Q. Define cost accounting. Explain the fundamental principles and functions of cost accounting.
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Ans. Meaning of Cost Accounting: Cost Accounting refers to the process of accounting for costs incurred in manufacturing, trading or services rendering types of businesses. Hence, cost accounting is the most systematic and scientific branch of accounting that deals with identification, analysis, recording, summarizing and communication of current and prespective cost.
Cost Accounting is a branch of accounting which deals with accumulation (collection), classification, recording, analysis, interpretation, reporting and control of current and prospective costs. It explains the cost of production of a product or a service according to its components per unit as well as total. Cost accounting is a specialised branch of accounting which involves classification, accumulation, analysis, assignment and control of cost. The rules and principles of cost accounting have developed over a period of time by experience. The cost accounting need arouse because of the limitation of financial accounting.
Cost Accounting is the classifying, recording and appropriate allocation of expenditure for the determination of the costs of products and services and for the presentation of suitably arranged data for the purpose of control and guidance of management. It includes the calculation of cost of every product, job, section, department, process, service. It is the method of accounting for cost.
Fundamental Principles of Cost Accounting: The following are the main principles of cost accounting:
1. A Cost should be related to its cause: A cost should be related as closely as possible to its cause for recovering the cost of product, job, process or cost centre. The effect of cost of an item on the various products, departments or processes should be established before it is charged to that product or cost centre. The cost are collected and analysed according to their nature and are to be allocated or apportioned on the basis of cause relationship. For example, rent of the factory building should be charged from all the production departments on the basis of the area occupied by each production department.
2. A Cost should be Charged only after its Incurrence: While calculating the cost of individual units those costs which have been incurred (actually or nationally) should be taken into account. As for example selling overheads should be charged only to those units which have been sold and all those units which are still in stock should not be charged with selling overheads. Similarly normal loss should be only absorbed by those units in which it has taken place and not in those units which are yet to be produced.
3. Abnormal Cost should be Excluded from Costing: A loss due to accident, fire, theft, riots, negligence is the abnormal loss. Abnormal losses should not be charged to the production cost as these are not related to production. The inclusion of abnormal loss in the cost of production would distort cost figures ans mislead the management as to the working results of the undertaking. For this reason only normal cost incidental to production is charged to product, job or cost centre and not the abnormal losses or abnormal cost. This is the reason abnormal losses are transferred to costing profit and loss account.
4. Past Costs are not charged to Future Periods: A past cost means a cost from which no more benefit is to accrue. A cost item which was incurred in the year 2015 is not to be charged from the cost of production from the product of the year 2016. It will unnecessary distort the cost of production and it may lead to wrong decision by the management regarding the product, cost centre or efficiency of the department. But if there is an item of expenditure in the past, the benefit of which will accure in the future, then it should be charged in future period as a deffered revenue expenditure as for example expenditure on advertisement. The items of past cost if remain uncharged from the product of that period then it should be transferred to costing profit and loss account with a note stating reason.
5. The concept of Conservatism has no place in Cost Accounting: Cost accounts should be prepared with facts without any biasness or with a secret purpose. The closing stock is valued at cost price or market price, whichever is less in financial accounts while in cost accounts stock is valued at cost only. There is no creation of secret reserve in cost accounts as in the case of financial accounts. If principle of conservation is asopted in cost accounting then the cost of production will not be comparable and purposeful.
6. Principle of Double Entry should not be Applied in Cost Accounting: The cost ledgers and other cost control accounts are kept on double entry principles. Costing, however requires a greater use of cost sheets and cost statements for the purpose of cost ascertainment, cost control and reporting to management.
Functions/Objectives of Cost Accounting: The main objectives of cost accounting may be:
1. To Ascertain Cost: With the help of cost accounting cost per unit of a product, job or process is calculated. For calculating cost of the product or service various methods like unit costing, contract costing, job costing etc. are applied. The technique of ascertaining the cost is known as costing.
2. Cost Control: Cost Control is reducing the cost of production by controlling the wastage of material, labour and other expenses. Cost control helps to improve the efficiency of organisation as a whole. For cost control bugetary control, standard costing and responsibility accounting are the main tools applied by the management.
3. Determination of Selling Price: Cost accounting has the main object to help in fixation of selling price of the product or service not only in normal condition but also under various stressing market conditions. To fix the selling price various factors like cost of production, market situation, business cycle, govt. policies, competition, change in fashion, income level of the people do play their role. Cost accounts helps to provide necessary information to take decisions under conditions like depression, export, or exploring the new market etc. Minimum selling price can be decided with the availability of proper cost data.
4. Ascertainment of Profitability: Profitability means capacity to earn profits of a department, section, product, job or a process or service. This capacity can be judged with the help of cost data provided by cost accounting. The expected profits are compared with the actual profits to know the reasons of difference, if any. This helps to analyse the efficiency of each segment of the organisation as well as the whole of the organisation. Before introduction of a new product, design, method, machine or operating Market profitability analysis helps to set targets and performance measurement. Thus, the object of cost accounting is to measure the profitability of the activities carried out or planned. Profit making capacity should be established.
5. Provides a base for setting business policies: Cost accounting helps to provide accurate cost information. These cost data help the management in taking short-term and long-term business policies to be followed. Cost accounts help in various decision making processes which may be very crucial to the organisation like:
(a) To introduce new product or new method of production or to explore a new market.
(b) How to use idle capacity if there remains any?
(c) Deciding the sales mix to maximise the profits or to maximise the use of available factors of production.
(d) Make or buy decision regarding a product
(e) Exporting goods in a foreign market even at below the cost of production or not.
(f) Closing down the plant or to contribute production even in losses.
(g) Replacement of old machinery with the new model or not.
6. Inter-firm Comparison: Cost accounting helps in making comparisons of cost or of profits of one firm with other firm operating in the same industry. For the inter-firm comparison there should be the application of uniform costing system within that industry.
7. Control on Wastage: Cost accounting can explain the source of wastage in the statement of cost (i.e. material, labour and other expenses) and thus can save the national factors of production.
8. Minimum Capital in Stocks: Cost accounting through various techniques like various levels of stock, analysis of slow moving material, continuous stock taking can decide the objective to minimise the investment of capital in stocks of raw material, work-in-progress or finished goods.
9. Effective Information System: The objective of cost accounting is to prepare regular reports regarding material, labour and other expenses and to communicate those reports at the effective level of management to make them effective.
10. Internal Audit System: The objective of cost accounting is to develop internal audit system which may help in effective working of different departments of the organisation.
SBP
Ans. MEANING OF COST ACCOUNTING: Cost Accounting is a specialised branch of general accounting in which detailed and systematic information related to cost of goods and services are maintained in such a way as to obtain detailed information about total and per unit cost and guidance for the analysis and control of cost.
Add definition here.
Conclusively, cost accounting may be defined as the body of concepts, methods, techniques and procedures used to compute, analyse or estimate the costs, profitability and performance of individual products, services or departments and other segments of an enterprise.
FUNDAMENTAL PRINCIPLES OF COSTING
The fundamental principles of costing are as follows:
1. Cost is related to its cause. A cost is related as closely as possible to its cause. Rent of the factory, for instance cannot be charged to office expenses, repairing charges of a machine cannot be charged to some other machine, and in the same way, a foreman's salary cannot be charged to one single unit, if many more units are produced in a department supervised by that foreman. The reason in all the above cases is that the cost is related to its cause.
2. Cost is charged after it is incurred. If a cost is not incurred either actually or notionally, it cannot be charged to a cost centre. For instance, a cost unit is not charged with selling costs while it is still under manufacture in the factory, as selling costs would occur only when the cost unit is finished in the factory and is sold. Similarly, normal loss or wastage is to be borne by the units of which it is a loss or wastage. Such a loss is not imposed on those units which are yet to pass the point of loss.
3. Abnormal costs are excluded from costing. A cost to meet the loss caused by'fire, riot, theft or accident is an abnormal cost. This cost is not charged to production as it is not related to production part. The presence of abnormal cost in costing would only distort cost figures and mislead the management for the purposes of cost control and decision-making. Similarly such financial expenses as have little or no relationship with costing, are also considered abnormal and are not charged to costing.
4. Past costs are not charged to future periods. A past cost is one from which no more benefit is to accrue. If, however, a past cost is such the benefit of which is to accrue in a future period also, as for instance, advertisement expense being treated as deferred revenue expenditure, then it is not a past cost and it can be charged during the period of benefit.
5. The concept of conservatism has no place in costing. The closing stock in financial accounting is valued at cost price or the market price, whichever is less, but in costing, the closing inventory and stocks are valued at cost only. There is a value attached to the concept of conservatism in financial accounting but it is not so in costing. Cost statements are required to be prepared so as to state facts with no known bias. If, however, a contingency is to be taken into consideration in cost accounting, it should be so stated and shown distinctly.
6. Accounting for cost is based on Double-entry Principle. The Cost ledgers and other cost control accounts are kept on the double-entry principle-the same principle which is adopted so exhaustively in financial accounting. Costing, however, requires a greater use of cost-sheets and cost statements for the purpose of cost ascertainment, cost control and guidance to management.
FUNCTIONS OR OBJECTS OF COST ACCOUNTING
The main functions or objects of cost accounting are as follows :
1. Cost ascertainment. The primary objective of cost accounting is to determine the cost of production of every unit, job, operation, process, department or service. The technique of ascertaining cost is known as 'Costing. In order to determine cost, all the expenses are accumulated, classified and analysed. It not only determines the cost at completion stage but also determines cost at various stages of production.
2. Cost control. Cost control is one of the important functions of cost accounting. To measure the efficiency of the organisation or of the cost centres, the various operations involved in the manufacture of products are to be carefully studied. Budgets and standards for the consumption of materials, use of labour, and for expending the overhead are to be set and compared with the actual performances. The variances arising out of the comparison so made tell the tale whether the cost is within control or not.
3. Cost reduction: Cost reduction refers to real or genuine savings through permanent reduction in cost of a product or service without impairing the quality and affecting its purpose for which it was intended to be used. In the competitive market situations, it is utmost important for the organisations to look for activities and search for new technology through research and development activities that can reduce the cost of a product. Cost reduction can be attainable in almost all the areas of business activities. The area covered for cost reduction are like product design, plant layout, production methods, material substitution, reduction in wastages, innovation marketing strategies, purchasing and material control etc.
4. Ascertainment of profitability: It is the object of cost accounting to ascertain the profit making capacity of that activity planned or being carried out and to compare the actual profits made with their profitabilities. Difference is analysed and efforts are made to earn the maximum profit as per capacity.
5. Determination of selling price: The supply price or the tender price of a product depends upon its total cost plus a margin of profit which the businessman wants to make depending upon the inter-play of factors of demand and supply. Cost accounting provides detailed information about the composition of total cost for the determination of the selling price. It also provides information to decide the extent to which the prices can be reduced to meet the challenge arising out of competition, by differentiating the costs into variable and fixed cost. Similarly, in the event of depression or recession, the cost accountant can guide as to which expenses can be curtailed, to reduce the cost of production and thus to decide the minimum selling price.
6. Providing a basis for business policy and decision-making. The objective of cost. account- ing is to help the management in the formulation of business policy and in decision-making. The gross-profit analysis, the cost-volume-profit relationship, the break-even point of sales, and the differential costing method, etc., help the management in profit-planning and in deciding crucial matters like (a) introduction or discontinuance of a product; (b) utilization of idle plant capacity; (c) selection of most profitable sales-mix; (d) dumping of goods in a foreign market at a cheaper price; (e) make or buy; (f) purchase of new plant or continuance with the old plant at the cost of heavy repairs, etc.
7. Compliance to statutory requirements: The Central Government, under Section 209(1) (d) of the Companies Act, has made it compulsory for 47 industries to maintain cost accounts. Thus, compliance to statutory requirements is also one of the objectives of cost accounting.
Define cost accounting. Explain the fundamental principles and functions of cost accounting.
