Cost Accounting: Nature and Role

1. Definition of terms;
2. Nature of cost accounting;
3. Objectives of Cost Accounting;
4. Comparison of Financial Accounting and Cost Accounting &
Management Accounting;
5. Functions of cost Accounting
6. Relevance of costing to public sector .
7.The functions of a cost accounting system.
8. Review questions
1. Definition of terms
Cost: Definition.
Cost of a product or cost of service refers to the cost of the various components
which make the final product or to deliver the service.
Cost accounting: Definition.
Cost accounting is “the establishment of budgets, standard costs (benchmark for
comparison with actual) and actual costs of operations, processes, activities or
products; and the analysis of variances, profitability or the social use of funds”.
Cost accounting is the process of accounting or recording all attributable and
allocable costs for a product or service, beginning with recording of income and
expenditure relating to the product and ending with preparation of statistical data.
Costing is essentially an activity of assigning the appropriate costs to a product and
creating a data for future references as regards the cost relating to it
1. Definition of terms
• Cost accounting process:
Collection of relevant cost data
Allocation and apportionment of cost
Recording of income and expenses
This data is used for;
i. Preparation of statistical data
ii. Management reports
iii. Various cost accounts
1. Definition of terms
Its main objective is the creation of an underlying data for use in
management accounting. This should include recording of:
1. Cost of goods produced or services rendered
2. Cost of combinations of activities grouped as a cost centre
3. Accumulation of revenues Profitability at any level
4. Optimum selling prices, ensuring all costs are covered
5. Value of inventory
6. Future costs
7. Actual cost versus budgeted cost for budgetary control
1. Definition of terms
• Cost accounting systems can be found in all type of organisations but
are highly developed and extensively used in the manufacturing
sector. This is because industry is sensitive to costs, and the
production costs need to be monitored and controlled effectively for
the profit margins to be at a desired level. Cost accounting can be,
and is generally, applied to all areas of the organisation. It is not
department specific.
Cost object: Definition. A product, service, item of equipment or
geographical location for which a separate cost determination is
required is known as a cost object.
1. Definition of terms
• A cost object is an activity, a unit of product or service, a customer, or
a segment of an organisation for which management needs a
separate measurement and accumulation of costs.
• Costs assigned to a cost object are either direct or indirect. A cost that
can be traced conveniently and assigned to a cost object in a cost-
effective manner is a direct cost.
• Indirect costs cannot be so easily traced to the products. Without a
direct relationship to the cost object, an indirect cost needs to be
assigned to the products or cost objects using a basis of allocation.
1. Definition of terms
Cost unit: Definition. A unit of product or service in relation to which
costs are determined is known as a cost unit.
A cost unit is a quantity, which may be one or more of products that
has a relationship with costs and which can be easily expressed in
money. Cost unit is the smallest unit for which cost is accumulated.
Cost centre: Definition. Production or service department, function,
activity, person or item of equipment for which costs are accumulated
is known as a cost centre.
2: Nature of cost accounting
The nature of cost accounting can be discussed as follows:
1. Cost accounting is a discipline: cost accounting, as a body of knowledge, as its
own established set of principles, conventions, concepts and rules which can be
applied to business situations as required. Thus, cost accounting is considered to
be an organised discipline.
2. Cost accounting is both science and art: cost accounting is an organised body of
knowledge, encompassing various disciplines like financial accounting, inventory and
production management, law, data processing, etc. Cost accountants must possess
inter disciplinary knowledge to carry on their tasks of determining cost of production,
selling price, assisting management to take important policy decisions, etc. The
principles and practices of cost accounting are established and proven knowledge
and can be applied in many industries. Thus, cost accounting is a science.
2: Nature of cost accounting
• Although the principles, concepts and conventions of cost accounting are
organised and systematic in nature, the cost accountants need to use their
personal skills and competence to apply these principles and conventions while
using the cost accounting techniques to aid in managerial decision making. Cost
accountants assist management in decisions like, establishing selling prices of
products / services, deciding whether to outsource an activity, deciding whether
to continue particular operations or not , etc. Thus, cost accounting is an art.
3. Cost accounting is a profession: a profession refers to an activity requiring
application of specialised knowledge which needs to be acquired through academic
studies and the application and conduct of which is regulated through a
representative body. Cost accounting is a profession since it satisfies the following
basic premise of a profession
2: Nature of cost accounting
a) Specialised body of knowledge: it has already been established earlier that
cost accounting is a specialised discipline, the knowledge of which can be
acquired by undergoing formal academic training.
(b) Representative associations: all over the world there are representative
bodies of cost accountants, like the Chartered Institute of Cost and Management
Accountants (CICMA) of Nigeria, the Institute of Cost and Works Accountants of
India (ICWAI), Institute of Certified Cost and Management Accountants (ICCA) of
United States, etc.
(c) Codes of conduct: the professional qualifications, activities and behaviours of
cost accountants are regulated by the representative bodies to which they belong
to, through codes of conduct developed and implemented by those bodies.
These bodies also spell out ethical codes to be practices by the cost accountants
3. Objectives of cost accounting
• The primary objectives of cost accounting is to ascertain costs, determine selling
price and record, analyse, summarise and present to the management cost
accounting data which would enable them to take informed decisions and control
costs. These objectives are pursued with an intention to frame and implement
appropriate ways to record, classify and allocate expenditures on material, labour
and overheads so that cost of production, selling prices and profits can be
accurately determined.
The main objectives of cost accounting are discussed below:
1. Ascertaining cost: this is the most important objective as the success of the entire
cost accounting system lies on the efficiency with which the cost of the product or
service in question is determined. The cost of production is usually ascertained in
terms of ‘per unit’, for example, cost per ton, cost kilogram, cost per meter, etc
3. Objectives of cost accounting
• Ascertainment of cost involves:
(a) The allocation of costs.
Example: The total costs incurred, Tshs10,000,000, will be allocated to
the various departments in which these are incurred for example,
Tshs5,000,000 allocated to the production department, Tshs3,000,000
allocated to distribution department and Tshs2,000,000 allocated to
the marketing department.
(b) The collation of such costs into meaningful groups: the costs thus
allocated are split into groups such as production overheads, selling
overheads and so on.
3. Objectives of cost accounting
(c) The application of these costs to inventory, products and services: the
costs thus grouped are ultimately charged to the units produced using
suitable bases for absorption. For example, the production overheads are
absorbed on the basis of labour hours required per unit.
2. Determination of selling price: maximising profit is the primary aim of
every business. In order to fulfil this aim, it is very important that sufficient
revenue is generated by selling the product / service at the most appropriate
price. Cost ascertained form the basis of determination of the selling price
(selling price equals to cost of production plus a profit margin). Cost
accounting provides accurate cost information related with the various stages
of production, thus, enabling the management to determine the selling price.
3. Objectives of cost accounting
3. Controlling and reducing cost: cost accounting aims at controlling and reducing
the costs incurred by an organisation in the various stages of manufacturing a
product (like, material procurement, hiring and deploying staff, production process,
etc.) or rendering a service. Techniques like inventory control, budgetary control,
standard costing, etc. are used for controlling and reducing costs. The steps
involved in cost control include:
1. Establishing pre-determined cost standards
2. Measuring actual costs during the production process
3. Comparing the actual costs against the pre-determined standards and
identifying variances (if any)
4. Investigating into the causes of such variances and taking corrective measures
where ever required.
3. Objectives of cost accounting
4. Ascertaining costing profit: cost accounting aims at ascertaining activity-wise
and product-wise profits. For this, the revenue / savings generated by each
activity / product is matched against the cost involved in performing the activity
or manufacturing the product. Profit statements can be generated at various
stages and periods of time as required by the management for decision making.
Such reporting of profits enables appropriate business analysis and improves
efficiency of operations.
5. Facilitating preparation of financial and other statements: financial
statements (like, the Statement of Comprehensive Income and the Statement of
Financial Position) are prepared either annually or semiannually. Cost accounting
system records all costs and revenues in shorter periods efficiently. Such data can
be used in preparing consolidated financial statements at the year end.
3. Objectives of cost accounting
6. Improving operational efficiency: cost accounting, through various
activities associated with ascertaining and controlling costs, enables an
organisation to reduce wastages, identify loopholes in various processes,
identify sources of economies associated with various resources, etc.,
thereby aiming at improving its overall efficiency.
7. Helping management in decision making: decision making forms one
of the prime responsibilities of the management of an organisation.
Good decisions need to be backed by relevant, accurate and timely
information, especially information relating to cost. Cost accounting aims
at presenting relevant information in a systematic manner to the
management so that informed and good quality decisions can be taken.
3. Objectives of cost accounting
• Managers depend upon cost information to formulate the operative
policies, some of which have been listed below:
No. Type of decision Meaning Information required to take these
decisions
(a) Product mix decision Which product are demand for the products offered
profitable and should availability of resources feedback from
continue to be offered customers political or technological
impact on the product
(b) Make or buy determining whether an availability of resources to produce the
decisions organisation would be product is the product readily available?
better off making a cost incurred if product is purchased
product or buying it
(c ) Discontinuation determining whether an cost of closing down any operation or
decisions operation or division division alternative uses of the assets of
should be closed down discontinued operations
(d) Pricing decisions determining if an competitors’ pricing policies customers’
organisation should price expectations impact of price on
3. Objectives of cost accounting
8. Making comparison possible: cost accounting aims to help
management compare the holistic performance of an organisation over
various time periods and across departments and business units. Such
comparative data help management to take various policy decisions.
4. Comparison of Financial Accounting and
Cost Accounting
• Cost accounting is “an integral part of management concerned with
identifying, presenting and interpreting information”.
• Importance of cost and management accounting
Cost accounting is used for:
Recording of materials, labour and overhead cost
Budgetary control
Price determination
Profitability
Future cost
Collation into meaningful groups
4. Comparison of Financial Accounting and
Cost Accounting
• At the moment we have a brief idea of what cost accounting and
management accounting are, their nature and scope, the type of information
generated by them and how one builds on the other to provide useful
information for management decision making. It is a process of preparation
of financial information that can be used by the internal management of the
organization.
• Financial accounting is collecting, classifying, recording and summarising the
financial transactions for the purpose of presenting the financial results of an
organisation for the given period.
• Financial accounting is the preparation of financial statements for use mainly
by persons or organisations external to the organisation. These may include:
4. Comparison of Financial Accounting and
Cost Accounting
1. Customers
2. Suppliers
3. Inland revenue
4. Shareholders
5. Financial institutions
The underlying data used in both cost and management accounting and
financial accounting is the same, but the information created from
these two sets of accounts differs. This is because the method of
analysing the data is different under these two accounting systems
4. Comparison of Financial Accounting and
Cost Accounting
Category Financial accounting Cost and management accounting
Time span Defined period – SOCI (income statement) - Period appropriate for purpose For e.g., the
usually 1 year Specific date - statement of sales data pertaining to the two quarters
financial position as on last day of the above
period
Statutory Legal requirement Management choice but cost records are
recommended at times.
Format All numbers are in aggregate and for the According to management choice and purpose
organisation as a whole. Financial accounts are of information. For e.g., the quantitative data
consolidated for the entire organisation. pertaining to the production in the past three
weeks for analysing whether the targets were
met.
Focus All numbers are in aggregate and for the Numbers are broken up into meaningful chunks
organisation as a whole. Financial accounts are to aid decision-making, for e.g., cost per
consolidated for the entire organisation. product or service. Management accounts focus
on specific areas of an organisation’s activities

Type of Mainly contains monetary value Incorporates non-monetary measures also such
information as machine hours, tonnes, and manhours. Cost
5. The functions of cost accounting
All the points discussed under ‘Objectives of cost accounting’ (ascertainment of cost,
selling price and profit, controlling and reducing cost, helping management in decision
making and preparation of other financial statements), are a part of the functions of a
cost accounting system as well. Apart from those already detailed in the above section,
following are some of the important functions of a cost accounting system:
Material management: material can be in form of raw material, work in progress and in
finished goods based on the stage that they are in the production process:
1. Raw material: purchased goods that form the basis of the final product.
2. Work-in-progress: an intermediate stage between raw materials and finished
product. These are raw materials for which a portion of work is performed but not
competed. These are no longer a part of raw materials and not yet a part of finished
goods.
3. Finished product: goods which are ready for sale
5. The functions of cost accounting
Example
Cotton Moods Inc is a garment manufacturing company. Their raw materials
would be cloth, threads; work-in-progress would be inventory at any stage
between the raw cotton and the finished product i.e. semi-finished cloth that yet
to be polished and finished goods inventory will be garments ready for dispatch.
In addition to this, material is classified as direct material and indirect material
based on the role that they play in the production process: Direct material:
I. Direct material is that part of material that can be specifically attributed to a
unit of production or a specific job or service provided.
II. Indirect material: cannot be directly attributed to a specific unit of
production
5. The functions of cost accounting
• Managing materials by maintaining proper sets of accounts for it is a
part of the cost accounting system.
• Accounting for material costs includes the whole procedure that ranges
from the purchase of raw materials to their issue for production.
Material costs are normally direct costs. They are part of the cost per
unit. However, indirect materials form a part of indirect costs. These are
termed as overheads.
• Budgeting and budgetary control: a budget helps an organisation to
plan its objectives for the future and the methodology to achieve these
objectives. Budgeting is an important function of cost accounting.
5. The functions of cost accounting
Definition
A budget is a quantitative statement for a defined period of time, which may
include planned revenues, expenses, assets, liabilities and cash flows. A budget
provides a focus for an organisation aids the co-ordination of activities and
facilitates control. Planning is achieved by means of a fixed master budget,
whereas control is generally exercised through the comparison of actual costs
with a flexible budget.
A budgetary control system (a part of the cost accounting system) is a means
of monitoring revenue and costs and thereby exercising control in an entity by
developing budgets and comparing budgeted figures with actual results. This
system highlights any discrepancies (variances) and allows corrective action to
be taken.
5. The functions of cost accounting
Cost audit: cost audit is a system of checking cost accounts and records of an
organisation and establishing whether cost accounting principles have been
adhered to. Thus, cost audit involves:
1. Examination of cost records to establish accuracy of cost data (relating to
material, labour and overheads), costing techniques, cost reports generated for
management use, statements of cost, etc.
2. Verifying whether the above have been prepared in accordance with the rules,
procedures, principles and practices of cost accounting.
The objective of cost audit is to ensure that there are no un-accounted or undue
losses before or during the production process, costs are reported appropriately
and reports are generated to help management decision making. Cost audit is
compulsory in case of certain categories of industries in the manufacturing sector.
5. The functions of cost accounting
Cost coding: allocating codes to various items produced, costs incurred by an
organisation and categories of its customers is an important function included in a cost
accounting system.
Definition
A code is a system of symbols designed to be applied to a classified set of items to give
a brief accurate reference, facilitating entry, collation and analysis.
Coding is the method of assigning codes to a unique set of items / a unique item in
order to distinguish it from another unique class of items. Through coding, the costs can
be identified and collected in a combination of alphabets and numbers or both for
further analysis. Once costs are classified, a coding system can be applied to make it
easier to manage the cost data, both in manual and in computerised systems.
Intelligent coding of input costs items is one of the most important activities to ensure
the proper control.
5. The functions of cost accounting
Example
• Gorgeous Plc deals in cosmetics. It has adopted a coding system for various
kinds of perfumes and foundations. The codes are designed to provide
information about the type of perfume, pack type and pack size.
• Under this system, the large pack of the men’s fragrance, Musk would be
coded as M (for men), MU (for Musk), and L (for Large pack). Similarly, the
small pack of the women’s fragrance Citrus would be coded as W (for
Women), CI (for Citrus) and S (for small pack).
• As a result, all the products can be classified according to their
characteristics. This helps to identify the products, even if the same
perfume is available in several pack types and sizes.
5. The functions of cost accounting
• Coded items can be easily classified into relevant groups for the purposes of recording and
processing data. A general ledger will consist of a large number of coded accounts. A business will
decide its own codes for its general accounts. Each customer is allocated an account which is
identified by a unique code number.
Generating reports: a report is formal document containing detailed discussion on a topic. The scope
of a report determines the contents of the report. The report may contain general information, details
of an investigation or provide recommendations about a topic.
A cost accounting system generates the following three types of reports:
1. Non financial report, written in an essay form, e.g. reports on expansion plans on where the
company should expand and the advantages and profits it can achieve if it does so.
2. Numerical report with information giving the number details, for example a comparison of
budgeted sales and actual sales where the major information provided is in the form of numbers.
3. Mix of the two reports, reports showing comparison of budgeted sales and actual sales with an
explanation of the differences in the budgeted and the actual sales.
6. The framework of cost accounting
The framework of cost accounting system of an organisation is built upon the following areas of application
of the discipline:
1. Ascertaining costs of products and services: this has been discussed under the heading of, ‘Objectives
of cost accounting’.
2. Planning, control and evaluation of performance: the technique of budgeting (discussed earlier in this
Study Guide) is used for planning activities and resources. A budget, apart from serving as a tool of
planning, also serves as a benchmark. Managers can use the figures depicted in the budget to
compare the actual costs and revenues. In case the budgeted and actual figures do not match with
each other, variances are calculated and investigated into in order to improve future performance.
Thus, in this way, costs and activities can be controlled and performance of various units of an
organisation can be appraised.
3. Identifying relevant cost for making decisions: one of the objectives of cost accounting is to help in
decision making in organisations. Management decision of any sort ultimately boils down to a ‘cost-
benefit analysis’ which involves weighing up the different alternatives. In order to arrive at the best
possible solution, the decision-maker needs to know which costs are really relevant to a decision and
therefore merit consideration
6. The framework of cost accounting
• Relevant costs are the costs pertinent to the making of a specific
managerial decision. These are essentially the future costs and should
differ amongst the possible alternative courses of action.
• Following are the features of relevant costs:
 Relevant costs are incremental and futuristic in nature
 Relevant costs are cash flows and opportunity costs
Committed costs and sunk cost are not relevant
6. The framework of cost accounting
• Lindsey owned two houses. She lived in one and the other was empty.
Even though the other house was empty, she needed to pay property
taxes of Tshs100, 000 every year for the house.
• In the year 20X9, Lindsey decided to rent out the other house at
Tshs1, 200,000 per annum. The payment of Tshs100, 000 as property
taxes is unaffected by the decision to rent out the house. These taxes
are incurred irrespective of whether or not the house is rented out.
Therefore these costs are irrelevant to the decisionmaking. However,
the net gain of Tshs1, 200,000 (from rent) is a relevant cost for
decision-making.
7. REVIEW QUESTIONS
QUESTION 1
Cost accounting is:
A. The production or service department, function, activity, person or item of
equipment for which costs are accumulated.
B. The establishment of budgets, standard costs (benchmark for comparison
with actual) and actual costs of operations, processes, activities or products;
and the analysis of variances, profitability or the social use of funds”.
C. A product, service, item of equipment or geographical location for which a
separate cost determination is required.
D. The cost of the various components which make the final product or to
deliver the service
7. REVIEW QUESTIONS
QUESTION 2
Which of the following statements relating to the objectives of cost
accounting is incorrect?
A. Cost accounting aims to report the profit / loss made by a company
in an accounting year.
B. Cost accounting aims to report product wise profitability of an
organisation.
C. Cost accounting aims to help in managerial decision making.
D. Cost accounting aims to control and reduce manufacturing costs
7. REVIEW QUESTIONS
QUESTION 3
The format for financial accounting statements is decided by management:
A. True
B. False
QUESTION 4
Which of the following functions of cost accounting helps in uniquely distinguishing
one item of cost from the other?
C. Budgeting
D. Budgetary control
E. Coding
F. Report generation
REVIEW QUESTIONS
QUESTION 5
Why is budgetary control important?
QUESTION 6
Which of the following sentences ascertains that cost accounting is a
profession?
A. Cost accounting helps in comparing data of various years.
B. Cost accounting helps in ascertaining the cost of production and selling
price of a product.
C. Cost accounting is a specialised body of knowledge.
D. Cost accounting facilitates preparation of other financial statements.