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. It includes the ascertainment of the cost of every order, job, contract, process, service or unit as may be appropriate.
Objectives of Cost Accounting
There can be several objectives of cost accounting. However, the following are its important objectives:
- To ascertain cost: The important objective of cost accounting is to ascertain cost of a product or services or jobs. Ascertainment of cost is process of determining cost after they have been incurred. Generally, there are two methods of determining the cost i.e job costing and process costing. Due to the difference in the nature of activity of industry, different methods of cost may be applied.
- To control cost: The objective of cost accounting is to control the cost by using various techniques such as standard costing, inventory control, marginal costing, etc.
- To provide information for decision making: Cost accounting is the formal system of accounting and provides information for various managerial decisions like
- Whether to accept or reject the offer,
- Whether to make or buy a product,
- Whether to continue or replace the existing machine and
- Whether to drop or continue the product or services
- To fix the selling price: Cost accounting can provide detailed information about the cost of a product or service to determine the selling price.
- To ascertain costing profit or loss: Cost accounting ascertains the total cost and total revenue of every product or service or job and calculates profit or loss by comparing with revenue and cost.
- To provide information in preparation of financial statements: Inventory should be valued for preparation of financial statements by comparing cost price and market price.
Importance and advantages of cost accounting
Cost accounting provides immense advantages to a firm. It also can be explained in terms of importance:
- Helping in ascertaining cost: Cost accounting uses different methods of costing such as job costing, process costing etc. applying this costing method cost of each product, process or job is ascertained.
- Helps in inventory control: It helps in inventory control using various techniques like ABC analysis, economic order quantity, stock level etc.
- Helps in the measurement of efficiency: It helps in the measurement of efficiency of operations through the establishment of standards and various analyses.
- Helps in preparation of budget: It helps in preparation of various budgets such as sales budget, production budget, material purchase budget, flexible budget etc.
Limitation of Cost Accounting
- Expensive: Cost accounting is expensive. It involves lots of clerical won for maintaining various costing records for different purposes. For medium and small size concerns, the benefit derived from costing system may not justify the cost involved.
- Lack of uniformity: Procedures of cost accounting followed by different organizations are different for different There is no uniformity. There is also possibility of difference in pricing material issues for production. All these lead to different cost results for the same operation.
- No Universal Application: Technique and methods of cost accounting differ from organization to organization. A single costing system may not be applicable to all industries because the costing system may be specially designed to meet the need of a specific industry.
- Exclusion of Incomes and Expenditure: Items of purely financial nature such as interest, financial charges, discount and loss on issue of shares and debentures, etc. are not taken into consideration in Cost Accounting. Therefore, it is difficult to calculate profit or loss of a particular product or service.
- Lack of Knowledge: A person having less knowledge about production procedures, record keeping, accounting techniques, report writing, materials and equipment used, etc. cannot produce results from cost
- Failure in some cases: Cost accounting does not always produce desired results required by the management. For example: if efficient management is lacking, the results brought out by the cost accountant is useless. Lack of cooperation of employees will affect the overall performance of cost accounting, etc.
Business firms for earning profit perform business activities. Each business activity involves financial transactions. Such financial transaction needs proper recording and systematic classification and analysis to know profit or loss and financial position usually at the end of each year.
Financial accounting is the art of recording, classifying and summarizing the financial transactions of a firm in such a manner that its profit or loss and financial position are ascertained at the end year and communicated to the user. It includes trading account, profit and loss account and balance sheet.
Objectives of Financial Accounting:
The main objectives of financial accounting are;
- To keep systematic record of financial transactions: The main objective of financial accounting is to record the financial transaction of a business in a systematic and scientific order. The need to record is necessary due to limited memory power of human beings.
- To ascertain profit and loss: Profit is the main motive of every firm. Everyone who is related to the firm is keen to know its profit or loss at the end of each year. It is also one of the important objectives of financial accounting.
- To reveal financial position: The firm is not only keen to know its profit or loss at the end of each year, but also its financial health on that date. The firm’s financial health is judged based on financial position.
- To determine tax liability: Payment of tax liability to the government is the legal responsibility of an organization. It can be calculated based on net profit. Net profit is revealed by the financial account and generally prepared at the end of year.
- To protect assets and properties: Financial accounting not only keeps records of all assets and properties acquired by the firm but also records of their use and transfer from one place to another. Recording of the firm’s assets and properties and their audit helps to protect from misuse and misappropriation.
- To communicate financial information: Financial accounting helps to communicate financial information such as expenses, incomes, profit, losses, assess, liabilities, etc. to the stakeholders including management, employee, investors, government, suppliers, etc.
Limitations of financial accounting
Financial accounting also suffers from limitations. Some notable ones are as follows:
- No detailed cost information: Financial accounting does not provide detailed cost information for different departments, processes, products, jobs, different services and functions. But, financial accounting does not make evaluation performances of units, departments, and processes.
- No segregation of cost: Segregation of costs by nature and behavior is essential for controlling costs and identifying responsibilities. Financial accounting does not segregate cost in terms of behavior such as variable or fixed costs, nor does it classify in terms of nature such as direct and indirect costs.
- Does not determine cost and price: Every firm must determine prices of its outputs in order to sell them. But, financial accounting does not determine the selling prices of the firms output.
- Difficult to analyze losses: Financial accounting does not provide separate cost data for each job, work, batch, etc. It also fails to show the wastages, idle time, etc so it is difficult to identify the causes of losses that occurred.
- No use of standards: Financial accounting does not possess an adequate system of standards to evaluate the performance of departments and employees working in the departments which is necessary to measure the efficiency in the use of material, labour and expenses.
- No control over cost: Expenses are not classified into direct and indirect, and therefore, cannot be classified as controllable and uncontrollable. Control of cost which is the most important objective of all business enterprises cannot be achieved with the aid of financial accounting alone.
- Historical data: Financial accounting contains historical cost information which is accumulated at the end of the accounting period. This accounting does not provide day-to-day information about costs and expenses. Historical cost is not a reliable basis for predicting future earnings, solvency, or overall managerial effectiveness.
DIFFERENCE BETWEEN FINANCIAL ACCOUNTING AND COST ACCOUNTING
|BASIS||COST ACCOUNTING||FINANCIAL ACCOUNTING|
|Objectives||The main objective of cost accounting is to record and report costs of output.||The main objectives of financial accounting are to report financial results in terms of profit or loss and financial position of a firm.|
|Segregation of costs||Cost accounting segregates costs into fixed and variable portions.||Financial accounting does not segregate costs into fixed and variable portions.|
|Users of information||Its user is mainly managers who use the cost data for their decision-making purpose.||Its users are owners, managers, creditors, employees, workers, consumers and government.|
|Legal requirement||It is voluntarily required for the firm to keep cost accounts.||It is legally required for the firm to maintain financial accounts.|
|Application||It is primarily applied in manufacturing concerns.||It is generally applied in all types of business concerns.|
|Inventory Valuation||It values inventory on a cost basis.||It values inventory based either on cost or market price whichever is low.|
|Use of standards||It uses standards to compare the results with actual costs, which helps management to take necessary corrective actions||It does not have any predetermined standards cost to evaluate the efficiency of an organization.|
|Time span of reporting||It can be reported as per need of management i.e.: daily, weekly, monthly, yearly, etc.||It is prepared to provide financial information to the concerned parties usually at the end of the fiscal year.|
METHODS OF ACCOUNTING
- Job order costing: This method is used to gathers and accumulates costs for each job order or work order received from customers. Since each job order is specific and terminates after it is completed, therefore all costs that are incurred in the job or order are accumulated after its termination.
- Contract costing: This costing refers to the form of specific order costing, which applies, where work is undertaken to customer requirements and each order is long duration as compared to job order costing. A job, which is big and spreads over long periods of time is known as a contract. The method of costing which is used in a contract is called contract costing. This method is used by builders, civil engineering contractors and construction firms.
- Process costing: The costing method that ascertains the cost of each process or stage of producing output is called process costing. Under this method, a separate account is opened for each process to which all costs incurred thereon are charged.
- Service costing: The method of costing which is used for ascertaining the costs of service rendered is known as service costing. Under this method, the cost per unit of service rendered such as cost per passenger kilometer, cost per ton kilometer, cost per kilowatt, or cost per patient day is determined. Therefore, this method is popular in industries and institutions that provide services instead of manufacturing products.
- Unit Costing: Unit or output costing is a method of costing, which is applied in those undertakings where units of output are homogenous. Here the costing is to ascertain the cost per unit of output. The cost per unit is ascertained by dividing the total cost incurred on the production of a product by the number of units of that product. It is commonly used in industries like mines, breweries, cement works, mills, sugar mills, textile industry, electrical appliances, etc.
- Batch costing: A batch consists of a lot of common units. Therefore, a number of identical units manufactured on a lot basis are called batch. The Uniform size of the product is produced in each batch. The costing method used to determine cost of products produced on lot wise basis is called batch costing.
- Multiple costing: An ascertainment of cost of product by using more than one costing method is defined as multiple costing. It is also called composite costing. It is adopted in those industries where several components are used to produce a final product.