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Introduction

Chapter Outline
Financial Accounting and its Limitations; Cost Accounting - Meaning, Scope, Objectives,
Cost Accounting, Financial ·Accounting and Management Accounting - Comparison,
Advantages and Limitations of Cost Accounting, Application, Concept of Cost, Cost Centre,
Cost Unit, Cost object, Methods and Techniques of Costing, Classification of costs, Elements
of Cost, Cost Sheet, Examination Questions.

Accounting seives the purpose of providing financial information relating to activities of a business.
Such information is provided tg shareholders, managers, creditors, debentureholders, bankers, tax
authorities and ~ ers. Broadly speaking, on ~he basI; of tw of accounting ~ tion and the
purpose for which such information is used, accounting may be divided into three categories:
1. Financial Accounting (or General Accounting),
2._Cost~ counting. and
3. Management Accounting
Accounting I

l I
Financial Cost Management
Accounting Accounting Accounting
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FIG. 1.1. Sub-fields of accounting

·~ l accounting is mainly co.ocerned with recording business transactions in the book;,.2f

account and prepare (a) Profit and Loss Account showing the net profit or loss during the year and
(b) Balance Sheetshowing the finan cial position of tlie company at a point of time.
Cost accounti ng is a branch of accounting which special~n V,e asce~ainment o~ c~of

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products ar.id services. It has been explained in detail in this book. ·

1.1

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 -- Cost Accounting •
1.2
f ccounts as a tool of managemet]t. It is
O
Management accounting is. the. mod~Q..IJC_
. thate pt a - to- managemen t . -
is useful
concerned with all such accounting mform~ ·

Limitations C!f.. Financial Accounting . .

f certain limitations • 1 accounting . Finan~l
of fin anoa
Cost acc?unting has emerged mainly because O . . hi h it can supply to management
accounting is so limited and inadequate in regard to the informati~n w ms like cost and management
that businessmen have been eager to adopt supplementary acco~ting sy e .
accounting. The limitations of financial accounting . are summansed as follows
-tin rovides information· . ab out profit , 1oss,
:snows onlx.,overa\l perfonpan.ce. Fin<1;11cia1 accoun g P • d ta regarding costs75y
cost etc., oTthe cg_llective activities of the business as a whole. It does not g~ve a __. - -~- _
departments,
. .products,
. processes
. and. sales territones,
. . hietc. . 1 • the .QQ.tg. are summarise . d on1Y at
~ 1stoncal in nature. Financial accounting IS stonca, smce ~ = ----~--- -:-
th~ counting period. There is no system of"coinputing day-d~ ' l co~ -~ d also c_o~pu~
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pre-determined costs. - • -----
p~rfom ance appraisal. In financial accounting, there is no system of developm~_!!Q.~
and standarg_§ to appraise the efficiency in the use of materials, labour and ~ther co~ts by c~mparmg
the actual performanc_~ with what s~ uld have been accQ!!!Iills~ ~uring a given pen~~f ~e.
~aterial control !Ystem. Generally, there is no proper Mtem of contro_l ou_nate_na~ losses
which may arise in the form of obsolescenc·e, deterioration, excessive scrap and IDISappropnation, etc.
~ hour co~t controC-in ~ c ial ~~counting, there is no sys~ of ~ corging~ ~ ~ ~
i.e., idle time. Labour cost is 1:tQt recorded by jo,21, proce~ es or.,departments and as -~ - 'llo~
system of incentj_ves may be ~ asil~ ~ e_c!._!9 compensate _![Orkers for _!heir above-standard performance.
~ No proQer classification of co.sts. In financial accounting, expenses. are not classified into
direct and indirect, fixed and variable and controllable and uncontrollable. These classifications have
utilic yof the~ ~- -- ...- -
_~ nalysis of ~ - Financial accounting does not fully__analyse the losses due to idle qme,
idle plant c~pacity, inefficient lab~J, sub-standard materials, etc. Thus, exact causes of the losses aie
no£~ - .
~ad~uate information for price fixatio:q, Costs are not available as an aid in determining
pnces of Eroducts, services or production orders.
9. No c~ compa~Ison.Comp~ son is foundation of modef!l_...:management. control. B~t
financial accounting does ,!1-Ot 12rovi,.d.~ ,dataj or ._co!,llparison of costs of dj{ferent periods, diff; ~t jobs
or departments, or sales territories, etc. - -- - ··
~ o supply useful data to management. Financial accounting fails to suE.E!_y_useful data
~o manadg~men! for t ~various_d decisions like pricing of pro due.t s, replacement of labour by ma~hines,
mtro -uction o new- pro- ucts, make-or- buy, selection of the most .profitable
_•
nrnn, • • · _._
pQ-UC:i-ITl:lX"} etc. .

Cost accounting has ---- -

primarily developed
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COST ACCOUNTING
to meet_ the
__needs of managem ent. Profit · and Loss
Account
- an d Baldance Sh eet are presented
• • to management by the fin anc1a · l accountant. But modern
management nee s muc m~re detailed mformation than suppli d b th fin •
accmmting provides detai[ecfcost informat;on t • l r e Y ese ancial statements. Cost
- o vanous eveLS of management f ffi . rf
of their fiincf1 he information supplied by cost accountin , t --~ <?!. e crent pe ormance
making optimu of scarce resources and ultimately
_ __ add_ to_ thge ac
prosfiatsb~litool
a 1 ty of of ~ ~anagement
bus~ ss. for
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 OBJECTIVES AND FUNCTIONS OF COST ACCOUNTING
The main objectives of cost accounting are as follows:
1. Ascertainment of cost. This is the primary objective of cost accounting. In other words, the

*Cost Accounting and Costing Methods - - Wheldon.

1.4 Cost Accounting

basic objective of cost accounting is to ascertain the cost of products and services. For cost ascertainment
different techniques and systems of costing are used in different industries.
_1...£01ttrol and reduction of cost. Cost accounting aims at improving .tlfidency_l>y controlling and
tecfuc ~ t . This objective is becoming increasingly important because of growing competition.
~ e to b~siness policy. Cost accounting aims at serving tne needs of managE;!,TI-ent _in
con~~ctm9: the busm es§ with utmost efficiency. Cost data movide guidelines for various managenal
decisions like make or buy, selling fielow cost, utilisation of idle plant capacity, introduction of a new
product, etc. ,,,
4. Determination of selling price. Cost accounting provides cost informati.on on the basis .
of w~ selling prices of products or services may be fixed. In periods of depression, costaccou.1!._ting
guides in deciding the extent to which the ~ lling prices ~ ay be reduced to me~t tile situation. -

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~ n9 and~ :r~ g performance. Cost accounting_m~smgs_;fficiency by c!~~ifying
and an~ ~g ~ost d~a_and then sug~~t__yaj,2,.us ~ eps in improving performance so that _profita~ility
3

is increased. - ·-
I n order to realise these objectives, the data provided by cost accounting may hav~ to be__re-
classified, re-organised and supplemented by other relevant business aata from outside the formalJ::ost
accounting sy~ . --

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COST ACCOUNTING AND FINANCIAL ACCOUNTING - COMPARISON
Both cost accQunting and finanf;i!!,J acCQunting are concerned.. with systematic recQiding ~ d
presen~ n of financial q.ata. The two systems rest on the siine principles concerning debit and credit
and have the same sources of recording the transactions. But cost accounting is much more detailed
than financial accounting. This is because in financial accounting profit or lnss is ascertainedJ.or_the
busin~ as a whole whereas in cost accounting detailed cost and profit data fol, yarj mJS pa:ct_~_of
business like departments. products, etc., are shown. This is explained in the following examJ>½ 1 :_ __
Suppose a comp~ manufacturing three products - A, B and C. Under financial accounting and
cost accounting the following tVJ1eS of stat~ments are premuea. •
Under Financial Accounting. A Profit and Loss Account is prepared to compute profit as shown
below (data is assumed):
Profit and Loss Account for the year ending 31st March, 2017
t /J.
To Materials 75,000 By Sales 1,50,000
To Wages 20,000
To Other expenses 25,000
To Profit (Balancing figure) 30,000
1,50,000 1,50,000

This statement shows that total profit is 30,000 but it does not disclose the details of profit/loss
of each of products A, B and C in the total profit. This is revealed by cost accounting .
Under Cost Accounting. A detailed statement is prepared as follows : (Data of above Profit and
Loss Account with further assumptions).
 ]ti
t,oduction 1.5

Statement of Cost and Profit for the year ending 31st March, 2017
Total Product A Product C
Product B
( ( ( (

Materials 75,000 40,000 23,000

12,000
wages 20,000 10,000 5,000
5,000
Other expenses 25,000 20,000 2,000
3,000
Total cost 1,20,000 70,000 20,000 30,000
Sales 1,50,000 96,000 26,000
28,000
Profit/Loss (- ) 30,000 26,000 8,000 (-) 4,000

In cost..E,unts, detailed costs are compiled for each product so that cost and profit on each
product..Ean be kn_gwn. In the ab?ve .State_ment of Cost and Profit, it can be seen that !otal profit is
30,000 i.e. the same amount as m financ1al ,Prq__fit and Loss Account. In addition, cost accounts show
that intlle total profit of~ 3 0,000, Product A is contributing 26,AOO and Product B 8,000~ whereas
Product C is showing a loss of ~ 00~. When management ge,t f this information, it sh~<!_'investigate
to find-ollt--r:tre""feasons of l o ' s ' ~ct C. If Product C cannot be made pro.filg.ble, its p roduction
shoula~ oesfopped to improve the overall profit picture of the co1!!Eany. However, this types of
infonnation 1s not revealed by_ financial accounting.

Basis
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rtie main points of difference between Cost Accounting and Financial Accounting are explained below:
Financial Accounting Cost Accounting
The main pur:2ose of Financial accounting is The main pur12ose of cost
to prepare Profit and Loss Account- and
Balance Sheet for reporting to owners -or
shareholdersand other outside agenc1es,,1e.,
external users. ·
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accounting is to provide detailed
cost information to management,
i.e., internal users.

2. Statutory These accounts are obligatory to be prepared Maintenance of these accounts is

'/4quirements
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according to the legal re quirements of voluntary · exc.t:et in cert~
Companies Act and Income Tax Act. · industries ·where it has been made
obli~ -to keep cost records
under the Companies Act.

Analysis of cost and- Financial accounts reveal the p!,2f!t or ~ s Cost accounts show the detailed
3.
~ rofit of the business as a whole for a particular c~ t and profit data ~ ach
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period. Ifaoes not show"' the fimot£ost product line, department, process,
and profit for indivi dual products, etc.
departments and processes.
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:i,,J'eriodicity_ of Financial reports (Profit and Loss Account Cost reportin g is u_ontin..lli1.us
~ep~ng and Balance Sheet) are prepared periodically, process and may be on daily,
usually on an annual basi_s. weekly, monthly basis, et c.

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5. Contr-oraspec:t It lays emphasis on the recording of financial It prQvides for a detailed S>7:!tem of
transactions and does not attach importance contrcls with the help of certain
to control aspect. specialtechn~ques- like .s tanda,ul

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costing and budgetary control.
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1.6 Cost Accounting

Historical and pre- It is concerned almost exclusively with It is concerned not onl:it wit h
determined costs historical records. The historical nature o'°f historical costs but also with ,I!re
financial accounting can be easily understood determined costs. This is ~~use

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in the context of the purposes fo r wfiich it cost accounting does not _!!!d ~ t h
was designed: - what has happened in th e past. It
extends to plans and poliae~- to
imp~ e performance in ~ ture:

7. Format of presgnting Financial accounting has a single uniform Cost accounting has varied forms
r formation format of presenting information, i.e., Protit of presenting cost information
and"i'.os's Account';""Balance Slieet and Cash which are tailored to _m~L the
Flow Statement.
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needs of management and thus
lacks a uniform fonnat. -
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8. , es of transactions Financial accounting records only ex~ l Cost accounting not onjy~~ords
recora ea transactions like sales, purchases, recejp_ts, external transactions but .....also
~-:,-~

etc., wit li'outside parties. It doesnot record internal or inter-dep~rt111ental

internal transactions. transactions ~e i ssue of mp.tep als
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by sto~e-~eeper to product.i on
depaljrnents. -
9. of statements Financial accounting prepares general Cost accounting generates special
prepared purpose statements · like Profit and Loss purpose statements and reports
Account and Balance Sheet. That like ~ ort on L;;";s of Materials,
that financia l accounting must produce Idle .Time Report, Vari~ Report,
information that is used by many classes of etc. Cost accounting identifies the
people, none of whom have expli2!_ly defined user, ~cusses his j!!Qhle.ms~ nd
informational needs. n e d_s- _and provides tailored
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informa.tion. -