What is the Usefulness of Cost Accounting? The shortcomings inherent in financial accounting have made the management to realize the importance of cost accounting. Meaning: Cost accounting is the classifying, recording and appropriate allocation of expenditure for the determination of the costs of products or services, and for the presentation of suitably arranged data for purposes of control and guidance of management. Whatever may be the type of business, it involves expenditure on labor, materials and other items required for manufacturing and disposing of the product. Moreover, big business requires delegation of responsibility, the division of labor and specialization.
Know and understand the Usefulness of Cost Accounting to Managers.
Management has to avoid the possibility of waste at each stage. Management has to ensure that no machine remains idle, efficient labor 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 the 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.
How to understand the Usefulness of Cost Accounting to Manager?
The various advantages derived by management on account of a good costing system can be put as follows:
Costing helps in inventory control and cost reduction.
Costing furnishes control which management requires in respect of stock of materials, work-in-progress and finished goods. Costs can be reduced in the long-run when alternates are tried. This is particularly important in the present-day context of global competition. Cost accounting has assumed special significance beyond cost control this way.
Costing makes comparison possible.
If the costing records are regularly kept, comparative cost data for different periods and various volumes of production will be available. It will help the management in forming future lines of action.
Provides data for periodical profit and loss accounts.
Adequate costing records supply to the management such data as may be necessary for preparation of profit and loss account and balance sheet, at such intervals as may be desired by the management. It also explains in detail the sources of profit or loss revealed by the financial accounts, thus helps in the presentation of better information before the management.
Costing results in increased efficiency.
Losses due to wastage of materials, the 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.
Useful in periods of depression and competition.
During trade depression, the business cannot afford to have leakages which pass unchecked. The management should know where economies may be sought, waste eliminated and efficiency increased. The business has to wage a war for its survival. The management should know the actual cost of their products before embarking on any scheme of reducing the prices or giving tenders. Costing system facilitates this.
Helps in pricing decisions.
Though economic law of supply and demand and activities of the competitors, to a great extent, determine the price of the article, the cost to the producer does play an important part. The producer can take necessary guidance from his costing records.
Helps in estimates.
Adequate costing records provide a reliable basis upon which tenders and estimates may be prepared. The chances of losing a contract on account of over-rating or the loss in the execution of a contract due to under-rating can be minimized. Thus, “Ascertained costs provide a measure for estimates, a guide to policy, and control over current production”.
Helps in channelizing production on right lines.
Costing makes possible for the management to distinguish between profitable and non-profitable activities. Profits can be maximized by concentrating or profitable operations and eliminating non-profitable ones.
Helps in reducing wastage.
As it is possible to know the cost of the 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.
Helps in increasing productivity.
The productivity of material and labor is required to be increased to have growth and more profitability in the organization. Costing renders great assistance in measuring productivity and suggest ways to improve it.
Advantages of Cost Accounting:
Profitable and Non-profitable Activities.
It will throw light upon those activities which bring profits and those activities which result in losses. This will be done only if the cost of each product or each job is ascertained and compared with the price obtained.
Support and guide in Reducing Prices.
In certain periods it becomes necessary to reduce the price even below the total cost. This will be so when there is a depression or slump. Costs, properly ascertained, will guide management in this direction.
Information for Proper Planning.
For a proper system of Costing, it is necessary to have detailed information about the facilities available about machine and labor capacity. This helps in proper planning of work so that no section is overworked and no section remains idle.
Control over all Materials.
Information about the availability of stocks of various materials and stores must be constantly available if there is a good system of Cost Accounting.
This helps in two ways. Firstly, production can be planned according to the availability of materials and fresh stocks can be arranged in time when old stocks are exhausted. Secondly, loss due to carelessness or pilferage or any other mischief will be known and, therefore, put down.
Decision Regarding Machine or Labor.
Some of the important questions before management can be solved only with the help of information about costs.
For example, if there is the problem of replacement of labor by machinery, Cost Accounting will at least guide management in finding out what the cost of production will be if either machinery or labor is used.
Expansion in Production.
Sometimes it is necessary to decide whether the production of one product or the other is to be increased. This problem can also be solved only if proper information about costs is available.
Reasons for Losses Detected.
Exact causes of the existence of profits or losses will be revealed by a system of Cost Accounting. For example, a concern may suffer not because the cost of production is high or prices are low but because the output is much below the capacity of the concern.
It is only Cost Accounting which will reveal this reason for the loss. It also helps in distinguishing between expenditure and loss which is necessary and that which is unnecessary, that is to say, between normal and abnormal losses.
Helps in Taking Decisions.
Cost Accounting inculcates the habit of making calculations with pencil and paper before taking a decision. It will certainly check recklessness. Also, some of the silly mistakes that sometimes occur can be avoided if there is a good Cost Accounting system.
To give an instance, a well-known firm once quoted for the supply of mosquito nets to the Government at a very low price. It was only after the order was obtained that the firm found that, by mistake, the price of materials was not included in the quotation.
Check on Accuracy of Financial Accounts.
A good system of Cost Accounting affords an independent and most reliable check on the accuracy of financial accounts. This check operates through reconciliation of profits shown by Cost Accounts and by Financial Accounts. On the basis of various advantages of Cost Accounting, it can be easily said that ‘a good system of costing serves as a means of control over expenditure and helps to secure economy in manufacture’.
Fixation of Prices.
In many cases, a firm is able to fix a price for its products on the basis of the cost of production. In such a case, the price cannot be properly fixed if no proper figures of cost are available.
In the case of big contracts, no quotation can be made unless the cost of completing that contract can be ascertained. If prices are fixed without costing information, it is possible that the price quoted may either be too high, in which case orders cannot be obtained, or it may be too low, in which case order will result in a loss.
It is a mistake on the part of any management to believe that mere increase in sales volume will result in profits; increased sales at prices lower than the cost may well lead the concern to the bankrupt court. Only Cost Accounting will reveal what price will be profitable.
Understand the Measurement and Improvement of Efficiency.
The chief advantage to be gained is that Cost Accounting will enable a concern too, first of all, measure its efficiency and then to maintain and improve it. This is done by suitable comparisons and analysis of the differences that may be observed.
For example, if materials spent upon a pair of shoes in the Year come to $ 100 and for a similar pair of the shoe, the amount is $ 120 in next Year. It is an indication of a decline in efficiency.
Of course, the increase may only be due to increase in the price of materials; it may also be due to greater wastage in use of materials or inefficiency at the time of buying so that unnecessary high prices were paid. Comparisons may also be made with average figures for the whole industry (if such figures are available) and with ideal figures which may have been determined before head.
In any case, it is this sort of comparison which tells management about the going up or coming down of efficiency. The study will certainly indicate the steps to be taken to remove the causes of inefficiency or to consolidate a factor which leads to greater efficiency.