Department of Accounting

Faculty of Management Sciences

University of Jos

INTRODUCTION TO COST AND MANAGEMENT ACCOUNTING

ACC 222

LEARNING OBJECTIVES
At the end of this topic you should be able to
• Define cost accounting and management accounting
• Know the origin and growth of Cost Accounting.
• Understand the purposes of cost and management accounting,
• Know the difference between cost accounting and financial accounting,
• Know the framework of cost accounting,
• Necessary factors to be considered when installing a costing system in an organization

INTRODUCTION
To define the concept Cost Accounting, it is very important we know the meaning of each of the
two words. First and foremost, the word Cost may be defined as the amount of resources
sacrificed or given up achieving a specific objective, which may be the acquisition of goods or
services, In other words. Cost means the amount of expenditure (actual or national) incurred on,
attributable to a thing or activity.

Accounting on the other hand, is an important service activity in business and is concerned with
the collecting, recording, evaluating, and communicating the results of the past events. The
usefulness of accounting lies in its capacity to provide information to various shareholders, in
business so that they could arrive at the correct decisions. Though accounting has been variously
defined, its commonly accepted definition as given by the American Institute of Certified Public
Accounts as "Accounting is the art of recording, classifying, and summarising in significant
manner and in terms of money, transactions and events which are, in part at least, of a financial
character and interpreting the results thereof",

Cost accounting, therefore, is the process of accounting for costs. It embraces the accounting
procedures relating to recording of all income and expenditure and the preparation of periodical
statements and reports with the object of ascertaining and controlling costs. It is thus the formal
mechanism by means of which costs of products or services are ascertained and controlled.

Cost accounting can also be defined as the procedure for accumulating data to provide
information for managerial action. Cost accumulation is the collection of cost data in some
organised ways by means of accounting systems. The cost accumulated will be related to specific
products and departments for planning, control and decision making by management.

DEFINITIONS OF COST ACCOUNTING

The following are important definitions of the term cost accounting by various authors:

1. According to R.N. Carter, cost accounting is defined as, "a system of recording in
accounts the materials used, and labour employed in the manufacture of a certain
commodity or on a particular job."
 2. According to Kohler, "Cost Accounting is the branch of accounting dealing with the
classification, recording, allocation, summarization and reporting of current and
prospective purpose."

3. According to Nichola, "Cost Accounting is a system of cost accumulating and

classification for product costing and managerial planning, control and decision-making
purposes. "

4. According to Sickle, "Cost Accounting is the science of recording and presenting

business transactions pertaining to the production of goods and services, whereby these
records become a method of measurement and a means of control."

Cost Accounting system is a management information system which analyses past, present and
future data to fit the variety of different problems confronting managers.

The ICMA (Institute of Cost and Management Accountants) now CIMA (Chartered Institute of
Management Accountants) official terminology defines cost accounting as “that part of
management accounting which establishes budgets and standard costs and actual costs of
operations, processes, departments or products and the analysis of variances, profitability or
social use of funds.”

Management Accounting is concerned with data gathering (from Internal and External Sources),
processing, analyzing, interpreting and communicating the resulting information for use within
the organization so that management can plan effectively, make decisions and control operations.

In carrying out this task effectively, the management accountant will use data from the financial
and cost accounting systems. He uses accounting techniques and appropriate techniques from
statistics and operations research and takes account of human element in all activities. He always
does all these things and many others so that he can produce information which is relevant for
internal purposes.

Although the above definitions is very broad, it is however, possible to posit that Management
accounting represent the process of generating relevant, sufficient and reliable information, both
quantitative and qualitative to management for the purpose of effective decision making.

According to CIMA, the word Management Accounting represents “An integral part of
management concerned with identifying, presenting and interpreting information used for.

• Formulating strategy
• Planning and controlling activities.
• Decision making
• Optimizing the use of resources
• Disclosure to employees
• Safeguarding assets.

Management accounting therefore focuses primarily on data gathering (from Internal and
External sources) analyzing, processing, interpreting, and communicating the resulting
information for use within the organization so that management can effectively plan, make
decisions and control operations. The above activities will therefore ensure effective:
 • Formulation of plans to meet objectives (i.e. strategic planning)
• Acquisition and use of funds (i.e. financial management)
• Recording of transaction (i.e. financial cost accounting)
• Formulating of short-term operational plans (i.e. budgeting and profit planning)
• Communication of financial and operating information
• Corrective actions to bring plans to results ( i.e. financial control)
• Reviewing and reporting on systems and operations (i.e. internal audit or management
audit).

ORIGIN AND DEVELOPMENT OF COST ACCOUNTING

Cost Accounting is a recent development in the accounting world. Since the beginning of the
twentieth century and particularly during and after the First World War (1914-1918),
industrialists became more and more cost conscious. This was due partly because of growing
competition among manufacturers and partly because of increasing government control over
pricing. During World War I most of the manufacturing was done on the “cost plus” system.
During World War II many governments brought down legislation which had the effect of placing
almost a blanket control over prices. In England during the industrial revolution a challenge to
the development of accounting as a tool of industrial management became apparent.
Consequently, Costing techniques were developed as guides to management actions. The
increasing awareness on the part of entrepreneurs and industrial managers for using scientific
principles of management in the wake of scientific management movement led to the
development of cost accounting. Cost Accounting deals with the application of costing principals,
methods and techniques for ascertaining the costs with a view to controlling them and evaluating
productivity of the enterprise.

Cost accounting was developed initially to focus mainly on ascertainment of costs but with the
advent of globalisation, entry of multinationals and increase in competition, cost accountants
now concentrate also on cost reduction through adopting stringent measures of cost control. Cost
accounting thus has come to serve the twin objectives of:

i. Cost ascertainment; and

ii. Cost reduction.

It aids both service and advisory, and economic decisions.

Thus it became imperative for manufacturers:

(a) To make efforts constantly for improving the quality of their products.
(b) To trace costs accurately of each job or product completed or manufactured by them.
(c) To control costs.

Financial accounting failed in achieving these objectives. Therefore, it made the accountants to
think deliberately. Thus a new technique of accounting known as Cost Accounting was developed.
Today, it has assumed so much of importance that if an industrial concern does not have an
efficient costing system; its very survival may become difficult.

Costing can be described as the technique and process of ascertaining costs. It forms a substantial
part of Management accounting. It embraces the accounting procedures relating to recording of
all information of expenditure.
SCOPE OF COST ACCOUNTING
The scope of cost accounting can be discussed in the following areas:

1. Costing. It refers to the techniques and processes of ascertaining costs. It involves systems,
methods and techniques of accumulation, analysis and appropriate allocation of expenditure
incurred in respect of a product or service.

2. Accounting. It is the system which records and determines, scientifically, the cost of
manufacturing goods or rendering service per unit control and guide the persons involved in the
organization. Thus, cost accounting is the formal mechanism by which cost data are provided for
purpose of ascertaining and controlling the costs of products or services,

3. Cost Control. Cost control involves the setting up of targets for expenses and production,
measurement of performance through comparison of actual with targets, to ascertain merit
of the variances, analysis of variances and initiating corrective action to eliminate redundancies.

4. Budgetary Control. It is a system whereby budgets are used as a means of planning and
controlling costs. Budgetary control is the establishment of budgets relating to the responsibilities
of executives to the requirement of a policy and the continuous comparison of actual with
budgeted results, either to secure by individual action the objective of that policy or to provide a
basis for its revision. It involves the establishment of budgets for each section of the organization,
measurement of the actual performance with reference to the budgeted performances the
ascertainment of deviations and taking suitable actions to remedy the defects, if any.

5. Cost Audit. It is the verification of the correctness of cost accounts and to ensure adherence
to the cost accounting plan. The purpose of cost audit is to ensure that the figures as shown by
cost accounts are correct and that cost accounts, cost centres and cost units have been properly
defined and charged.

These areas are designed to aid management take sound and effective decisions concerning the
operations of the internal system of the entity. The cost accounting system of any organization is
the foundation or the internal financial information system. Management needs a variety of
information to plan, to control and make decisions. Information regarding the financial aspects
of performance is provided by the costing system. Examples of the information provided by a
typical costing system and their uses are given below.

Information provided by Costing System Possible use by Management.

Cost per unit of production or a process Use as a factor in making Decisions,
Production Planning and Cost Control
Cost of running a section, department, or Organizational planning and Cost Control
Factory
Wages costs for a unit of production or per Production planning, decisions on
period of production alternative methods, wages and cost control
Scrap/Rectification Costs Material Cost Control and production
planning
Cost behaviour with varying Profit planning, make or buy decisions and
levels of activity cost control

Note: The scope and examples listed above are not by any means exhaustive. It is common to
find cost information being used for purpose other than those shown above.
Illustration to demonstrate the value of Financial Accounting and Cost Accounting

We can illustrate the value of cost accounting information by showing final accounts drawn up
both on financial accounting lines and also by cost accounting methods.

The financial accountant prepares a simple account for the year as follows:
N N
Materials consumed 15,000 Sales 30,000
Wages 7,000
Production expenses 2,000
Gross profit (20%) 6,000 _______
N30, 000 N30, 000

Administration expenses 2,000 Gross profit 6,000

Selling and distribution
Expenses 1,000
Net profit (10%) 3,000
N6, 000 N6,000

Although the accounts have disclosed a profit of N3,000 the information is too general to be of
great use to management, who need to know the profit or loss on each product, so that policy
decision can be made.

The allocation of costs to each product is one of the main functions of a cost accounting system,
so that reliable production costs can be ascertained. The cost accountant may produce a simple
cost statement, which may look like this:

A B C Total
N N N N
Materials Consumed 4,800 3,700 6,500 15,000
Wages 1,500 2,500 3,000 7,000
Production overhead 500 600 900 2,000
Administration overhead 700 800 500 2,000
Selling and distribution overhead 300 400 300 1000
Total cost 7,800 8,000 11,200 27,000

Sales 10,240 10,800 8,960 30,000

Profit 2,440 2,800 Nil 3,000

Loss - - 2,240 -
Profit (%) 24 26 - 10

This statement shows clearly that products A and B are obtaining approximately 25 percent
profits, but that Product C is pulling down the total profit to 10 percent.

Ignoring such items as plant capacity, plant utilization, volume of sales, etc., there are four
possible courses which management may follow:

(a) Investigate thoroughly Product C to find possible economies.

(b) Stop production of C.
 (c) Increase the Selling Price of C.
(d) Produce C as a “Loss-Leader”, that is produce and sell C in the hope of encouraging
consumers to buy A or B.

The cost accountant points out the facts and where possible, suggests remedies management
should take to make the final decision on a policy. For example, if course (b) was followed, the
overhead which had been absorbed by product C may have to be absorbed by product A and B, or
if course (c) was followed, market research may have to be employed to determine consumers’
reactions.

PURPOSES OF COST ACCOUNTING

The followings are the summary of the usefulness of cost accounting:
1. It helps to analyse and classify with reference to the cost of products and operations the
same expenditure which, in the Financial Accounts, has been recorded and summarized
under Nominal Account headings.
2. It helps to arrive at the cost of production of every unit, job, operation, process,
department, or service, and to develop cost standards.
3. It helps to indicate to management any inefficiencies, and the extent of various forms of
wastes, be it materials, time, expense, or in the use of machinery, equipment, and tools.
The analysis of the causes of unsatisfactory results may lead to remedial action.
4. It helps to provide data for periodic Profit and Loss Accounts (Statements of
Comprehensive Income) and Balance Sheets (Statements of Financial Position) at such
intervals, e.g. weekly, monthly, quarterly, half yearly or as may be desired during the
financial year and not only for the whole business but also for departments or individual
products.
5. It helps to reveal sources of economies in production, having regard to methods, types of
equipment, design, output, and layout. Daily, weekly, monthly, or quarterly information
may be necessary to ensure prompt actions.
6. It helps to provide actual figures of cost for comparison with estimates, and to serve as a
guide for future estimates, or quotations, and to assist the management in their price-
fixing policy.
7. It helps to show where Standard Costs are prepared, what the cost of production is to be,
and with which the actual costs which are eventually recorded may be compared.
8. To present comparative cost data for different periods and various volumes of production
output, and to provide guidance in the development of the business. This is valuable in
connection with budgetary control.
9. It helps to indicate whether the cost of certain articles or components made in the factory
is such that it would be more economical to buy from outside sources.
10. It helps to record the relative production results of each unit of plant and machinery in use
as a basis for examining its efficiency. A comparison with the performance of other types
of machines may suggest the necessity of replacement.
11. It helps to provide a perpetual inventory of stores and other materials, so that
a) Interim Profit and Loss Accounts (Statements of Comprehensive Income) and
Balance Sheets (Statements of Financial Position) can be prepared without stock-
taking, and
b) Checks on stores and adjustments are made at frequent intervals.
12. It helps to explain in detail the sources of profit or loss revealed in total in the Profit and
Loss Account/Statement of Financial Position.
Process of Management Accounting
Management accounting is importantly linked with Cost Accounting; therefore, it is imperative to
discuss the processes of management accounting as below:

1. Identification – The recognition and evaluation of business transactions and other

economic events for appropriate accounting action.

2. Measurement – The qualification including estimates of business transactions or other

economic events that have occurred or may occur.
3. Accumulation - The disciplined and consistent approach to recording and classifying
appropriate business transactions and other economic events.

4. Analysis – The determination of resources for, and the relationships of the reported
activity with other economic events and circumstances.

5. Preparation and interpretation – The meaningful coordination of accounting

and/or planning data to identify a need of information, presented in a logical format, and,
if appropriate, including conclusions drawn from those data.

6. Communication – The reporting of pertinent information to management and others

for internal and external uses.

Usefulness of Management Accounting

1. Planning – To gain an understanding of expected business transactions and other
economic events and their impact on the organization.

2. Evaluate – To judge the implications of various past and/or future events.

3. Control – To ensure the integrity of financial information concerning organization’s

activities or its resources.

4. Assure Accountability – To implement the system of reporting that is closely aligned

to organizational responsibilities and that contributes to the effective measurement of
management performance.

Functions of Management Accountant

The financial manger is generally the overall in charge of the finance and accounting activities.
Two officers – treasurers and controller – work under his direct supervision and control. The
main function of the treasurer is to manage the firm’s funds. His major duties include forecasting
and planning of the financial needs, administering the flow of cash, managing credit, raising funds
by floating securities and security loans, maintaining relations with financial institutions and
safeguarding securities and funds. Controller is the chief accounting officer. There are various
designations by which a controller may be known. Other titles of controller are Management
Accountant, Chief Accountant, and General Manager of (accounts) and so on. The title:
Management Accountant is more descriptive of the functions, which an accountant has to perform
to facilitate management process.

The functions of the management accountant or controller relate to the providing information to
formulate accounting and costing policies, preparation of financial reports direction of internal
auditing, budgeting, inventory control taxes etc.
The functions of Management Accounting include the following:

1. Planning and Control: To establish, coordinate and administer as part of

management, a plan for the control of operations. This plan would provide, to the extent,
required in the business, profit planning, budgets for capital investments and for
financing, sales forecasts, and expense budgets.

2. Reporting and interpreting: To compare actual performance with operating plans

and standards, and to report and interpret the results of operations to all levels of
management and to the owners of business. To enable management know about the
financial implication of its actions.

3. Tax Administration: To establish and administer tax policies and procedures.

4. Government Reporting: To supervise or coordinate the preparation of report to

government agencies.

5. Protection of assets: To ensure the protection of business assets through internal

control, internal auditing, and providing adequate insurance covers for valuable and risky
assets.

6. Economic Appraisal: To appraise economic and social forces.

7. Help analyse and interpret Government influences, and their effects on business.

DIFFERENCES BETWEEN COST ACCOUNTING, MANAGEMENT ACCOUNTING

The terms "cost accounting" and "management accounting" have sometimes been used
synonymously in recent years. But these two systems of accounting are not one and the same
thing. Although over the years, the subject matter of cost accounting has broadened, it is,
concerned mainly with the techniques of product costing procedures and related information
processing. It helps management in planning and controlling costs related to both production
and distribution activities.

By nature, management accounting refers to the reporting system designed to cater to the
decisional and executions’ needs of management. The accounting statements and reports in
management accounting are situation-specific and are prepared with respect to a specific
problem, situation, or decision. The points of difference between Cost Accounting and
Management Accounting are as under:

1. Origin and Development

Cost accounting owes its origin to the industrial Revolution. Financial accounting proved
inadequate to satisfy the information needs (about costs) of the management. Cost accounting
was evolved as a necessary adjunct of financial accounting. On the other hand management
accounting owes its origin to the management consciousness of mid-twentieth century. Thus
management accounting is of a more recent origin.

2. Object
The main object of cost accounting is to determine the cost of product or a service. However, in
modern times, cost control and price fixation have also come to be recognised as important
objective of management accounting which is to provide meaningful information to the
management for decision-making and control.

3. Nature
Cost accounting includes both present and future, whereas management accounting is mainly
future-oriented. It is primarily concerned with the projection of figures for future.

4. Scope
The scope of cost accounting is limited to cost ascertainment and control. It deals with cost data
only. The scope of management accounting is much wider than cost accounting. It includes
financial accounting, cost accounting, tax planning and decisional accounting.

5. Types of Data Used

Cost accounting deals with the monetary cost of products and services. It covers only quantitative
aspects. On the other hand, management accounting makes use of both quantitative and
qualitative data, i.e., monetary as well as non-monetary figures.

ADVANTAGES OF COSTING SYSTEM

A good costing system provides the following advantages to management:

1. It assists management to determine the profitability of its various activities and aids
managers when considering what action to be taken on whether or not to eliminate
unprofitable activities;

2. It provides cost information regarding new products or services to management;

3. It assists management to exercise some control over their activities.

4. Uniform costing system allows organization to assess performance of their various units.

Cost Department
The cost department is responsible for keeping the cost accounting records. A good cost
department should ensure that:
1. Records are properly kept in such ways that allow costs like production, marketing,
administration costs etc to be analysed.
2. The system of recording should cater for preparation of periodic performance statements
which are necessary to planning ways for control purposes.
3. The system should be capable of analyzing past, present and future costs.

Sources of Information
Accounting Information usually arises outside the Accounting Department. This information
includes:

- Material Cost: Information comes from invoices, records of physical stock levels,
material requirements.

- Labour Cost: Information comes from the payroll and workers time sheet.

- Overheads cost
Qualities of Good Cost Accounting Information
Good Cost Accounting information should possess the following qualities before users can
rely on it:

(a) Relevance: The accounting information must include enough facts to satisfy the need of
the user. For instance, management accounting information should be relevant to the
decision to be taken with it. Financial accounting information should disclose enough
information to satisfy the various users.

(b) Reliability: The source of information must be verifiable, and one source of evidence
must corroborate the other.

(c) Comparability: There should be no change in the basis for the preparation of the
accounting information from period to period so that it will be easy to compare the result
of operations over some accounting periods.

(d) Timeliness: Accounting information must be made available early enough for its use.
For instance, management requires certain information on daily basis or weekly basis for
effective running of the business; if it comes late it would be useless. Annual reports and
accounts must be published not long after the year end.

(e) Objectivity: There must be no bias, window dressing or subjective judgement in the
presentation of accounting information. Objectivity includes ability to trace transactions
to documentary evidence and complying with required regulations in its presentation.

(f) Comprehensiveness: Accounting information must contain just enough details for
good understanding. The detail must neither be too little nor too much.

Organization of the Costing Department

The organization structure of the costing department will depend on
- the scope of the work required to do
- the size of the company

Functions of Costing Department

- Time keeping
- Material cost recording
- Labour cost recording
- Overheads cost recording and analysis.
- Budget officer
- Production cost analysis
- Variance report
- Cost behaviour assessment
 INSTALLATION OF COSTING SYSTEM
The installation of a costing system requires careful consideration of the following two inter-
related aspects:

i. Overcoming of the practical difficulties in introducing the system.

ii. Major consideration that should govern the installation of such a system.

Practical difficulties: The difficulties in the installation of a costing system and

recommendations to overcome them are listed below:

1. Lack of Support from top management: Many a times the costing system is
introduced on behalf of the managing director or the other directors without first preparing the
other members of the top management team. This results in opposition from various managers
as they consider it as interference as well as unnecessary checks on their activities. They, therefore,
resist the additional work involved in the cost accounting system. This difficulty can be overcome
by taking the top management into consideration before installing the system. A sense of cost
consciousness has to be instilled in their minds.

2. Resistance from the existing staff: The existing financial accounting staff may offer
resistance to the system because of a feeling of their being declared redundant under the new
system. This fear can be allayed by explaining to the staff that the costing system would not replace
them but strengthen the existing system. Possible opportunities offered by the introduction of the
cost department must be explained.

3. Non-cooperation at other levels: The foremen and other supervisory staff may resent
the additional paperwork and may not co-operate in providing the basic data which is so essential
for the success of the system. This needs re-orientation and education of employees. They have to
be told the advantages that will accrue to them and to the organizations as a whole on account of
efficient working of the system.

4. Shortage of trained staff: Costing is a specialized job in itself. In the beginning

therefore, qualified staff may not be available. However, this difficulty can be overcome by giving
the existing staff requisite training and recruiting additional staff if required.

5. Heavy costs: The costing system will involve heavy costs unless it has been suitably
designed to suit specific requirements. Unnecessary sophistication and formalities should be
avoided. The costing office should serve as a useful service department.

Factors to Be Considered When Installing Costing System

In view of the above difficulties and suggestions to overcome them, the following should be the
main considerations to be kept in mind while introducing a costing system in a manufacturing
organization.

1. The product: The nature of the product determines to a great extent the type of costing
system to be adopted. A product requiring high value of material content requires an elaborate
system of materials control. Similarly, a product requiring high value of labour content requires
an efficient timekeeping and wage systems. The same is true in the case of overheads.

2. The Organization: The existing organization should be disturbed as little as possible. It

becomes, therefore, necessary to ascertain the size and type of organization before introducing
the costing system. The scope of authority of each executive, the sources from which the cost
accountant has to derive information and the reports to be submitted at various managerial levels,
should be carefully gone through.

3. The objective: The objectives and information which the management wants to achieve
and acquire are to be considered. For example, if the firm wants to expand its operations, the
system of costing should be designed in a way so as to give maximum attention to production
aspect. On the other hand, in case of a concern which is not in a position to sell its products, the
selling aspect would require greater attention.

4. The technical details: The system should be introduced after a detailed study of the
technical aspects of the business. Effort should be made to secure the assistance and support of
the principal members of the supervisory staff and workmen.

5. Informative and simple: The system should be informative and simple. In this
connection the following points may be noted:
i. It should be capable of furnishing full information required, regularly and
systematically so that continuous study and check of the progress of business is
possible.

ii. Standard printed forms can be used so as to make the information detailed, clear
and intelligible. Over-elaboration, which will only complicate matters, should be
avoided.

iii. Full information about departmental output, processes and operations must be
properly classified.

iv. Data must be complete and reliable in all respects. It should be provided in a lucid
form so that measurement of the variations between actual and standard cost is
possible.

6. Method of maintenance of cost records: A choice has to be made between integral

and non-integral accounting systems. In case of integral accounting system two separate
set of books are maintained for costing transactions but they are interlocked with financial
transactions into one set of books. In case of non-integral system separate books are
maintained for cost and financial transactions.

At the end of the accounting period the results shown by the two set of books are
reconciled. In case of a big business it will be appropriate to maintain separate set of books
for cost transactions.

7. Elasticity: The costing system should be elastic and be capable of adapting to the
changing requirements of the business.

It may, therefore, be concluded from the above discussion that costing system introduced
in any business will not be a success if it is unduly complicated and expensive; if cost
accountant does not get the co-operation of the staff; if cost statements cannot be
reconciled with financial statements; and if the results actually achieved are not compared
with the expected ones.
DIFFERENCES BETWEEN COST ACCOUNTING AND FINANCIAL ACCOUNTING

The main differences between cost accounting and financial accounting are:

1. Objectives: Financial accounting aims at safeguarding the interests of the business and
proprietors and others connected with it. This is done by providing suitable information
to various parties such as shareholders or creditors. Cost accounting on the other hand
records information for the guidance of the management for proper planning, control and
decision making.

2. Mode of Presentation: Financial accounts are prepared according to some accepted

accounting concepts and conventions. They are required in a manner so as to comply with
the requirements of the Companies and Allied Matters Act 1990 (CAMA) as amended to
date, Tax Laws and other status. Maintenance of cost records is purely voluntary and
therefore there are no statutory forms regarding their presentation.

3. Recording: In case of financial accounting stress is on the ascertainment and exhibition

of profits earned or loss incurred in the business. Thus, in financial accounts, the
transactions are recorded, classified and analyzed in a subjective manner i.e. according to
the nature of expenditure. Cost accounting on the other hand emphasises on the aspects
of planning and control and therefore, transactions are recorded in an objective manner
i.e. according to the purpose for which costs are incurred. For example, if N20,000,
N35,000 and N40,000 have been paid as wages for products A, B and C, financial accounts
will record wages separately for each product, besides that, in cost accounts a difference
will also be made between direct and indirect wages.

4. Analyzing Profit: Financial accounting reveals the profit of the business as a whole
while cost accounting shows the profit made on each product, job or process. This enables
Management to eliminate less profitable product and maximize the profits by
concentrating on more profitable ones.

5. Periodicity of Reporting: Financial accounting is largely concerned with the

transaction between the undertaking and third parties and therefore it has to observe the
accounting period convention which is usually a year. Cost accounting is mainly concerned
with the people in the organization and therefore it is not subject to the domination of this
convention. The cost reports are frequently submitted to Management and in some cases
they are submitted every week.

LIMITATIONS OF FINANCIAL ACCOUNTING

1. It does not classify the accounts so as to give data regarding costs by departments,
processes, products, in the manufacturing division; by units of product, lines, and sales
territories in the selling or distribution division and by department, services and functions
in the administration division.

2. It does not classify the expenses as direct and indirect items nor does it assign them to the
product at each stage of production. Thus controllable and uncontrollable items of
overhead costs are not shown separately.
 3. It does not provide day-to-day cost information because the data do not permit the
computation of predetermined costs which help in taking corrective steps at appropriate
stages.

4. It does not provide analysis of losses due to idle plans and equipment, defective material,
inefficient labour and seasonal conditions. It does not also distinguish between avoidable
and unavoidable losses.

5. It does not provide adequate information for reports to outside agencies such as banks,
government, insurance companies and trade associations.

IMPORTANCE OF COST ACCOUNTING

The limitations of financial accounting have made management to realize the importance of cost
accounting. Whatever may be the type of business, it involves expenditure on labour, materials,
and other items required for manufacturing and disposing of the product. Moreover, big business
requires delegation of responsibility, division of labour and specialization. Management must
avoid the possibility of waste at each stage. It has to see that no machine remains idle, efficient
labour gets due initiative, proper utilization of by-products is made, and costs are properly
ascertained. Besides management, creditors and employees are also benefited in numerous ways
by installation of a good costing system in an industrial organization. Cost accounting increases
the overall productivity of an industrial establishment and, therefore, serves as an important tool
in bringing prosperity to the nation. Thus, the importance of cost accounting in various spheres
can be summarized under the following headings.

Cost Accounting and Management

As regards cost and management accounting, the following are the importance:

1. Cost accounting provides invaluable aid to management. It is so closely aligned to

management that it is difficult to indicate where the work of the cost accountant ends, and
managerial control begins.

2. Adequate costing data help management in reaching certain important decisions such as,
whether direct labour should be replaced by the machinery or not, whether a particular
product line should be discontinued or not etc.

3. Costing checks recklessness and avoids occurrence of mistakes. Costs can be reduced by
proper organization of the plant and executive personnel.

4. As an aid to management, it also provides invaluable information to enable management

increase efficiency of the business, and to check wastage and losses.

5. It facilitates delegation of responsibility for management to be capable of using it in a

proper way the information provided by the cost accounts. The various advantages derived
by management on account of a good costing system can be put as follows:

ADVANTAGES OF COST ACCOUNTING

1. Costing helps in periods of trade depression and trade competition: In period
of trade depression the business cannot afford to have leakages which go unchecked. Management
should know where economies may be sought, waste eliminated, and efficiency increased. The
business has to wage a war for its survival. Management should know the actual cost of their
products before embarking on any scheme of reducing the prices of giving tenders.
2. Provides estimates of costs: Though Economics’ law of supply and demand and
activities of the competitors, to a great extent, determine the price of an article, cost to the
producer does play an important part. The producer can take necessary guidance from his costing
records.

3. Helps in estimates: Adequate costing records provide a reliable basis upon which
tenders and estimates may be prepared. The chances of losing contract on account of over-rating
or the loss in the execution of a contract due to under-rating can be minimized. Thus, costs well
ascertained provide estimates that can guide policy formulations and help control over current
production.

4. Helps in channelling production on right lines: Costing make it possible for

management to distinguish between profitable and non-profitable activities. Profits can be
maximized by concentrating on profitable operations and eliminating non-profitable ones.

5. Wastages are eliminated: As it is possible to know the cost of an article at every stage,
it becomes possible to check various forms of waste, such as of time, expense etc., or in the use of
machinery, equipment and tools.

6. Costing makes comparison possible: If the costing records are regularly kept,
comparative costs data for different periods and various volumes of production will be available.
It will help the management in forming future lines of action.

7. Provides data for periodical profit and loss accounts: Adequate costing records
supplied to management should include that such data may be necessary for preparation of profit
and loss accounts and balance sheets, at such intervals as may be desired by management.

8. Aids in determining and enhancing efficiency: Losses due to wastage of materials,

idle time of workers, poor supervision etc. will be disclosed if the various operations involved in
manufacturing a product are studied by a cost accountant. The efficiency can be measured, and
costs controlled and through it various devices can be framed to increase the efficiency.

9. Helps in inventory control: Costing furnishes control which management requires in

respect of stock of materials, work-in-progress and finished goods.

FRAMEWORK OF COST ACCOUNTING

A cost: This is defined as amount of expenditure incurred on or attributable to a specified thing
or activity. This cost relates to past cost which has two components: quantity used and price.

Cost Object: The purpose or object for which costs are measured is called a cost object. A cost
object may be a unit or a product, a group of products, department, a division, a machine, or job
and so on.

For planning purpose, cost should be measured for and associated with the segments of the firms
which are attributed to products or services and other cost objects.

Cost Unit: A cost unit is quantitative unit of product or service in relation to which costs are
ascertained. The cost unit to be used in each situation is that which is most relevant to the purpose
of the cost ascertainment exercise. This means that in any one organization numerous cost units
may be used for a particular purposes. Examples of cost units are packets of sugar, litres of petrol,
and cartons of beer and so on.

Cost Centre: When costs are accumulated for an organizational unit or departments, it is called
a cost centre e.g. assembly department or painting department. Therefore, a cost centre is a
location or person for which costs may be ascertained.

Cost estimation and ascertainment

Cost estimation is the process of pre-determining the costs of a certain product, job or order. Such
pre-determination may be required for several purposes such as budgeting, measurement of
performance efficiencies, preparation of financial statements (valuation of stocks etc), make or
buy decisions; fixation of the sale prices of the products etc. Cost ascertainment is the process of
determining cost while computation of future costs is cost estimation.

Cost estimation as well as cost ascertainment are inter related and are of immense use to
management. In case a concern has a sound costing system, the ascertainment of costs will greatly
help management in the process of estimation of rational accurate costs which are so necessary
for a variety of purposes stated above. Moreover, the ascertainment of costs may be compared
with the pre-determination of costs on a continuing basis, and proper and timely steps be taken
for controlling costs and maximizing profits.

Costs Allocation and Cost Apportionment

Cost allocation and cost apportionment are the two procedures which describe the identification
and allotment of costs to cost centres or cost units.

1. Cost allocation refers to the allotment of whole items of cost to cost centres or cost unit.
2. Cost apportionment refers to the allotment of proportions of items of cost to cost centres
or cost units.

Thus the former involves the process of charging direct expenditure to cost centres or cost unit.
For example, the cost of labour engaged in a service department can be charged directly and
wholly to it but canteen expenses of the factory cannot be charged directly and wholly to it. Its
proportionate share will have to be found out. Charging of costs in the former case will be termed
as Allocation of costs while the later as Apportionment of costs.

Cost Reducing and Cost Control

Cost reduction and cost controls are two different concepts.
1. Cost control is achieving the cost target as its objective.
2. Cost Reduction is directed to explore the possibilities of improving the targets themselves.

Thus cost control ends when targets are achieved while cost reduction has no visible end. It is a
continuous process.

The difference between the two can be summarized as follows:

1. Cost control aims at maintaining the costs in accordance with established standards while
cost reduction is concerned with reducing costs. Cost reduction challenges all standards
and endeavours to better them continuously.
 2. Cost control seeks to attain lowest possible cost under existing conditions. While cost
reduction recognizes no condition as permanent, since a change will result in lower costs.

3. Cost control emphasis is on past and present while in the case of cost reduction it is on the
present and future.

4. Cost control is a preventive function, while cost reduction is a corrective function. Cost
reduction operates even when an efficient cost control system exists.

Note: Nature of Cost: Cost is a foregoing or sacrifice measured in monetary terms, incurred to
achieve a specific purpose.

Review Questions
1. Write short notes on the following terms:
i. Cost Accounting and Cost Apportionment
ii. Cost Audit, Cost Unit, Cost Centre
2. Discuss the difference between cost reduction and cost control.
3. Financial Accounting and Cost Accounting are the same. Discuss.
4. Cost Accounting Functions defers from Management Accounting functions. Discuss.
5. Give vivid account of the origin of Cost Accounting.
6. What are the factors to be considered when installing a costing system?