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MODULE 1

Syllabus-Cost accounting-Meaning ,Definition Scope, objectives -Distinction between cost and financial
accounting-Preparation of Cost sheet

Introduction
Cost Accounting is a branch of accounting and has been developed due to limitations of financial accounting
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II provides information regarding the profit and loss that the business enterprise is making
and also its financial position on a particular date
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Limitations of Financial Accounting
1
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Butfinancial accounting does not give a clear
reason for profit or loss
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Weakness not spotted out by colleetive results: Financial Accounting shows the net result of an organization
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not help in fixing the price: In Financial Accounting,
get the total cost of production but it does not
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we

4
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Further expenses are not classified as direct or indirect, controllable and uncontrollable overheads and
the value added in each process is not reported
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No data for comparison and decision making: It does not supply useful data to management for comparison
with previous period and for taking various financial decisions as introduction of new products, replacement of
labour by machines, price in normal or special circumstances, producing a part in the factory or buying it from
outside market, production of a product to be continued or given up, priority accorded to different products,

investment to be made in new products or not etc
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No control on cost: Financial Accounting does not help to control materials, supplies, wages, labour and
overhead costs
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Does not provide standards to assess the performance: Financial Accounting does not help in developing
standards to assess the performance of various persons ordepartments
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Provides only historical information: Financial Accounting records only the historical costs incurred
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Costing and Cost Accounting
The costing terminology of C
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M
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, London defines costing as the "the techniques and processes of ascertaining
costs"
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Cost Accounting mayberegardedas "aspecialized branch of accounting which involvesclassification
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" The costing terminology of C
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M
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In its widest usage
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General

Principles

of Cost

Accounting

The following may be considered as the General Principles of Cost Accounting:
1
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2
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For example, a cost unit should not be
charged to the selling costs, while it is still in the factory
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3
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In Cost Accounting this convention must be
determining
ignored, otherwise, the management appraisal of the profitability of the projects may be vitiated
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M
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If a contingency needs to
be taken into consideration it should be shown separately and distinctly"
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Abnormal costs should be excluded from cost accounts: Costs which are of abnormal nature (eg
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) should be ignored while computing the cost, otherwise, it will distort costs figures and mislead
management as to working results of their undertaking under normal conditions
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Past costs not to be charged to future period: Costs which could not be recovered or charged in full during
the concerned period should not be taken to a future period, for recovery
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of double
should be applied wherever necessary: Costing requires a greuter use of cost
shets and cost statements for the purpose of cost ascertainment and cost control, but cost ledger and cost control
accounts should be kept on double entry principle as far as possible

6
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Information regarding cost of each product or
service would enable the management to know where toeconomize on costs, how to fix prices, how to maximize

profits and so on
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LToanalyseandclassify allexpenditurewithreferenceto the costof products andoperations
2
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3Toindicatetothe managementanyineficienciesandtheextentof various forms
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equipmentandtools
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4Toprovide datiafor periodicalprofitandloss
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e
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weekly
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not
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orindividual products
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and
5
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layout
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Monthly or Quarterly information may be necessary to ensure prompt constructive
estimates or
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7
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where Standard Costs are prepared, what the cost of production ought to be and with which the actual
costswhich are eventually recorded may be compared
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To present comparative cost data for different periods and various volume of output and to provide guidance in
the development of business
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9
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A comparison with the performance of other types of machines may suggest the necessity for
replacement
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To provide a perpetual inventory of stores and other materials so that interim Profit and Loss Account and
Balance Sheet can be prepared without stock taking and checks on stores and adjustments are made at frequent
intervals
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Or /Objectives Of Cost Accounting
1
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It

helps

to

ascertain

cost

of each

activity

such

as

process,

operation, job etc
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Fix Selling Price

Cost accounting provides base for determination of selling price of company's product by ascertaining the cost of each

product
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3
...

4
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It helps to make a choice out of two or more courses of action
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Ascertainment Of Profit

Cost accounting helps in tracking and ascertaining profitability of the product by preparing profit and loss account and
balance sheet periodically
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Formulating Policies
Cost accounting plays important role to formulate policies of the organization
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7
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) of the company
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2
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System

Financial Accounting

Cost Accounting

Financial accounts are maintained on

Cost accounts lay emphasis on both

the basis of historical records
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Financial Accounting is used even by

Cost Accounting is used only the

management of the concern
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Financial Accounting uses the double-Cost Accounting does not use thedouble31 Page

entry system for recording financial

entry for collecting cost data
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Scope

Financial Accounting covers all items

Cost Accounting covers all items related to

of income and expenditure whether
5
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relatedto thecost centers ornot,
Financial Accounting results are shown Cost Accounting results are shown in Cost

Sheet/ Coating Profit& Loss A/c/ Reports

P&L A/c and balance sheet
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7
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_

Cost Accounting concentrates

cost

centers and not on period
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at cost or realisable value, whichever is
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In financial accounts, the Profit or Loss
ofthe entire enterprise is disclosed into
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DISTINGUISH
BETWEEN MANAGEMENT ACCOUNTING AND COSTACCOUNTING
Cost accounting and Management accounting are two modern branches of accounting
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Cost

accounting is concerned not only with cost ascertainment, but also cost control and managerial decision making
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The functions of cost

accounting and management accounting are complimentary
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Though it appears that there is
overlapping of areas between cost and management accounting, the following are the differences between the two
systems
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The function of management accounting is to provide information to management for efficiently performing the

functions of planning, directing, and controlling
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Principles and Procedures: Established procedures and practices are followed in cost accounting
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The analysis is made and the resulti conclusions
are presented in reports as per the requirements of the management
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e)Scope: Management accounting includes, financial accounting, cost accounting, budgeting, tax planningand
reporting to management, whereas Cost accounting is concerned mainly with cost ascertainment and control
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Whatever may be the type of business, it involves expenditure on labour, materials and other items required for
manufacturing and disposing of the product
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It provides
detailed costing information to the management to enable them to maintain effective control over stores and

inventory, to increase efficiency of the organization and to
responsibility for important tasks and rating of employees
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It facilitates

delegation

For all these the management should be

of

capable of
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using the information provided by cost accounts in a proper way
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Cost
accounting
helps
in
periods
of
trade
depression
and
trade
competiion
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The management must know areas where
economies may be sought, waste eliminated and efficiency increased
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The management should know the actual cost of their products before
embarking on any scheme of price reduction
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2
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Although the law of supply and demand determines the price of the product,
cost to the producer does play an important role
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3
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Adequate costing records provide a reliable basis for making
estimates and quoting tenders
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Proper costing information makes it possible
for the management to distinguish between profitable and non-profitable activities: profits can be maximized by
concentrating on profitable operations and eliminating non-profitable ones
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Cost accounting eliminates wastages
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6
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Proper maintenance of costing records provides various costing
data for comparisons which in turn helps the management in formulating future lines of action
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management with 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
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Losses due to wastage of materials, idle time of
workers, poor supervision etc will be disclosed if the various operations involved in the production are studied
carefully
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Cost accounting furnishes control which management requires, in
9Cost
accounting
helps
in
inventory
control
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Investors, banks and other money lending institutions have a stake in the
success of the business concern are therefore benefitted immensely by the installation of an efficient system of
costing
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c) Costing as an aid to employees
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They are benefited by a number of ways by the installation of an efficient system of costing
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d) Costing as an aid to National Economy
An efficient system of costing brings prosperity to the business enterprise which in turn brings prosperity to the
business enterprise which in turn results in stepping up of the government revenue
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Control of costs,

elimination of wastages and inefficiencies led to the progress of the industry and, in consequence of the nation as a
whole
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Cost accounting refers to the process of determining the cost of a

particular product or activity
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Internal

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reporting presents details of cost data in a summarized and aggregate form
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In order that cost accounting satisfies the requirements of both internal and external reporting, the following are
the different activities which are undertaken under cost accounting system:

1) Cost Determination: This is the first step in the cost accounting system
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This is a critical activity since the other three activities, explained below,
depend on it
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Cost recording may be done according to integral or non-integral system a separate set of books
is maintained for costing and financial transactions
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Meaningful cost analysis depends largely upon the clear
understanding of the cost finding methods used in cost accounting
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to use cost
intelligently it is necessary for the managers to have good understanding of

In order

information

different cost accounting concepts
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The main functions of cost accounting are:
i) To serve as a guide to price fixing of products
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ii) To reveal sources of economy in production
iv) To provide for an effective system of stores, materials etc
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process

vi) To ascertain the profitability of each product
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Vii) To present and interpret data for management decisions
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)To facilitate planning and control of business activity
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ADVANTAGES OF COST ACCOUNTING
1) Helps in Decision Making: Cost accounting helps in decision making
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For instance, cost accounting helps in deciding:
Whether to make a product buy a product?
2
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It provides detailed cost data of each

product (both on the aggregate and unit basis) which enables fixation of selling price
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3) Formulation of future plans: Cost accounting is not a post-mortem examination
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On the basis of past experience, it helps in the formulation of definite future plans in quantitative
terms
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4) Avoidance of wastage: Cost accounting reveals the sources of losses or inefficiencies such as spoilage,
leakage, pilferage, inadequate utilization of plant etc
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5) Highlights causes: The exact cause of an increase or decrease in profit or loss can be found with the aid of

cost accounting
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6) Reward to efficieney: Cost accounting introduces bonus plans and incentive wage systems to suit the
needs of the organization
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7) Prevention of frauds: Cost accounting envisages sound systems of inventory control, budgetary control
and standard costing
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8) Improvement in profitability: Cost accounting reveals unprofitable products and activities
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The resources released from unprofitable

products can be used to improve the profitability of the business
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It helps in the
preparation of interim profit and loss account and balance sheet without physical stock verification
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By adopting them, the management can notice the deviation from the plans
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LIMITATIONS OF COST ACCOUNTING

In spite of the various advantages claimed by cost accounting, the discipline suffers from the following limitations:

)

Cost Accounting is costly to operate: It involves heavy expenditure to operate
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2) Cost Accounting involves many forms and statements: It involves usage of many forms and statements
which leads to increase of paper work
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Cost accounting methods can be devised for all types of industries,
and services
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Costing system estimates costs scientifically based on past and present situations and with suitable
modifications for the future
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But for the predetermined costs, cost accounting also becomes another 'Historical Accounting'
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6) Bias Judgments: Many judgments are biased and depend on individual discretion
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1
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3
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Organization of the factory
Conditions of incidence of cost
Requirements of the costing system ie
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Availability of information

Profit centre=

A profit centre is that segment of activity of a business which is responsible for both revenue and expenses and

discloses the profit of a particular segment of activity
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Cost centre is the smallest
unit of activity or area of responsibility for which costs are collected whereas a profit centre is that segment of
activity of a business which is responsible for both revenue and expenses
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e
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(11) Cost centers are not autonomous whereas profit centres are autonomous
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(iv) There may be a number of cost centres in a profit centre in a profit centre as production or service cost centres
or personal or impersonal but a profit centre may be a subsidiary company within a group or division in a
company
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Properclassification of costs is very
important for identifying the costs with the cost centers or cost units
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By Nature or Elements
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e
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Materials can further be sub-classified as rawmaterials components, spare

parts, consumable stores, packing materials etc
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It also helps in valuation of work
in-progress
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By Functions: This classification is on the basis of costs incurred in various functions of an organization ie
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According to this classification, costs are divided into
Manufacturing and Production Costs and Commercial costs
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Commercial Costs are (a) administration costs (b) selling and distribution costs
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By Degree of Traceability to the Product: According to this, costs are divided direct costs and indirect
costs
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Eg:- Materials, Labour
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Eg:- Rent ofBuilding, electricity charges, salary of staff etc
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By Changes in Activity or Volume: According to this costs are classified according to their behavior in
relation to changes in the level of activity or volume of production
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Fixed Costs are those costs which remain fixed in total amount with increase or decrease in the volume of the

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Output or productive activity for a given period of time
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Eg: rent, insurance of factory building
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Variable Costs are those costs
which vary in direct proportion to the volume of output
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Eg:- direct material costs, direct labour costs, power, repairs etc
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For example;
Depreciation, for two shifts working the total depreciation may be only 50% more than that for single shift

working
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Product costs are
those which are traceable to the product and included in inventory cost, thus product cost is full factory cost
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thus it includes all selling and
administration costs
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6
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7
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Normal costs are the costs whichare normally
incurred at a given level of output under normal conditions
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Eg:- damaged goods due to
machine break down, extra expenses due to disruption of electricity, inefficiency of workers etc
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By Relationship with Accounting Period: There are capital and revenue expenses depending on the length of
the period for which it is incurred
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Such cost is incurred at one point of time but the benefits accruing from it are spread over a number of

accounting years
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Eg:- cost of materials, salary and wages paid, depreciation, repairs and maintenance, selling and distribution
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By Time
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The costs which are ascertained and recorded after it has been incurred is called historical costs
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Predetermined costs are also
known as estimated costs as they are computed in advance of production taking into consideration the previous

periods' costs and the factors affecting such costs
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Standard costs are used to prepare budgets and then the actual cost incurred is later-on compared with such

predetermined cost and the variance is studied for future correction
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In other words,
decision is made
is the benefit given up when
opportunity cost
Opportunity
cost
represents an alternative given up when a decision is made
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The opportunity cost would be the difference between the cost of
the cash outlay for the equipment and the improved productivity versus how much money could have been saved had
the money been used to pay down
costs that have already been incurred and will
Sunk costsare historical
has committed
costs
those costs that

management
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or
unrecoverable
unavoidable

not make any
to and are

current decisions

Elements of cost

By grouping the above elements of cost, the following divisions of cost are obtained

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