Learn, Explain Cost Accounting: Objectives, Nature, and Scope!
Cost accounting examines the cost structure of a business. It does so by collecting information about the costs incurred by a company’s activities, assigning selected costs to products and services and other cost objects, and evaluating the efficiency of cost usage. Discuss the topic, the Concept of Cost Accounting: Meaning of Cost Accounting, Definition of Cost Accounting, Objectives of Cost Accounting, Nature and Scope of Cost Accounting, and Limitations of Cost Accounting! Cost accounting is mostly concerned with developing an understanding of where a company earns and loses money, and providing input into decisions to generate profits in the future. Also learned, Management Accounting, Cost Accounting: Objectives, Nature, and Scope!
Cost accounting involves the techniques for as: 1) Determining the costs of products, processes, projects, etc. in order to report the correct amounts on the financial statements, and 2) Assisting management in making decisions and in the planning and control of an organization. For example, cost accounting is used to compute the unit cost of a manufacturer’s products in order to report the cost of inventory on its balance sheet and the cost of goods sold on its income statement. This is achieved with techniques such as the allocation of manufacturing overhead costs and through the use of process costing, operations costing, and job-order costing systems.
Cost accounting assists management by providing analysis of cost behavior, cost-volume-profit relationships, operational and capital budgeting, standard costing, variance analyses for costs and revenues, transfer pricing, activity-based costing, and more. Cost accounting had its roots in manufacturing businesses, but today it extends to service businesses. For example, a bank will use cost accounting to determine the cost of processing a customer’s check and/or a deposit. This, in turn, may provide management with guidance in the pricing of these services.
Key activities include:
- Defining costs as direct materials, direct labor, fixed overhead, variable overhead, and period costs.
- Assisting the engineering and procurement departments in generating standard costs, if a company uses a standard costing system.
- Using an allocation methodology to assign all costs except period costs to products and services and other cost objects.
- Defining the transfer prices at which components and parts are sold from one subsidiary of a parent company to another subsidiary.
- Examining costs incurred in relation to activities conducted, to see if the company is using its resources effectively.
- Highlighting any changes in the trend of various costs incurred.
- Analyzing costs that will change as the result of a business decision.
- Evaluating the need for capital expenditures.
- Building a budget model that forecasts changes in costs based on expected activity levels.
- Determining whether costs can be reduced.
- Providing cost reports to management, so they can better operate the business.
- Participating in the calculation of costs that will be required to manufacture a new product design, and.
- Analyzing the system of production to understand where bottlenecks are positioned, and how they impact the throughput generated by the entire manufacturing system.
#Meaning of Cost Accounting:
An accounting system is to make available necessary and accurate information for all those who are interested in the welfare of the organization. The requirements of the majority of them are satisfied by means of financial accounting. However, the management requires far more detailed information than what the conventional financial accounting can offer. The focus of the management lies not in the past but on the future. For a businessman who manufactures goods or renders services, cost accounting is a useful tool. It was developed on account of limitations of financial accounting and is the extension of financial accounting. The advent of factory system gave an impetus to the development of cost accounting.
It is a method of accounting for cost. The process of recording and accounting for all the elements of the cost is called cost accounting.
#Definition of Cost Accounting:
The Institute of Cost and Works Accountants, London defines costing as, “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 wider 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”.
The Institute of Cost and Works Accountants, India defines cost accounting as, “the technique and process of ascertainment of costs. Cost accounting is the process of accounting for costs, which begins with the recording of expenses or the bases on which they are calculated and ends with the preparation of statistical data”. To put it simply, when the accounting process is applied to the elements of costs (i.e., Materials, Labour and Other expenses), it becomes Cost Accounting.
#Objectives of Cost Accounting:
Cost accounting was born to fulfill the needs of manufacturing companies. It is a mechanism of accounting through which costs of goods or services are ascertained and controlled for different purposes. It helps to ascertain the true cost of every operation, through a close watch, say, cost analysis and allocation.
The main objectives of cost accounting are as follows:-
- Cost Ascertainment: The main objective of cost accounting is to find out the cost of product, process, job, contract, service or any unit of production. It is done through various methods and techniques.
- Cost Control: The very basic function of cost accounting is to control costs. Comparison of actual cost with standards reveals the discrepancies (Variances). The variances reveal whether the cost is within the control or not. Remedial actions are suggested to control the costs which are not within control.
- Cost Reduction: Cost reduction refers to the real and permanent reduction in the unit cost of goods manufactured or services rendered without affecting the use intended. It can be done with the help of techniques called budgetary control, standard costing, material control, labor control and overheads control.
- Fixation of Selling Price: The price of any product consists of total cost and the margin required. Cost data are useful in the determination of selling price or quotations. It provides detailed information regarding various components of cost. It also provides information in terms of fixed cost and variable costs, so that the extent of price reduction can be decided.
- Framing business policy: Cost accounting helps management in formulating business policy and decision making. Break-even analysis, cost volume profit relationships, differential costing, etc are helpful in making decisions regarding key areas of the business.
#Nature and Scope of Cost Accounting:
Cost accounting is concerned with ascertainment and control of costs. The information provided by cost accounting to the management is helpful for cost control and cost reduction through functions of planning, decision making, and control. Initially, cost accounting confined itself to cost ascertainment and presentation of the same mainly to find out product cost. With the introduction of large-scale production, the scope of cost accounting was widened and providing information for cost control and cost reduction has assumed equal significance along with finding out the cost of production. To start with cost accounting was applied in manufacturing activities but now it is applied in service organizations, government organizations, local authorities, agricultural farms, extractive industries and so on.
Cost accounting guides for an ascertainment of cost of production. Cost accounting discloses profitable and unprofitable activities. It helps management to eliminate the unprofitable activities. It provides information for estimate and tenders. It discloses the losses occurring in the form of idle time spoilage or scrap etc. It also provides a perpetual inventory system. It helps to make effective control over inventory and for preparation of interim financial statements. It helps in controlling the cost of production with the help of budgetary control and standard costing. Cost accounting provides data for future production policies. It discloses the relative efficiencies of different workers and for fixation of wages to workers.
#Limitations of Cost Accounting:
- It is based on estimation: as cost accounting relies heavily on predetermined data, it is not reliable.
- No uniform procedure in cost accounting: as there is no uniform procedure, with the same information different results may be arrived by different cost accounts.
- A large number of conventions and estimate: There is a number of conventions and estimates in preparing cost records such as materials are issued on an average (or) standard price, overheads are charged on the percentage basis, Therefore, the profits arrived from the cost records are not true.
- Formalities are more: Many formalities are to be observed to obtain the benefit of cost accounting. Therefore, it is not applicable to small and medium firms.
- Expensive: Cost accounting is expensive and requires reconciliation with financial records.
- It is unnecessary: Cost accounting is of recent origin and an enterprise can survive even without cost accounting.
- Secondary data: Cost accounting depends on financial statements for a lot of information. Any errors or shortcomings in that information creep into cost accounts also.