Meaning, Nature, Scope of Cost Accounting

09/05/2020 4 By indiafreenotes

Cost: The term ‘cost’ has to be studied in relation to its purpose and conditions. As per the definition by the Chartered Institute of Management Accountants (C.I.M.A.), London ‘cost’ is the amount of actual expenditure incurred on a given thing.

Costing: The C.I.M.A., London has defined costing as the ascertainment of costs. “It refers to the techniques and processes of ascertaining costs and studies the principles and rules concerning the determination of cost of products and services”.

Cost Accounting: It is the method of accounting for cost. The process of recording and accounting for all the elements of cost is called cost accounting. I.C.M.A. has defined cost accounting as follows: “The process of accounting for cost from the point at which expenditure is incurred or committed to the establishment of its ultimate relationship with cost centers and cost units. In its widest usage it embraces the preparation of statistical data, the application of cost control methods and the ascertainment of the profitability of activities carried out or planned”.

Cost Accountancy: The term ‘Cost Accountancy’ includes Costing and Cost accounting. Its purposes are Cost-control and Profitability – ascertainment. It serves as an essential tool of the management for decision-making.

I.C.M.A., has defined cost accountancy as follows: “The application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and the ascertainment of profitability. It includes the presentation of information derived there from for the purpose of managerial decision making”.

Objectives of Cost Accounting

a) To serve as a guide to price fixing of products.

b) To disclose sources to wastage in various operations of manufacture.

c) To reveal sources of economy in production process.

d) To provide for an effective system of stores and material.

e) To measure the degree of efficiency of the various departments or units of production.

f) To provide suitable means and information to the top management to control and guide the operations of the business organisation.

g) To exercise effective control on the costs, time and efforts of labour, machines and other factors of production.

h) To compare actual costs with the standard costs and analyse the causes of variation.

i) To provide necessary information to develop cost standards and to introduce the system of budgetary control.

j) It enables the management to know where to economize on costs, how to fix prices, how to maximize profit and so on.

Scope of Cost Accounting

The term scope here refers to field of activity. Cost accounting refers to the process of determining the cost of a particular product or activity. It provides useful data both for internal and external reports reporting. Internal reporting presents details of cost data in a summarized and aggregate form. For instance, in case a company manufacturing electrical goods cost of each product.

In order that cost accounting satisfies the requirements of both internal and external reporting, the following are the different activities which are undertaken under cost accounting system:

Cost Determination: This is the first step in the cost accounting system. It refers to determining the cost for a specific product or activity. This is a critical activity since the other three activities, explained below, depend on it.

Cost Recording: Its is concerned with recording of costs in the cost journal and their subsequent posting to the ledger. Cost recording may be done according to integral or non-integral system a separate set of books is maintained for costing and financial transactions.

Cost Analyzing: It is concerned with critical evaluation of cost information to assist the management in planning and controlling the business activates. Meaningful cost analysis depends largely upon the clear understanding of the cost finding methods used in cost accounting.

Cost Reporting: Its is concerned with reporting cost data both for internal and external reporting purpose. In order to use cost information intelligently it is necessary for the managers to have good understanding of different cost accounting concepts.

Functions of Cost Accounting

According to Blocker and Weltemer, “Cost Accounting is to serve management in the execution of polices and in comparison, of actual and estimated results in order that the value of each policy may be appraised and changed to meet the future conditions”. The main functions of cost accounting are:

i) To serve as a guide to price fixing of products.

ii) To disclose sources of wastage in process of production.

iii) To reveal sources of economy in production process.

iv) To provide for an effective system of stores, materials etc.

v) To exercise effective control on factors of production.

vi) To ascertain the profitability of each product.

vii) To suggest management of future expansion policies.

viii) To present and interpret data for management decisions.

ix) To organize cost reduction programmes.

x) To facilitate planning and control of business activity.

xi) To supply timely information for various decisions.

xii) To organize the internal audit systems etc.

Advantages of Cost Accounting

Helps in Decision Making: Cost accounting helps in decision making. It provides vital information necessary for decision making. For instance, cost accounting helps in deciding:

  1. Whether to make a product buy a product?
  2. Whether to accept or reject an export order?
  3. How to utilize the scarce materials profitably?

Helps in fixing prices: Cost accounting helps in fixing prices. It provides detailed cost data of each product (both on the aggregate and unit basis) which enables fixation of selling price. Cost accounting provides basis information for the preparation of tenders, estimates and quotations.

Formulation of future plans: Cost accounting is not a post-mortem examination. It is a system of foresight. On the basis of past experience, it helps in the formulation of definite future plans in quantitative terms. Budgets are prepared and they give direction to the enterprise.

Avoidance of wastage: Cost accounting reveals the sources of losses or inefficiencies such as spoilage, leakage, pilferage, inadequate utilization of plant etc. By appropriate control measures, these wastages can be avoided or minimized.

Highlights causes: The exact cause of an increase or decrease in profit or loss can be found with the aid of cost accounting. For instance, it is possible for the management to know whether the profits have decreased due to an increase in labour cost or material cost or both.

Reward to efficiency: Cost accounting introduces bonus plans and incentive wage systems to suit the needs of the organization. These plans and systems reward efficient workers and improve productivity as well improve the morale of the workforce.

Prevention of frauds: Cost accounting envisages sound systems of inventory control, budgetary control and standard costing. Scope for manipulation and fraud is minimized.

Improvement in profitability: Cost accounting reveals unprofitable products and activities. Management can drop those products and eliminate unprofitable activities. The resources released from unprofitable products can be used to improve the profitability of the business.

Preparation of final accounts: Cost accounting provides for perpetual inventory system. It helps in the preparation of interim profit and loss account and balance sheet without physical stock verification.

Facilitates control: Cost accounting includes effective tools such as inventory control, budgetary control and variance analysis. By adopting them, the management can notice the deviation from the plans. Remedial action can be taken quickly.

Limitations of Cost Accounting

In spite of the various advantages claimed by cost accounting, the discipline suffers from the following limitations:

Cost Accounting is costly to operate: It involves heavy expenditure to operate. The benefits derived by operating the system are more than the cost.

Cost Accounting involves many forms and statements: It involves usage of many forms and statements which leads to increase of paper work.

Costing may not be applicable in all types of Industries: Existing methods of cost accounting may not be applicable in all types of industries. Cost accounting methods can be devised for all types of industries, and services.

It is based on Estimations: Costing system relies on predetermined data and therefore it is not reliable. Costing system estimates costs scientifically based on past and present situations and with suitable modifications for the future. This leads to accurate cost figures based on which management can initiate decisions. But for the predetermined costs, cost accounting also becomes another ‘Historical Accounting’.

It is not an exact science: Like any others accounting system, it is not an exact science but an art that has developed through theories and practices.

Bias Judgments: Many judgments are biased and depend on individual discretion.

Difference in opinion: Different views are held by different cost accounts about the items to be includes in cost.

Characteristics of a good Costing System

An ideal system of cost accounting must possess some characteristics which bring all the advantages, discussed above; to the business, in order to be ideal and objective. The main characteristics are:

Simplicity: It must be simple, flexible and adaptable to the changing conditions. And it must be easily understandable to the personnel. The information provided must be in the proper order, in right time and to the right persons so as to be utilized fully.

Flexibility and Adaptability: The costing system must be flexible to accommodate the changing conditions and circumstances. The expansion, contraction of changes must be adopted in the existing system with minimum changes.

Economy: The costing system must suit the finance available. The expenditure must be less than the benefits derived from the system adopted.

Comparability: The management must be able to make comparison of the facts and figures with the past figures, figures of other concerns, or other departments of the same concern.

Minimum Changes to the Existing one: When introducing a costing system, it may cause minimum change to the existing set up of the business.

Uniformity of Forms: Forms of different colours can be used to distinguish them. Forms must be uniform in size and quality. Form should contain instructions to fill, to use and for disposal.

Less Clerical Work: Printed forms will involve less labour to fill in, as the workers may be a little educated. They may not like to spend much time in filling the forms.

Efficient Material Control and Wage System: There must be a proper procedure for recording the time spent on different jobs, by workers for the payment of wages. A systematic method of wage system will help in the control of labour cost. Since the cost of material forms a great proportion to the total cost, there must be an efficient system of stores control.

A Sound Plan: There must be proper and sound plans to collect, to allocate and to apportion overhead expenses on each job or each product in order to find out the cost accurately.

Reconciliation: The systems of costing and financial accounting must be facilitated to reconcile in the easiest manner.

Overall Efficiency of Cost Accountant: The work of the cost accountant under a good system of costing must be clearly defined as to his duties and responsibilities to the firm are very essential.