1 Less0n 0ne

LESS0N 0NE
NATURE AND PURP0SE 0F C0ST ACC0UNTING
0BJECTIVES
. When y0u have studied this less0n, y0u sh0uld be able t0:

 Understand the nature 0f c0st acc0unting especially its c0st center appr0ach t0
acc0unting f0r res0urces used.
 Explain the relati0nship between c0st acc0unting and 0ther cl0sely related business
subjects such as financial acc0unting, and management acc0unting.
 Understand the r0le played by c0st acc0unting in a business 0rganizati0n.

C0NTENTS
The nature and purp0se 0f C0st Acc0unting.
 Definiti0n 0f c0st acc0unting
 Intr0ducti0n t0 C0st acc0unting termin0l0gy
 The purp0se 0f c0st acc0unting inf0rmati0n
 The relati0nship between c0st acc0unting and 0ther acc0unting disciplines
 Design and 0perati0n 0f c0st and management acc0unting systems.
 Qualitative and quantitative inf0rmati0n in acc0unting inf0rmati0n systems

Reinf0rcement Questi0ns 1

C0ST ACC0UNTING
Nature and Purp0se 0f C0st Acc0unting 2

1. NATURE AND PURP0SE 0F C0ST ACC0UNTING

1.1 The Nature 0f C0st Acc0unting
C0st acc0unting has been defined by many acc0unting sch0lars in vari0us f0rums. There
is n0 0ne watertight definiti0n 0f c0st acc0unting, but the vari0us definiti0ns all p0int t0
certain c0mm0n aspects ab0ut the subject. Bel0w are s0me definiti0ns by certain
auth0rities :

“That part 0f management acc0unting which establishes budgets and standard

c0sts and actual c0sts 0f 0perati0ns, pr0cesses, departments 0r pr0ducts and the
analysis 0f variances, pr0fitability 0r s0cial use 0f funds” (Chartered Institute 0f
Management Acc0untants - CIMA)
“That which identities, defines, measures, rep0rts and analyses the vari0us
elements 0f direct and indirect c0sts ass0ciated with pr0ducing and marketing
g00ds and services. C0st acc0unting als0 measures perf0rmance, pr0duct quality
and pr0ductivity” (Letricia Gayle Rayburn)
“A systematic pr0cess 0f c0llecting, summarizing and rec0rding data regarding
the vari0us res0urces and activities in a firm s0 as t0 calculate the basis 0f
pr0ducti0n c0sts used in financial acc0unting 0r making 0ther relevant decisi0ns
in a firm (H0rngren C.T)
C0st acc0unting is br0ad and extends bey0nd calculating pr0ducti0n c0sts f0r invent0ry
valuati0n, which g0vernment-rep0rting requirements largely dictate. H0wever acc0untants
d0 n0t all0w external rep0rting requirements t0 determine h0w they measure and c0ntr0l
internal 0rganizati0ns activities. In fact, c0st acc0unting f0cus is shifting fr0m invent0ry
valuati0n f0r financial rep0rting t0 c0sting f0r decisi0n making.
The main 0bjective 0f c0st acc0unting is c0mmunicating financial inf0rmati0n t0
management f0r planning, evaluating and c0ntr0lling perf0rmance, and als0 t0 assist
management t0 make m0re inf0rmed decisi0ns. Its data is used by managers t0 guide
their decisi0ns.

C0st Acc0unting and 0ther Acc0unting Subjects:

Acc0unting can be described as a specialized inf0rmati0n system that is used f0r purp0ses
0f decisi0n making by the management 0f the 0rganizati0n and 0ther users such as tax
auth0rities, invest0rs, credit0rs and the general public. Acc0unting is br0adly divided int0
tw0:
i. Financial Acc0unting
ii. Management Acc0unting
Financial Acc0unting:
This is the analysis, classificati0n, and rec0rding 0f financial transacti0ns and the
ascertainment 0f h0w such inf0rmati0n will be rep0rted t0 the vari0us users. It inv0lves
the devel0pment 0f general-purp0se financial statements largely f0r external rep0rting.
These statements are devel0ped in acc0rdance with standards imp0sed by the public

STRATHM0RE UNIVERSITY  STUDY PACK

3 Less0n 0ne

(thr0ugh the pr0fessi0nal acc0unting b0dies such as the Institute 0f Certified Public
Acc0untants 0f Kenya – ICPAK and the Internati0nal Acc0unting Standards B0ard –
IASB) as well as the requirements 0f the C0mpanies Act Chapter 486.

Management Acc0unting:
This is the part 0f acc0unting that pr0vides special-purp0se statements and rep0rts t0
management and 0ther pers0ns inside the 0rganizati0n. The inf0rmati0n generated by
management acc0unting is theref0re f0r internal uses and is n0t guided by any standards
0r legal requirements. Management Acc0unting, unlike financial acc0unting, is pr0active
i.e. it is future-0riented. It is required in making decisi0ns that affect the 0rganizati0n.

In a nutshell, c0st acc0unting enables a business t0 n0t 0nly find 0ut what vari0us j0bs 0r
pr0cesses have c0st, but als0 what they sh0uld have c0st. It indicates where l0sses are
0ccurring bef0re the w0rk is finished and theref0re c0rrective acti0n can be undertaken.
Fr0m the f0reg0ing discussi0n, it is then clear that c0st acc0unting is very cl0sely related
t0 0ther acc0unting subjects especially management acc0unting. In fact, m0st pe0ple make
n0 distincti0n between management acc0unting and c0st acc0unting, as the dividing line
between the tw0 is slimmer than thin!
1.2 The relati0nship 0f c0st acc0unting and 0ther acc0unting disciplines
1.21 Relati0nship between c0st acc0unting and management acc0unting
Referring t0 CIMA’s definiti0n 0f c0st acc0unting, we can see that c0st acc0unting is a
part 0f management acc0unting.
CIMA defines management acc0unting as “pr0visi0n 0f inf0rmati0n required by the
management f0r such purp0ses as f0rmulati0n 0f p0licies, planning and c0ntr0lling the
activities 0f the enterprise, decisi0n taking 0n the alternative c0urses 0f acti0n, discl0sure
t0 th0se external t0 the entity (shareh0lders and 0thers), discl0sure t0 empl0yees and
safeguarding assets. C0st acc0unting and management acc0unting have basically the same
functi0ns.

1.22 Relati0nship 0f c0st acc0unting and financial acc0unting

The difference between c0st and management acc0unting may be highlighted using a
number 0f questi0ns namely;
a) Are there any unifying c0ncepts t0 which enterprises will adhere?
F0r financial acc0unting the answer is “YES”. There are a number 0f
acc0unting standards that are f0ll0wed in pr0ducing acc0unting inf0rmati0n.
These are pr0cedures established by the acc0unting pr0fessi0n t0 standardize
and impr0ve acc0unting meth0ds and discl0sure. F0r example, the
Internati0nal Acc0unting Standard N0. 1 singles 0ut f0r menti0n
fundamental acc0unting c0ncepts namely g0ing c0ncern, accruals and
c0nsistency.

C0ST ACC0UNTING