COST ACCOUNTING – I

Module I : Introduction to Cost Accounting

Introduction :

Accounting provides information to a diverse group of people such as

shareholders, managers, creditors, tax authorities etc. On the basis of the
purpose for which this information is used, accounting is divided into three
parts :

1. Financial Accounting
2. Cost Accounting
3. Management Accounting

Financial Accounting is mainly concerned with recording business transactions

in the books of accounts for the purpose of presenting final accounts to
management, share holders and tax authorities. It consists mainly of Profit &
Loss Account, Balance Sheet and Cash Flow Statement

Cost Accounting started as a branch of financial accounting. But with the

increased complexity of modern industry cost accounting gained importance as
a separate stream of accounting. It is concerned with the ascertainment of
past, present and future costs of products manufactured or services supplied.
It is primarily developed to meet the needs of the various levels of the
management.

Management Accounting is concerned with all such accounting information

that is useful to management. It is mostly concerned with the provision of
accounting information for management activities such as decision making,
planning and controlling, etc.

Meaning of Costing and Cost Accounting :

The Chartered Institute of Management Accountants (CIMA), London has

defined costing as “the techniques and processes of ascertaining costs.” Thus
costing simply consists of principles and rules which are used for determining :

a) the cost of manufacturing a product, e.g. motor car, furniture, chemical,

etc.
 b) the cost of providing a service, e.g. electricity, transport, education, etc.

Difference between costing and cost accounting :

Both these terms are usually used inter changeably, but there is a difference
between the two. Costing is simply determining costs by using arithmetical
methods. Cost Accounting on the other hand denotes the formal accounting
mechanism by means of which costs are ascertained by recording them in the
books of accounts i.e it means costing using double entry system of
accounting.

Cost Accountancy is thus the art, science and practice of a cost accountant.
Cost Accountancy includes costing, cost accounting, cost control and cost
audit.

Objectives and Functions of Cost Accounting :

The main objectives of cost accounting are as follows :

1. Ascertainment of Cost :
This is the primary objective of cost accounting. In cost accounting, cost
of each unit of production, job, process or department etc. is
ascertained. Not only actual costs incurred are ascertained but costs are
also pre determined for various purposes. For cost ascertainment,
various methods and techniques are employed under different
situations.

2. Cost control and cost reduction :

Cost Accounting aims at improving profitability by controlling and
reducing costs. For this purpose, various specialized techniques like
standard costing, budgetary control, inventory control, value analysis,
etc. are used. This objective of cost control and cost reduction is
becoming increasingly important in the present scenario because of
growing competition in the business world.

3. Guide to business policy :

Cost accounting aims at serving the needs of the management in
conducting the business with utmost efficiency. Cost data provides
 guidelines for various managerial decisions like make or buy, selling
below cost, utilization of idle plant capacity, introduction of new
product, etc.

4. Determination of Selling Price :

Cost Accounting provides cost information on the basis of which selling
prices of products or services may be fixed. In periods of depression,
cost accounting guides in deciding the extent to which the selling prices
may be reduced to meet the situation.

Advantages of Cost Accounting :

The deficiencies of financial accounting may be stated as the advantages of

cost accounting because the latter has emerged to overcome the limitations of
the former. The principle advantages of cost accounting are as follows :

Advantages to the Management :

1. Reveals profitable and unprofitable activities :

On the basis of the information from cost records the management may
take steps to reduce or eliminate wastages and inefficiencies occurring
in any form such as idle time, under utilisation of plant capacity spoilage
of materials, etc.

2. Helps in Cost Control :

Cost accounting helps in controlling costs with special techniques like
standard costing and budgetary control.

3. Helps in decision making :

It supplies suitable data and other related information for managerial
decision making such as introduction of a new product line, replacement
of old machinery with an automatic plant, make or buy, etc.

4. Guides in fixing selling prices :

Cost is one of the most important factors to be considered while fixing
prices. A system of cost accounting guides the management in the
 fixation of selling prices, particularly during depression period when
prices may have to be fixed below cost.

5. Helps in inventory Control :

Perpetual inventory system, which is an integral part of cost accounting,
helps in the preparation of interim profit and loss account. Other
inventory control techniques like ABC analysis, level setting, etc are also
used in cost accounting.

6. Aids in formulating policies :

Costing provides information that enables the management to formulate
production and pricing policies and preparing estimates of contracts and
tenders.

7. Helps in cost Reduction :

It helps in the introduction of a cost reduction programme and finding
out new and improved ways to reduce costs.

8. Reveals idle capacity:

A concern may not be working to full capacity due to reasons such as
shortage of demand, machine breakdown or other bottlenecks in
production. A cost accounting system can easily work out the cost of idle
capacity so that the management may take immediate steps to remedy
the position.

9. Checks the accuracy of financial accounts:

Cost accounting provides a reliable check on the accuracy of financial
accounts with the help of reconciliation between the two at the end of
the accounting period.

10.Prevents frauds and manipulation:

Cost audit system, which is a part of cost accountancy, helps in
preventing manipulation and frauds and thus reliable cost data can be
furnished to the management and others.
Cost concepts and classifications :

Meaning of cost :

Cost is the amount if expenditure, actual or notional, incurred or attributable

to a given thing. “(CIMA, London)

Meaning of expense :

Expense is defined as an expired cost resulting from a productive usage of an

asset. In other words, an expense is that portion of the revenue earning
potential of an asset which has been consumed in the generation of revenue.
Unexpired or unconsumed cost is recorded as an asset in the balance sheet.
Such an unexpired cost is converted into an expense when it expires while
helping to earn revenue.

Meaning of Loss :

Loss is defined as reduction in a firm’s equity, other than from withdrawals of

capital for which no compensation value has been received. A loss is an expired
cost resulting from the decline in the service potential of an asset that
generated no benefit to the firm.

Meaning of Cost Centre :

A cost centre is defined as a location, person or item of expenditure (or group

of these) for which costs may be ascertained and used for the purpose of
control. Thus it refers to a section of the business to which costs can be
charged. It may be a location, an item of equipment or a group of these. The
main purpose of ascertaining the cost centre is control of cost.

Types of cost centres :

1. Production Cost Centre :

These are those centres where actual production work takes place.

2. Service Cost Centre :

These are those centres which are ancilliary to and render services to
production cost centres.
A cost accountant sets up cost centres to enable him to ascertain the costs he
needs to know. The person in charge of the cost centre is held responsible for
the control of cost of that centre.

Meaning of Cost unit :

A cost unit is defined as a unit of product or service in relation to which const

are ascertained. A cost unit is unit of measurement of cost. Cost units may be
of two types :

1. Units of production, eg. A tone of steel, a metre of cable, etc.

2. Units of service, eg. Passenger miles, cinema sears, consulting hours, etc.

Methods of Costing :

1. Job Costing
2. Batch Costing
3. Contract or Terminal Costing
4. Unit/Single/Output Costing
5. Process Costing
6. Operation Costing
7. Operating Costing
8. Departmental Costing
9. Multiple Costing

Techniques of Costing :

1. Standard Costing
2. Budgetary Control
3. Marginal Costing
4. Total Absorption Costing
5. Uniform Costing

Difference Between Cost Accounting and Financial Accounting :

1. Purpose
2. Statutory Requirements
3. Analysis of Cost and Profit
4. Period of Reporting
5. Control aspect
6. Types of Costs
7. Format of presenting information
8. Types of transactions recorded
9. Final or End user