What is Cost Accounting?

Cost accounting is a branch of accounting. It was developed because financial accounting alone is not sufficient and cannot serve all the purposes of business. Financial accounting only shows the operation and performance of the business but it does not show how to carry on the business. 

To run a business, management requires more information other than financial accounts to carry on day to day work. In a manufacturing company management must be concerned for the industrial activities such as is there any wastage of material, what should be the level of inventory, what should be the selling price of the goods, when price of goods should be increased or decreased etc.

Only financial accounting cannot serve all these purposes of the business therefore cost accounting was developed to assist in such purposes.

Cost accounting can be defined as the technique and process of ascertaining costs. It helps to analyze the costs of the business and helps to compare the cost of previous years and the current years.

What is the Cost?

Cost is the monetary value which is incurred in exchange for providing goods and services to the customers. All the expenditure incurred for the production of goods and services is called cost. There are various types of costs such as prime cost, sunk cost, indirect cost.

Classification of Costs

Costs can be classified on the basis of nature, functions, traceability and normality.

On the basis of nature costs can be classified into three categories and those are:

•  Material cost: It is the cost of materials used in the production of goods. Cost of materials can be raw material costs, spare parts cost, packaging cost, etc.
• Labor cost: Labor costs are those costs which are paid to the labors as salary and wages for producing goods and services.
• Expenses: It includes all the expenses incurred in making and selling the goods and services.

On the basis of functions, costs can be classified into two categories:

• Production costs: Production costs are those costs which are associated with the actual manufacturing of the goods.
•  Commercial costs:  Commercial costs include selling, distribution of costs etc.

On the basis of normality costs can be categorized into:

• Normal cost: These costs are incurred at the normal level of output in standard costing.
• Abnormal cost: These costs are not incurred normally at a given level of output. They are not a part of the cost of production.

Objectives of cost accounting

In cost accounting various cost principles, methods and techniques are required to ascertain the cost and control the cost by matching the present cost with the budget of the company.

Following are the various advantages of cost accounting:

• Cost accounting helps to ascertain the cost associated with the business. Classification of expenditure is very essential for the allocation. Expenses which can be charged directly to the product. Then those are allocated and others are apportioned on some other basis.
• It helps to know the cost of manufacturing goods. To ascertain cost various types of books are maintained to record all the elements of the cost. Various techniques and methods are used to ascertain the cost such as historical costing, standard costing, marginal costing, job costing, unit costing etc.
• Cost accounting helps in fixation of selling price of goods. It ascertains every cost at each stage of production. There are other factors also which are also considered in fixing selling price of the product like market condition, market size, volume of sales etc. But the most important thing to fix the cost of the product is to know the cost of its production.
• Primary objective of cost accounting is to control the cost which will increase your profit margin. Cost accounting helps in determination of the right amount of inventory or material required, helps to control labor cost, quality control etc.
• Cost accounting helps in decision making and forming various policies of the business. Cost has an important role in decision making. Various investment decisions are taken considering their cost.

Types of Costing

• Marginal costing: Marginal costing only allocates variable cost such as direct material, direct expenses, direct labour, direct overheads to the production. It does not allocate fixed costs.
• Absorption costing: In this method both fixed and variable costs are considered. It absorbs the fixed and variable cost to the production.
• Standard costing:  In standard costing costs are predetermined on the basis of set standard.
• Historical costing: In this method cost is determined only after it is incurred. Here costs are not determined on the basis of predetermined standards else costs are determined in terms of actual costs.

Relation and differences between Cost Accounting and Financial  Accounting

Relations:

• In both financial accounting and cost accounting double entry systems are applicable.
• Both systems of accounts reveal the result of the business.
• Both the accountings help in taking future decisions.
• In both systems of accounting invoices and vouchers constitute the common basis for recording transactions.
• Both systems are related to each other. Cost accounting is considered as the part of financial accounting but it is not right saying, right thing is that both are complementary to each other.

Differences:

Following are the basics difference between financial accounting and cost accounting:

• Financial accounting serves its purposes to internal as well as external individuals such as owners, creditors, tax authorities etc. But the purpose of cost accounting is to assist the internal management of the company.
• Financial accounting is mandatory to prepare by the businesses and must be prepared accounting to companies act and Income tax act. Whereas cost accounting is not mandatory to prepare by business, many businesses prepare voluntarily to maintain the cost of the business.
•  Financial accounting shows the overall profit of the business whereas cost accounting shows profit of each product, process or operation.
• Financial accounting does not include any control methods but cost accounting includes control methods such as marginal costing, standard costing, budgetary control, etc to control the cost.
• In financial accounting inventory is valued at cost or market price whatever is less, but in cost accounting it is always valued at cost.

Factors to be considered before installation of cost

Following are the major factors which must be considered before its installation into the business:

• Nature of the business: nature of business serves as the basis of the installation of cost accounting. Nature of a business means its size, position of business in the market, growth prospects, etc.
• Organizational factors: Installation of cost accounting is a bit easier in a new business as compared to the existing business. The organizational factors such as size of the business, department, level of management, delegation and responsibility, centralization and decentralization must be considered.
• Product: Kind and range of product also considered for selecting the methods of costing. Size and range of the product must be analyzed.

Limitation of Cost Accounting

Following are the limitations of the cost accounting:

• Complexity: Coat accounting included numbers of steps such as collection of overhead, classification of overheads; these tend to delay in the preparation of accounts.
• Lack of accuracy: Various techniques such as marginal costing, standard costing, lack of accuracy. And the evaluation of the stock is also based on cost and not on market price.
• Costly: Installation of cost accounting is very expensive for the business.
• It is not suitable for the small businesses as it involves large costs.
• There are various methods and techniques of cost accounting, if the wrong method is used then it will mislead the business.

Context and Applications:

This topic is significant in the professional exams for both undergraduate and graduate courses, especially for: 

• BBA
• Bachelor of Commerce
• Master of Commerce