Introduction

Financial accounting provides information regarding profit or loss and

the financial position of a business at the end of the financial year. It
does no provide any detailed information as to why such profit or loss
occurred or why balance sheet shows a particular position of inventories.
It also does not provide information on the method of valuing
inventories. In general sense, financial accounting does not provide
detailed information regarding the operational cause of profit or loss and
the balance sheet position and the end of financial year. This mandates
the requirement of cost accounting as it tries to provide various
operational information and the causes behind the value of inventories.
Through cost accounting anyone can get detailed information regarding
the working of business and its production process.
The information provided by cost accounting is vital in nature and can reveal
the secrets of business to the competitors, hence, the cost accounting data is
never shared in public domain. It is used only by the top management to
analyze and control any deviations in the production process.

Cost accounting is limited to production only as it provides cost details and

hence, it provided backend information. It provides the structure of cost and is
various constituents. It does not deal with what happens to a product after its
production, whether it is sold or not or how it is sold. It ends up as soon as
production is completed and goods are ready for sale. Thus it is the process of
recording and accounting for all the elements of the cost.
 Meaning of Cost Accounting
Costing is referred to “ as classifying, recording and appropriate allocation of
expenditure for the determination of the costs of products or services”
Costing is the technique and process of ascertaining cost.
The ICWA, UK define Cost Accounting 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 centres and cost units”
The ICWA, India define “Cost Accounting is the technique and process of
ascertaining of costs. Cost accounting is the process of accounting costs, which
begins with recording of expenses or the bases on which they are calculated and
ends with preparation of statistical data.”

I.C.M.A., has defined cost accountancy as “The application of costing and cost
accounting principles, methods and techniques to the science, art and practice
of cost control and the ascertainment of profitability. It includes the
presentation of information derived there from for the purpose of managerial
decision making”.
 Nature of Cost Accounting
1. Specialized Branch of Knowledge: Cost Accounting has its own principles,
rules and conventions. It is a separate branch of knowledge requiring specific
knowledge and skills.

2. It is a Profession: Cost Accounting is regarded as separate profession due to

its specialized knowledge and skills. It has a separate and organized body
for the working of cost accountants.

3. Both Science and Art: Cost Accounting is considered as science because it

has sound theory base and its own principle and regulations. Cost
Accounting is considered as an art because application of cost accounting
prefers from business and from person to person. Everyone has its own set of
skill and way of applicability and of cost accounting principle.

4. Helpful to Management: Cost Accounting and Cost Accountants are helpful

to management by the way of providing vital information regarding cost of
production, cost of labour and profit margin.
 Scope of Cost Accounting
1. Cost Analysis: Cost accounting determines the deviation of the actual cost as
compared to the planned expense, along with the reason for such variation.
2. Cost Audit: To verify the cost sheets and ensure the efficient application of
cost accounting principles in the industries, cost audits are done.
3. Cost Report: Cost reports are prepared from the data acquired through cost
accounting to be analyzed by the management for strategic decision making.
4. Cost Ascertainment: To determine the price of a product or service, it is
essential to know the total cost involved in generating that product or
service.
5. Cost System: It provides for time to time monitoring and evaluation of the
cost incurred in the production of goods and services to generate cost reports
for the management.
6. Cost Comparison: It examines the other alternative product line or activities
and the cost involved in it, to seek a better opportunity for generating high
revenue.
7. Cost Control: Sometimes, the actual cost of a product or service becomes
higher than its standard cost. To eliminate the difference and control the
actual cost, cost accounting is required.
8. Cost Computation: When the company is engaged in the production of bulk
units of a particular product or commodity, the actual per-unit cost is derived
through cost accounting.
9. Cost Reduction: It acts as a tool in the hands of management to find out if
there is any scope of reducing the standard cost involved in the production of
goods and services. Its purpose is to obtain additional gain.
 Objectives of Cost Accounting
1. Control and Reduce Cost: Cost accounting continuously focuses on
managing the cost of production per unit to improve profitability without
compromising with the quality of the product.
2. Determine Selling Price: It provides the total cost incurred in the product or
service, which is the base for fixing an appropriate selling price.
3. Assist Management in Decision Making: The reports and cost sheets
generated based on cost accounting back the managerial decisions of the
organization.
4. Ascertain Closing Inventory: It determines the closing inventory value at
the end of the financial year.
5. Ensure Profit from Each Activity: Cost accounting reviews the cost and
takes corrective actions at each level to ensure profitability from all business
activities.
6. Budgeting: It generates the estimated cost of products or services to assist in budget
planning, implementation and control.
7. Setting Performance Standards: It provides a standard cost of goods or services to
sets a level for the future course of action.
8. Business Expansion: It estimates the cost of production at different stages,
based on this analysis, the management can plan for expansion of the
business.
9. Minimizing Wastage: Cost control and reduction so attained helps in
reducing the wastage during the manufacturing process.
10. Improves Efficiency: Cost accounting assures cost management, profit
appreciation and less wastage which ultimately enhances the overall
production and manufacturing process of products.
 Advantage of Cost Accounting
1. Helps in controlling cost: Cost accounting helps to control the cost of the
business by applying different type of techniques and methods such as
standard costing and budgetary control etc.
2. Helps in fixing prices: Cost accounting also helps to fix the prices of
product or service. It provides detailed cost data of each product in
aggregate as well as in per unit, which helps in fixation of selling price.
Cost accounting provides basis information for the preparation of tenders,
estimates and quotations.
3. Provides cost information: It provides necessary cost information to the
management for planning, implements and controlling.
4. Ascertains the total per unit cost of production: It ascertains the total and
per unit cost of production of goods and services that helps to fix the selling
prices as well.
5. Discloses the profitable and non profitable activities: It discloses the
profitable and non profitable activities that enable management to decide to
eliminate or control unprofitable activities and expand or develop the
profitable activities.
 Advantage of Cost Accounting
6. Provides information for the comparison of cost: It provides reliable data
and information which enable the comparison of cost between periods,
volume of output, determent and processes.

7. Checks the accuracy of financial accounts: It helps checking the accuracy

of financial accounts. This is done by preparing cost reconciliation statement.

8. Helps invests and financial institutions: It is also advantageous to

investment and financial institutions since it discloses the profitability and
financial position in which they intend to invest.

9. Beneficial to workers: It is beneficial to workers as well since it emphasizes

the efficient utilization of labor and scientific systems of wages payment.
 Limitations of Cost Accounting
1. The system is more complex: Cost accounting needs to identify the different
types of expenses and allocation of expenses is considered as a complicated
system of accounting. It needs different forms and formulas to collect the data
and preparing the reports. Also it requires number of steps in ascertaining such
details. So it involves a more complex system. More complex and complicated
system of cost accounting is one of the limitation facing by the cost accounting.

2. It is expensive: In installing and maintaining cost accounting system requires

more man power and resources. More analysis, allocation and absorption of
overheads requires considerable amount of additional work. If the expenses
incurred in ascertaining the cost is more than what is derived from it, then the
process of cost accounting is meaningless. In short, the expenses of cost
accounting should not be more than the profit derived from cost accounting.
Many companies does not adopt cost accounting owing the fact that it is more
expensive and not economical.
 Limitations of Cost Accounting

3. Inapplicability of costing method and technique: Technique and methods of

cost accounting differ from organization to organization. One standard method is
not adequate for all the requirement of different organizations. It depend on the
nature of business and the type of service/product manufactured by the firm. If
wrong technique or method is used, it will affect the result. So inapplicability of
same costing method and technique is the one of the main limitation of cost
accounting.

4. Not suitable for small scale units: One of the limitation faced by the cost
accounting in installing it in all types of business is that it is not applicable to
small scale units. Through the traditional accounting, small scale units can
control the cost effectively.

5. Lack of Accuracy: Use of notional cost such as standard cost, estimated cost
etc would not bring out the actual cost of the product. So the cost accounting
lacks the accuracy of its results.
 Limitations of Cost Accounting

6. It serves the information need of the management: We cannot depend on

cost accounting for the financial information required by the share holders,
creditors, employees and the society at large. It only serves the requirement of
information needed by the management.

7. Not useful for determining the tax liabilities: We cannot treat cost
accounting as a basis for determining the tax liabilities of the business. Financial
accounting is required for the determination of tax liabilities.
 Types of Costs
1. By Nature or Element
a. Material Cost
b. Labour Cost
c. Expenses

2. By Functions
a. Production Cost
b. Selling Cost
c. Distribution Cost
d. Administrative Cost
e. Research & Development Cost
f. Pre Production Cost

3. As Direct or Indirect:
a. Direct Cost
b. Indirect Cost
 Types of Costs

4. By Variability
a. Fixed Cost
b. Variable Cost
c. Semi Variable Cost

5. By Controllability
a. Controllable Cost
b. Uncontrollable Cost

6. By Normality
a. Normal Cost
b. Abnormal Cost

7. Opportunity Cost

8. Implicit Cost/ Imputed Cost

 Basis Cost Accounting Management
Accounting
Limited scope as provides Broader scope as it works on
Scope information of costs only information of both FA &
CA
Generally used at middle Generally used at higher
Organization Status & lower level of level of management
management
To ascertain costs & to Planning, Controlling &
Purpose
ensure maximum profit Decision Making
Essential Compulsory in bigger Not at all compulsory
Requirement organization
Can be used without MA Cannot be used without CA
Installation
& FA
 ELEMENTS OF COST
COSTS

MATERIAL LABOUR OTHER

EXPENSES

DIRECT INDIRECT DIRECT INDIRECT

DIRECT INDIRECT

OVERHEADS

WORK ADMIN SELLING DISTRIBUTION

OVERHEADS OVERHEADS OVERHEADS OVERHEADS
 ELEMENTS OF COST
1. Direct Material: Direct Materials are those that can be directly identified
in a product. These materials becomes a major part of the product. It is
also known as process material or production material or prime cost
material.

2. Direct Labour: It is the labour spent in converting raw materials into

finished goods. Wages given to workers who are engaged in converting
raw material into finished goods comes under direct labour. It is the
labour that is directly involved in the production of a commodity. This
cost is easily traceable in the total cost of product. Direct labour is also
known as direct wages or prime cost labour or productive labour.

3. Direct Expenses: These include expenses other than direct material and
direct labour which are incurred in manufacturing a product. These can
be directly identified and allocated to a process of production. These are
also known as prime cost expenses or productive expenses or process
expenses.
 ELEMENTS OF COST
4. Indirect Material: Materials that cannot be identified as part of a
product are called indirect materials. These materials cannot be easily and
conveniently identified and related with a particular product.

5. Indirect Labour: Wages that cannot not be directly identified with a

product are called indirect labour. It includes all labour not directly
engaged in converting raw materials into finished products.

6. Indirect Expenses: Expenses that are not directly identified with a

product are called indirect expenses. All indirect costs other than indirect
material and indirect labour are termed indirect expenses. These cannot
be directly identified and allocated to a process of production.
 Methods of Costing
1. Job Costing: It is used when the cost of each job is ascertained
separately. It is suitable in all cases where work is undertaken on
receiving customer’s order like printing press.
2. Batch Costing: It is practiced where jobs are arranged in different
batches. This method is particularly suitable for pharmaceutical
industries.
3. Contract Costing: It is suitable for firms engaged in the construction
of bridges , roads etc. A contract is a big job. It is much similar to job
costing.
4. Process Costing: It aims at calculating the cost at each stage through
which a product passes in production process. This system of costing
is suitable for the extractive industries.
5. Operation Costing: It is an extension of process costing. This system
is employed in industries where mass or repetitive production is
carried out. It is mainly used in case of firms rendering transport
services, water supply etc.
 Methods of Costing
6. Standard Costing: Standard Costing is a system under which the cost
is determined in advance on certain predetermined standards. It may
be used as a basis for price fixing and for cost control through
variance analysis.
7. Marginal Costing: It is a technique in which allocation of expenses
are restricted to those expenses that arise as a result of production.
This technique is useful in manufacturing industries with varying
levels of output.
 Techniques of Costing
1. Absorption Costing: It is a traditional technique which is helpful in
preparing quotation and tenders. It takes into consideration all the
cost, whether fixed or variable in calculating total cost.
2. Marginal Costing: It is a technique in which cost is bifurcated into
fixed and variable cost. The cost of product is accessed by taking into
consideration only variable cost needed for its production. The fixed
cost is later on deducted from the contribution i.e. total sale price –
total variable cost.
3. Direct Costing: This is a technique in which all the direct cost are
charged as cost of production. No indirect cost is taken into
consideration while calculating cost of production. They are
separately written off from profits later on.
4. Differential Costing: It is a technique in which costing of two or
more production process is calculated to arrive on the techniques of
production.
 Techniques of Costing

5. Standard Costing: It is a technique where in standards are pre defined

and the actual activity cost is calculated after the compilation of work.
Any deviation in actual cost or standard cost is then checked and
reasons are find out.
 Installation of Costing System
The cost accounting system depends upon the nature of business and the
product manufactured. The costing system must suite the needs of the
business. The benefits derived from the costing system must be more than
the investments made on it. The system must be simple and it must lead to
saving through the control of materials, labours and overheads. Following
essential conditions must be kept in mind before installing costing system:

1. There must be an efficient system of material control.

2. A sound method of wage payment must be set up.
3. There must be a sound bases absorption of all indirect expenses.
4. The duties and responsibilities of cost accountant must be made clear.
5. Printed formats should be used for quick reporting.
 Factors to be Taken Into Consideration Before
Installing Costing System
1. History of Business Unit: It refers to the time of existence, rate of
growth, policy of management and necessity of cost accounting
system. After review these factors, the decision should be made over
installation of costing system.
2. Nature of Business Unit: The installation of costing system depends
upon the nature of business i.e. manufacturing or trading, as it will
determine the method of costing to be followed.
3. Objective of business Unit: The costing system of business also
depends upon the objectives of the management for its installation.
The objectives may be cost control, increase in efficiency or
implementation of new production process.
4. Range of Product: Installation of costing method also gets affected
by the range or number of product and the level of production a
which firm is operating.
 Factors to be Taken Into Consideration Before
Installing Costing System
5. Organizational Factors: Various other organizational factors should
be taken into consideration while preparing for installation of new
costing system. An old enterprise will be more resistant towards
installation as compared to new enterprise.
6. Area of Control: It refers to the importance of a particular work in a
production process. Costing system depends on the area of control
for the production process. Area of control does not signifies the area
of office or factory but the importance of work. If priority is more for
raw material control in the total production, it will require more area
under control.
7. Technical Considerations: Technical points which effects costing
system are – (a) Size and Layout of the factory. (b) Flow of
Production. (c) Existence of Production and Service department. (d)
Existence of Laboratories. (e) Production Control Techniques. (f)
Internal Transport and Material Handling Equipments.
 Factors to be Taken Into Consideration Before
Installing Costing System
8. Selling & Distribution Method: Costing system is also affected by
warehousing facilities, transportation support, market research
facilities etc.
9. Practical Consideration: The cost accounting system to be installed
must be flexible in operation and must be capable of adopting to
changing needs of business.
10. Uniformity: Various ledgers, registers and forms of costing system
should be uniform throughout the organization to facilitate intra and
inter firm comparison.
11. Reporting: Cost accounting system must ensure frequent and prompt
reporting to the management and should avoid duplication of
reporting.