA) London. During the Second World War, the need for developing the profession in the country was felt, and the leadership of forming an Indian Institute was taken by some members of Defence Services employed at Kolkata. Costing profession was in an embryonic stage at that time.
Basics of Cost Accounting India was established at Kolkata. The Institute has grown in stature, having Fellow, Associate and Student Members. The Institute controls its function through its Head Office at Kolkata and four Regional Offices at Mumbai, Kolkata, Delhi and Chennai. Each of the Regional Offices has several chapter Offices to look after the interest of the local members and the profession.
The profession assumed further importance in 1968, when the Government of India introduced selective Cost Audit under Section 233-B of the Companies Act, 1956 and framed Cost Accounting Record Rules, 1968 for this purpose. Although Cost Audit is not compulsory, but selective for a few nominated industries yet the profession was greatly benefited, and more persons are now interested to join the profession. Today, the extensive use of cost accounting techniques has led to new concept of information technology, operational control and performance measurement.
In financial accounts, the monetary transactions of the business are recorded, classified and analysed in an orderly manner, so as to prepare periodic results in the form of profit and loss account or income statement and balance sheet, indicating the financial position of the business at the end of that period.
The financial accounting is guided by various rules and regulations, some of which are mandatory. The system cannot normally deviate from the accepted accounting practices. The object of financial accounting is to provide information mainly to outsiders such as shareholders, investors, government authorities, financial institutions, etc. The analysis and interpretation of financial data contained in the income statement and the balance sheet enable persons interested in the business to make meaningful judgement about the profitability, liquidity and solvency of the enterprise.
Besides, income-tax, central excise, banks and insurance companies rely on the data contained in the financial statements. Cost accounting, on the other hand, deals with the ascertainment of the cost of product or service. It is a tool of management that provides detailed records and reports on the costs and expenses associated with the operations, mainly for internal control and decision making. Cost accounting basically relates to the utilisation of resources, such as material, labour, machines, etc. nd provides information like products cost, process cost, service or utility cost, inventory value, etc. so as to enable management taking important decisions like fixing price, choosing products, preparing quotations, releasing or withholding inventory, etc. The objective of cost accounting is to provide information to internal managers for better planning and control of operations and taking timely decisions. In the early stages, cost accounting was considered as an extension of financial accounting. Cost records were maintained separately.
Cost information and data were collected from financial books, since all monetary transactions are entered in the financial accounts only. After developing product cost or service cost and valuation of inventory, the costing profit and loss account is prepared. Cost and Management Accounting inancial books do not enter into product cost, while some of the expenses are included in cost accounts on notional basis i. e. without having incurred actual expense. However, a system of integrated account has been developed subsequently, wherein cost and financial accounts are integrated avoiding maintining two sets of books. The basic difference between financial and cost accounting may be summarised as follows: Financial Accounting
- Accounting of monetary transactions of the business.
- Consists of recording, classification and analysis of financial transactions.
- Leads to preparation of income statement and balance sheet at periodic interval.
- Aims at external reporting to the shareholders, investors, Government authorities and other outside parties.
- The accounting systems are mandatory and structured as per legal and other requirements.
- Subject to verification by external auditor.
Cost Accounting Accounting of product cost or service cost. Consists of developing product or service cost with elementwise cost breakdown. Leads to development of product or service cost, indicating profitability of each product or service as and when required.
Aims at internal reporting both routine as well as special reporting to managers for internal control and decision making. The system is much less structured and is not mandatory, except those covered by cost audit required u/s 233-B of the Companies Act, 1956 Cost audit is not compulsory but selective to some specific industries/products.Management accounting is not a specific system of accounts, but could be any form of accounting which enables a business to be conducted more effectively and efficiently.
Management accounting in the words of Robert S. Kaplan, is a system that collects, classifies, summaries, analyses and reports information that will assist managers in their decision making and control activities. Unlike financial accounting, where the primary emphasis is on reporting outsiders, management accounting focuses on internal planning and control activities. Therefore management accounting requires the collection, analysis and interpretation not only financial or cost data, but also other data such as sales, price, product demands and measures of physical quantities and capacities.
In the process, the system utilises all techniques of financial and cost accounting including marginal or direct costing, standard costing, budgetary control, etc. Management accounting therefore appears as the extension of the horizon of cost accounting towards newer areas of management. Management accounting is largely concerned with providing economic information to managers for achieving organisational goals. The information flow system is, therefore, extremely important while designing the system.
Basics of Cost Accounting activities take place. Service cost centres are those, which are ancillary and render services to the production cost centres, so that manufacturing activities can take place. In a biscuit manufacturing company, making, baking and packing are production cost centres while personnel, purchase, stores, canteen, accounts are service cost centres.
The main purpose of cost centre is two fold :
- Recovery of cost: Costs are collected, classified and accumulated in respect of a location, person or an item of equipment and then the costs are distributed over the products for recovery of incurred cost
- Cost control: Cost centres assist in making a person responsible for the control of expenditure incurred by the cost centre.
Manager of each cost centre shall control costs incurred in his area of responsibility. The size of the cost centre depends on the activity and operation, and feasibility of cost control.
Sub-cost centres are created if the size of the cost centres become too big from control point of view. Cost Unit While cost centres assist in ascertaining costs by location, person, equipment, operation or process, cost unit is a unit of product, service or a combination of them in relation to which costs are ascertained or expressed. The selection of suitable cost unit depends upon several factors, such as, nature of business, process of information, requirements of costing system, etc. but usually relates to the natural unit of the product or service.
For example, in steel and cement industry, the cost unit is ‘tonne’, while in transportation services, the unit may be passenger-kilometre or tonne-km, etc. It may be noted that while the former is a single cost unit, the latter is a composite unit, i. e. a combination of two units. Cost classification refers to the process of grouping costs according to their common characteristics, such as nature of expense, function, variability, controllability and normality. Cost classification can be done on the basis of time, their relation with the product and accounting period. Cost classification is also made for planning and control and decision making.
Thus, classification is essential for identifying costs with cost centres or cost units for the purpose of determination and control of cost :
By nature of expenses: Costs can be classified into material, labour and expenses as explained earlier.
By function: Costs are classified, as explained earlier, into production or manufacturing cost, administration cost, selling and distribution cost, research and development cost.
Production cost begins with the process of supplying material labour and services and ends with primary packing of the finished product. Administration cost is the aggregate of the costs of formulating the policy, directing the organisation and controlling the operations of an undertaking, which is not related directly to production, selling, distribution, research and development activity or function. Selling cost refers to the expenditure incurred in promoting sales and retaining customers.
Distribution cost begins with the process of making the packed product available for despatch and ends with making the reconditioned returned empty package available for reuse. Research and development cost relates to the costs of researching for new or improved products, new application of materials, or new or improved methods, processes, system or services, and also the cost of implementation of the decision including the commencement of commercial production of that product or by that process or method.
Pre-production cost refers to the part of development cost incurred in making trial production run preliminary to formal production, either in a new or a running factory. In a running factory, this cost often represents esearch and development cost also. Pre-production costs are normally considered as deferred revenue expenditure and are charged to the cost of future production.
By variability: Costs are classified into fixed, variable and semi-fixed / semi-variable costs according to their tendency to vary with the volume of output. Fixed costs tend to remain unaffected by the variation or change in the volume of output, such as supervisory salary, rent, taxes, etc. Variable costs tend to vary directly with volume of output, such as direct material, direct labour and direct expense.
By controllability: Costs can be classified under controllable cost and uncontrollable cost. Controllable cost can be influenced by the action of a specified member of an undertaking. Uncontrollable cost cannot be influenced by the action of a specified member of an undertaking.
METHODS OF COSTING
Various methods of ascertaining costs are available to suit the business need. But the basic principles are the same in every method. The choice of a particular method of costing depends on the nature of business of the concern.
There are two basic methods of costing viz.
- Specific order or job costing
- Continuous operation or process costing
All other methods are either variation of job or process costing or are just techniques used for particular purpose under specific conditions. Brief description of each of the methods are as follows: Job Costing Job costing is the basic costing method applicable to those industries where the work consist of separate contracts, jobs, or batches, each of which is authorised by a specific order or contract.
The most important feature is that each job or order can be identified at each stage of production and therefore, costs which can be directly identified with a job or order is charged to that job or order. A share of indirect expenses is also charged to the same. Variation of job costing are contracts costing and batch costing.
Contract costing is the form of specific order costing, generally applicable where work is undertaken to customer’s special requirements and each order is of long duration, such as building construction, ship building, structurals for bridge, civil construction, etc. The work is usually done outside the factory. Batch costing is that form of specific order costing which applies where similar articles are manufactured in batches either for sale or for use within the undertaking. Costs are collected according to batch order number and total costs are divided by total numbers in a batch to arrive at unit cost of each job.
The method is applicable in aircraft, toy making, printing industries, etc. Operation Costing Process and Services Process costing method is applicable where goods or services result from a sequence of continuous or repetitive operations or processes and products are identical and cannot be segregated.
Costs are charged to processes and averaged over the units produced during the period. Examples are food processing, chemical, dairies, paints, flour, biscuit making, etc. Variations of process costing are found in single or output costing, operation costing, departmental costing as explained below: Single or output costing is used when the production is uniform and identical and a single article is produced. The total production cost is divided by the number of units produced to get unit or output cost. Examples are mining, breweries, brick making, etc. Operation costing refers to the methods where each operation in each stage of production or process is separately costed. Thereafter, the cost of finished unit is determined.
If one product passes through a number of departments for completion, cost of each department will be picked up and the total unit cost will be the aggregate of unit cost of the departments through which the product passes. Service or Operating Costing Operating costing is applicable to service organisation that do not make or sell tangible goods but render services. Examples are transportation companies, hotels, hospitals, schools, electric and gas generation and distribution, etc. Cost of providing and operating a service is ascertained and unit cost is found out by dividing total cost of units of services rendered.
Composite units, such as tonne-mile, passenger-kilometre, KWH, etc. are generally used. Composite or multiple costing: The manufacture of certain products involve a lot of complexities and therefore, any one of the basic methods of job or process costing cannot be used for collecting and presenting product cost. In fact, industries making complex products such as cycles, automobiles, aeroplanes, radios, etc. use combination of various costing methods and the methods are known as composite or multiple costing.