CONTENTS e “pter Pages 1. CosTACCOUNTING: ANINTRODUCTION .....-...-. 4.1 2. cost; ELEMENTS, CONCEPTS AND CLASSIFICATION D (ASPERCASS Geos 09 feet) 25 a MATERIAL COST ACCOUNTING (INCLUDING MATERIAL -—~ PURCHASE AND ISSUE PRICING) .. 2-2. eee eee 43 5 4 MATERIAL/INVENTORY COST CONTROL : CONCEPT AND ~~ TECHNIQUES (INCLUDING TREATMENT OF MATERIAL LOSSES) . 85 5. LABOUR COST ACCOUNTING LABOUR TURNOVER, IDLE TIME AND OVERTIME (IN THE CONTEXT OF CAS-7) .. 2.2.2... 120 6. METHODS OF WAGE PAYMENT (INCLUDING INCENTIVE ) SCHEMES) = «23-5 -:::+:-5,--.-+3,-.....: 142 7. ACCOUNTING FOR OVERHEADS : CLASSIFICATION AND TREATMENT ..-.,5,.,...:,...:.-...... -!..; 165 -8. | OVERHEADS : ALLOCATION, APPORTIONMENT (DEPARTMEN- TALISATION) AND ABSORPTION (IN THE CONTEXT OF CAS-3) . “179 /§. MACHINE HOUR RATE ATE METHOD xm he odo coon — an OR OUTPUT COSTING-I (COST SHEET, COST STATEMENT AND PRODUCTION ACCOUNT) Ww Oe 230 aye UNIT OR OUTPUT COSTING-II (CALCULATION OF ESTIMATES, TENDER AND’ QUOTATION PRICE) uv Be ee we eww we 283 CONTRACT COSTING (INCLUDING AS-7)4S. JOBANDBATCHCOSTING © ee. ee eee 377 OY PROCESS COSTING (INCLUDING JOINT PRODUCTS AND S BY-PRODUCTS) PROCESS COSTING : INTER-PROCESS PROFITS. . 4 440 De PROCESS COSTING : EQUIVALENT PRODUCTIONT .. . . . . . 457 COST CONTROL ACCOUNTS : NON-INTEGRATED AND x INTEGRATED EEE tt nt RCT or ieee 568 21. ABSORPTION COSTING AND MARGINAL COSTING (CONCEPT AND COMPUTATION) «6.2... 000... cae 607 MARGINAL COSTING : AS A TOOL FOR DECISION-MAKING. . .627 COST-VOLUME-PROFIT ANALYSIS (BREAK-EVEN POINT)... . . .673 STANDARD COSTING ©... 0.0.2 cee ee eee eee 784 VARIANCE ANALYSIS () (MATERIAL & LABOUR VARIANCE), /- . .793 VARIANCE ANALYSIS (I) (OVERHEAD VARIANCE) ar 24. BUDGETING AND BUDGETARY CONTROL ...:........ 737 ® 4s 28. COST RECORDS1 . COST ACCOUNTING : AN INTRODUCTION In the beginning the scope of accounting was limited to keeping of records of business transactions and to prepare Profit & Loss Account from the view of financial results and Balance Sheet from the view of financial position. In this system profit analysis was the main criterion for measuring the efficiency of an enterprise. Later on, it was realised that along with profit analysis the cost analysis is also equally important. In fact, cost computation, cost control and cost analysis have become very useful and important aspects in this era of severe business competition and in this context a new branch of accounting known as ‘Cost Accounting’ has emerged. # MEANING AND DEFINITIONS OF COST ACCOUNTING Cost accounting is a specialised branch of general accounting in which detailed and systematic informations related to cost of goods or 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. Some of the definitions of cost accounting are as follows : @ “Cost Accounting is the technique and process of ascertainment of cost.” ) : —I. CM. A,, London (2) “Cost Accounting is the provision of such analysis and classification of expenditure as will enable the total cost of any particular unit of production to be ascertained with reasonable degree of accuracy and at the same time to disclose exactly how such cost is constituted.” —Walter WBigg (3) “Cost Accounts are accounts supplementary or subsidiary to financial accounts and are compiled for the purpose of giving additional information as to the detailed cost of working of an undertaking or any particular section thereof.” _L. B. Dicksee (4) “Costing is the classifying, recording and appropriate allocation of expenditure for the determination of the cost of products or services, and for the presentation of suitably arranged data for the purpose of control and guidance of the management. It includes the ascertainment of the cost of every order, job, contract, service or unit as may be appropriated. It deals with the cost of production, selling and distribution.” —Harold J. Wheldon e, : Conclusively, cost accounting may be defiend 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. Aa ae ‘SAHITYA BHAWAN PUBLICATIONS COST : CONCEPTS AND DEFINITIONS Or COST, COSTING, COST ACCOUNTING AND COST ACCOUNTANCY ‘The concept of cost accounting can be understood properly only when we understand various inter-related and many a times interchangeable terms like ‘Cost’, ‘Costing’, ‘Cost Accounting” ‘and ‘Cost Accountancy’. In this context the concept of these terms has been explained as follows : Cost 1.C.M.A., London has defined the term ‘cost’ as a noun as well as a verb. As a noun it means “the amount of expenditure (actual or notional) incurred on or attributable to a specified thing or activity.” As a verb, it means to ascertain the cost of a specified thing or activity. The specific thing or activity may be a product, job, services, process or any activity. Thus, cost can be termed as the amount of resources given up in exchange for some goods or services. The resources given upare cash or cash equivalent values sacrificed to obtain some goods or services. In other words, “Cost is a foregoing, measured in monetgry terms, incurred or potentially to be incurred to achieve a specific objective.” According to(Cost Accounting Standard-1 “Cost is a measurement in monetary terms of the amount of resolFSes used for the purpose of production of goods or rendering services.” It should also be understood that the word cost can rarely stand alone and should be qualified as to its nature and limitations. Costing “The techniques and process of ascertaining costs is known as Costing.” —IC.M.A. Costing relates to the determination of cost of a product manufactured or service rendered. In order to ascertain cost, it involves system, methods and techniques of accumulation, clas- sification and analysis of cost. The technique refers to principles and rules which are applied for ascertaining cost. There are various techniques of ascertaining costs, such as Historical or Absorption Costing, Marginal Costing, Standard Costing, Uniform Costing, etc., which can be applied for specific purposes. The process of ascertaining cost includes the day to day routine of determining cost through the process related to allocation, apportionment and absorption of costs, besides the presentation of statement of cost, showing how the costs have been arrived at. Cost Allocation. Allocation is the process whereby cost items are charged direct to a cost unit or cost centre, i.e., a cost can be specifically identified with a department that cost is allocated to that department. Cost Apportionment. Apportionment is the process of division of costs among two or more cost centres on estimated basis of benefit received. Cost Absorption. It is a process of ascertaining the charge of indirect cost per unit of production or service. In other words, the overhead is absorbed by the physical units manufac- tured or units of services rendered during a period or for specific job. Cost Accounting sient eounting is the process of accounting for cost from the point at which expenditure us incurred or commited to the establishment of its ultimate relationship with cost centres and cootunita Ta ie st ‘sage it embraces the preparation of statistical data, the application of ‘ethods and the ascertainment of the profitability of activities carried out or planned.” In short “Cost Accounting involves a study of i hich help in nertining soy anng valves a sty 0 those concepts, tools and techniques,COST ACCOUNTING : AN IN accounting. All the costs incurred from the very beginning of manufacturing operation till the final stage of disposal of goods find their recording and accounting in cost accounting. Further, cost accounting serves as a tool of management process and evaluates monetary and non-monetary data to provide necessary, adequate and reasonable information for integral planning, contro! of business operations, managerial decisions and special analysis, Cost Accountancy “Cost Accountancy is 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 therefore for the purpose of managerial decision-making.” The term ‘Cost Accountancy’ includes (i) Costing and (ii) Cost Accounting. Its purposes are (i) Cost-control and (ii) profitability-ascertainment. It serves as an essential tool of the manage- ment for decision-making. Cost-control is the objective of cost accountancy but the application of cost-control methods lies in the domain of cost accounting. The cost-control methods are : (i) Budgetary Control, (ii) Standard Costing and (iii) Responsibility Accounting. The cost-control does not necessarily mean cost-reduction. If the prices of material and labour go up and consequently the operation cost goes up, the cost can be said to be within control even with the increased cost provided there is no abnormal wastage or greater idle capacities or any marked inefficiency. However, the costs reduced as a result of application of cost-control methods are very much welcomed. Profitability is different from profit-making. Profitability is the potentiality to make profit, inherent in the business, or in a enterprise. An enterprise may be capable to yield a profit of 2 one lakh, but due to non-applicability of cost accounting techniques, it may be earning only a profit of 60,000. In other words, the actual profit in this case is 60,000, while the profitability of the enterprise is € one lalch. ‘The ascertainment of profitability is the function or the objective of cost accountancy but the application of methods for its ascertainment is the task of cost accounting. DIFFERENCE BETWEEN COSTING, COST ACCOUNTING a AND COST ACCOUNTANCY Basis, |__ Basis of Difference Cost Accountancy 1. | Meaning and relation Tt is concerned with | It is concerned with | It is re with the | ascertainment of cost. | recording of cost. principles,,;, techniques | and methods of costing adopted by the Heise 2. | Scope It is very narrow in its | It is narrow in its scope. | It is much wider in its scope. | scope. 3. /Pointoffunctioning [It begins where ac- | It begins where costing It is the starting point countancy ends. | ends. | of costing system. 4. | Persons involved It is related with cost This work is related | It involves cost account- accountant. with cost clerks. ant as well as manage- ment accountant. © NATURE AND CHARACTERISTICS OF COST ACCOUNTING ‘The nature and main characteristics of cost accounting can be identified as under : (1) Specialised Branch of Accounting : Cost accounting is a specialised branch of accounting which covers collection, classification, recording, apportionment, determination and control of cost. Though it is based on double entry system but has its own concepts and conventions also. ASAHITYA BHAWAN PUBLICATIONS — (2) Art and Science Both : Cost accounting is a science because it has its own principles and rules, which are followed on regular basis and in a systematic manner. It is also an art because its principles and techniques are used in solving the business problems through cost data. (8) Recognised as a Profession : As cost accounting is a specialised branch of knowledge, it is recognised as a profession also. The Institute of Cost and Works Accountants of India provides professional assistance to cost accountants and frames the rules for their professional working and approach, (4) Determination of various Components of Total Cost : It ascertains cost of products and services through the process of accumulation, classification, analysis and recording. The elements of cost include (a) material, (b) labour and (c) expenses. The main function of this system is to determine total cost and cost per unit. It also determines the cost of incomplete work or job in case if the work remains uncompleted. (5) Application of Statistical Data of Computing Profit and Cost : The extensive use of this system involves application of statistical data, control methods and techniques and determining profitability. The statistical data are helpful in preparation of cost sheet, cost statement, various cost accounts and are used for the purpose of cost comparison. (6) Helpful to Management : This system provides information and measures for control and guidance for various levels of management. _ @SCOPE OF COST ACCOUNTING The scope of cost accounting is very broad. An organisation having an effective cost accounting system helps the management in performance of their responsibilities in an efficient and effective manner. In brief, cost accounting covers the following aspects : ¢1. Classification of Cost. The cost classification is the process of grouping costs according to their characteristics. In this context the cost can be classified according to elements, functions, nature, controllability, normality and relevance to decision-making. 2. Cost Recording. After cost classification, cost transactions are recorded in various ledger accounts. 3. Cost Allocation. It includes allotment of whole items of cost to cost centres or cost units according to pre-determined basis. 4. Cost Determination. It is also called as ‘cost measurement’ and it means computation of cost of individual products, services, departments or other segments of an enterprises. It can be done by preparing cost sheet or statement of cost. Production account can also be prepared for this purpose. 5. Cost Control. It is an important aspect of cost accounting and for this purpose various techniques such as standard costing, budgetary control, inventory control, quality control, ete can be adopted. ‘ 6. Cost Comparison. It referes to comparison of current cost with previous cost or cost of similar other concerns. 7. Cost Reporting. It means communication of cost data on regular basis which may be used by management for decision-making or which are made available to government or some outside agencies. 8. Cost Reduction. It means permanent and genuine reduction in per unit cost of goods produced or services rendered. ° 9. Cost Analysis. It involves the estimation of relationship between costs and various determinants of costs. 10. Cost Audit. It means an examination of the appropriateness of the cost accounting system adopted by the business and effectiveness of its implementation.COST ACCOUNTING : AN INTRODUCTION 5 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, whicheveris 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. fi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, innova tion 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- ingis 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. TYPES AND TECHNIQUES OF COSTING The main types and techniques of costing are as follows : 1. Historical Costing. “The ascertainment of costs after they have been incurred.” Historical costs are, therefore, ‘post-mortem’ costs as under this method,all the expenses incurred on the production are first incurred and then the costs are ascertained. 2. Standard Costing. “The preparation and use of standard costs, their comparison with actual costs and the analysis of variances to their causes and points of incidence.” —I.C.M.A. Here the standards are first set and then they are compared with actual performances. The difference between the standard and the actual is known as the variance. The variances are analysed to find out their causes and also the points or locations at which they occur. Standard costs are predetermined costs in conformity with the most efficient operation and use of the resources within the concern. Standard costing is widely used as tool of cost control in industries. 3. Marginal Costing. “The ascertainment of marginal costs and of the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs.” LOMA. The fixed costs are those which do not change but remain the same, with the increase or decrease in the quantum of production. The variable costs are those which do change propor-JUNTING : AN INTRODUCTION 7 tionately with the c range ta in quantum of production. The marginal costing takes into account only the variable costs to find out ‘marginal costs’. The difference between Sales and Marginal costs is known as ‘Contribution’ and contribution is an aggregate of Fixed costs and Profit/Loss. Fixed costs attributable to the relevant period are deducted from the contribution to find out the profits. Marginal costing is a technique to ascertain the effect on profit by the change in the volume of output or by the change in the type of output. 4, Direct Costing. “The practice of charging all direct costs to operations, processes or products, leaving all the indirect costs to be written off against profits in the period in which they arise.” LOMA. Direct costs or the variable costs such as direct material, direct labour and variable manufacturing expenses are examples of costs charged to the product. This technique is similar to “Marginal Costing’ except that some fixed costs could be considered to be the direct costs in appropriate circumstances. 5. Absorption Costing. “The practice of charging all costs, both variable and fixed, to operations, processes or products.” LOMA, ‘This is the traditional technique as opposed to Marginal or Direct costing techniques. Here both the fixed and variable costs are charged in the same manner. 6. Uniform Costing. “The use by several undertakings of the same costing principles and/or practices.” LOMA. When several similar undertakings join together to adopt a common approach to costing problems. They adopt the same method of costing and the same set of books in order to compare the performance of one with the other and thus, to derive the benefit of one’s performances by the other. ¢@ METHODS OF COSTING Costing methods refers to the methods of ascertaining cost of a product manufactured or service rendered. The costing methods depending on the nature of industries, can broadly be classified into two categories viz., (A) Specific order costing method, and (B) Continuous operation costing method. (A) Specific Order Costing Method Specific order costing methods are used by those business concerns which take on any manufacturing activity or render services to individual customers on receipt of specific orde% The gpecific order costing methods are as follows : 1. Job Costing. Job costing method is a system of costing in which costs are ascertained in terms of specific jobs or orders which are not comparable with each other and non-repetitive in nature. This method is applied where work is undertaken on the request of customer’s special requirements and each order is comparatively of shorter time period and work is usually carried out within the factory premises or workshop and moves through activities, processes and operations as a continuously identifiable unit. However, sometimes, the job may be performed outside the factory premises depending upon the nature of job, e.g., plumbering job, sanitary job, fitting job, etc. Job costing methods are applicable where the unit of manufacture is one and complete in itself. They include printers, job foundries, tool manufacturers, contractors, etc. In job costing, the quantity to produce and its requirement is first estimated and thereafter the expenges are determined as per the nature, size or specification of job. . Contract Costing. Contract costing is a costing method which applies where work is executed under customer's specific requirements and each order is of long duration which may cover or go into several accounting yea This method is applied in undertakings erectingsuauee ~__ SAHITYA BHAWAN PUBLICATIONS _ buildings or carrying out constructional works, e.g., House building, Ship building, Civil Engineering contracts. Here the cost unit is one and complete in itself. The cost unit is a contract which may continue for over more than a year. It is also known as the Terminal Costing, since the works are to be completed within a specified period as per terms of contract or agreement executedby the contractor and the contractee for a specific contract price. e Batch Costing. In this method, a batch of similar or identical products is treated as a job. Here, the unit of cost is a batch or a group of products. Costs are collected and analysed according to batch numbers and the costs are ascertained batchwise. This method is applied in phar- maceutical industries where medicines or injections are manufactured batchwise or in general engineering factories producing components in convenient batches. 4, Target Costing. In this method, before commencement of job, the cost of work is estimated with the help of experts. This estimated cost is termed as target cost. The contractor is paid commission at a certain percentage on this cost. This method is used mainly in Govt. construction work. (B) Continuous Operation Costing Method This method of costing is applied in those industries where mass production is done on a continuous basis and where production accumulates in stock and then is sold from the stock on demand later on. The continuous operation costing is classified into the following : 1. Process Costing. Process costing method is applicable to those industries which manufac- ture a number of units of output requiring processing. Here, an article or product has to undergo two or more processes for reaching the stage of finished goods and the finished goods of the preceding process is treated as a raw material for the succeeding process till completion. The order or sequence of processes is specific and pre-determined and the units manufactured are uniform and standardised. The cost unit is per article, per kg, per ton or similar other units and this method is applicable to chemical industries producing, for example, soap, vegetable ghee, edible or non-edible oils, paints, varnishes, etc., or to refineries or to gas and electricity generatjrfg concerns. % Single or Output Costing. This method is used where the production is uniform and consists of only a single product. The cost is ascertained per unit of output. The units are identical to each other and are the standard ones. Where the products manufactured are of different grades, the costs of products are ascertained gradewise and the cost per unit is determined by dividing the total cost of each grade by the number of articles of that grade. This method is applied to industries like mining, quarries, flour mills, steel works, etc., where the cost per unit is required to be ascertained. *3. Operation Costing. In the operation method, the cost ofeach operation in the process of production is ascertained. Operation cost is generally termed as conversion cost, i.e., cost of labour and variable overhead used in converting the shape of raw material. This method can suitably be applied to those industries where mass production of repetitive nature goes on. 4/Operating Costing. This method is applied to those undertakings which do not manufac- turb/goods but render services, e.g., the Transport companies, Railways, Hotels for lodging, Canteens, Hospitals, Electricity and Water supply companies. These undertakings involve large amount of capital expenditure in their fixed assets but employ less amount of working capital to carry on day to day business activities. The cost unit in case of transport companies and Railways can be per Passenger-km or per ton-km, for Hotel—per room, for canteen—per meal, for hospital—per patient and so on. The total cost of providing service is divided by the total units and thus cost per unit is obtained. 5. Departmental Costing. This method is applicable where the cost of a department or a cost-centre is required to be ascertained. This is similar to operation costing. Here, the total cost_ COST ACCOUNTING : AN INTRODUCTION _ 9 of a department is divided by the total units manufactured in that department to know the cost per unit of the output. This method is good for a comparative study of the identical costs of different departments. ceca or Multiple Costing. Where more than one method is used in conjunction, the method becomes a Composite or Multiple Costing Method. In the production of radio, television, motor-cars, aeroplanes, a variety of components—some based on one method and the others on a different method of costing—are produced and then assembled. Since more than one method of costing is applied, the method in such a case is known by the name of Composite or Multiple Costing Method. « IMPORTANCE AND ADVANTAGES OF COST ACCOUNTING (1) To Management and its Functions (@ Planning. Planning involves policies, procedures, methods, programmes and budgets. These factors seek guidance from cost-informations for their determination. The budget is usually the most important tool in planning and the ‘budgetary-control’ plays a useful part in the control phase of the management. The objectives are set in the budgets and the actual performances are compared with the budget-targets. This helps the cost accounting in planning. Gi) Organisation. The activities of the manufacturing enterprise are grouped into functions like production, administration, selling and distribution. The cost of each function is ascertained by applying costing techniques and is analysed according to department, process or operation to make them useful for comparative study. (iii) Motivation. Human beings, unlike machines, are guided more by incentives, affection, sentiments and emotions. Labour force being an important element in cost of manufacture, is motivated by the incentive plans of remuneration. There are various incentive plans of wage payment and cost accounting measures the results of the application of these remunerating incentives with the labour-performances and helps the management to decide how best the labour can be motivated. (iv) Control. Control is an important function of cost accounting. Control ensures the quantitative and qualitative performance of work in the organisation, exposes the management lapses and helps the management to adopt the remedial measures to plug the loopholes before it is too late. Standard costing, Budgetary control and Responsibility accounting are the methods which cost accounting provides to exercise control. Budgets and/or standards are set-up for materials, labour, overheads, sales, finance and other allied activities and the actual performan- ces are compared with the budgets and standards so set. The variances arising out are studied and located to bring to light the lapses in the performances. (2) Other Advantages of Cost Accounting (i) Control on Wastage of Material and Labour. This system keeps a good check and control on the purchase, storing and issue of materials. The wastage of materials in the form of spoilage, excessive scraps, etc., is revealed and controlled. Similarly, with the proper recording of labour costs, the inefficiencies do not go unchecked; the idle time, overtime and labour turnover remain within limits and the wastage of time is duly controlled. Gi) Economy in Cost. The cost reduction programmes together with operation research and value analysis techniques contribute a great deal in economising the costs. _. Gi) Proper Utilisation of Plant. The proper utilization of plants and machines to the fall desired capacity is measured and wastages and idle capacities are controlled. (iv) Budgetary Control. With the help of standard costing and budgetary controls, the optimum level of efficiency is set and compared with actual performances. The variances help— e — t has to keep an eye only on : ent by exception’ which means that the management keep ee are below the norms and not to bother for the organisation as a whole, (v) Periodical Profit & Loss Account. Perpetual Inventory System exercises inventory control and helps continuous stock-taking which facilitates preparation of periodical profit & loss account. ; : i is isoni for cost control. The comparison of costs (vi) Cost Comparison. Cost comparison is necessary T r Repebetorse seca) cost centres, etc, between the two periods or the comparison of costs of different firms under Inter-firm Comparison System helps to control the costs. ee (wii) Use in Policy Decisions. Marginal costing helps the management in deciding the internal policies of sales, price fixation, increase in production, etc., and the differential costing helps to choose the better of the two alternatives open to the management. (8) Advantages to Employees / / Cost accounting system is useful to the employees also. It.is wrong to suppose that it exploits the labour class. This system believes in (a) imparting training to workmen and to make then efficient, (b) introducing incentive plans of remuneration, and (c) providing welfare amenities, In the event of a dispuie arising, the cost records help to do away with the misunderstandings (4) Advantages to Consumer Cost accounting system provides cost control which leads to reduction in cost of product and services. These help the organisation to offer product and services to the consumers at lower price and of good quality. (5) Advantages to Government This system is useful for Government for deciding the state subsidy to industry and also for economic planning and development by the State. The Government requires various details of cost in formulating various economic policies, such as Tax policy, Business policy, Industrial policy, Financial policy, Import-Export policy, etc. (6) Advantages to Investors The Banks and other investors also find it useful to make investment in the companies which employ costing methods because it helps in determining the worthiness of credit being granted to them. COST ACCOUNTING IS A SYSTEM OF FORESIGHT AND NOT OF POST MORTEM. IT CONVERTS THE LOSSES INTO PROFITS, MAKES THE ACTIVITIES DYNAMIC AND REMOVES WASTAGES The above statement reflects the limitations of financial accounting and advantages of cost accounting. ‘Post mortem’ means analysis after the completion of work and to identify the causes of results. Financial accounts present the results of a business at the end of the year and after that only post mortem is possible. At that stage it is not feasible to take remedial measures to check losses or wastages during relevant year, whereas the function of cost accounting is not limited only to find out the cost and to determine the selling price. It provides a number of useful BHAWAN PUBLICATIONS 10 — __8h t should be the total cost of any product or service and what should be the share of standard cost of material, labour and overheads? Similarly budgets are prepared on the basis of future expectations and forecasting and budgetory control is adopted on the basis of continuous flow of information. Thus, it is clear that “Cost accounting is a system of foresight and not of post mortem.” The second part of the statement lays emphasis that “It (Cost accounting) converts the losses into profits, makes the activities dynamic and removes wastages.” The fact is thatCOST ACCOUNTING : AN INTRODUCTION - techniques of cost control and cost reduction are adopted in cost accounting. Minimum or optimum level of sales is determined on the basis of break-even analysis and on the basis of. variance analysis remedial measures are taken to control the causes responsible for adverse variances, It all results in conversion of losses (if any) into profits. After adopting cost accounting all steps are taken to make the activities dynamic in order to procure raw material, to operate the manufacturing process and to ensure the availability of finished products in right quantity and at right time. Cost accounting increases the effectiveness of stores control, determines the level of normal wastage and ensures profitable use of scrap. It all helps in removal of unnecessary and abnormal wastages. On thewhole, the above statement lays emphasis on the importance and advantages of cost accounting which can be understood, in detail, as follows : [Here advantages to management given in points (1) and (2) under the heading ‘Importance and Advantages of Cost Accouting’ discussed earlier are to be mentioned.) LIMITATIONS OF A COST SYSTEM The cost system has the following limitations : 1. Based on Estimates. The system is based on estimates and the results differ from actualities. 2. Problem of Different Methods, Bases and Techniques. The methods, bases and techniques adopted within the system are several and their applications varying on different planes make the results unworthy of cost comparison and cost control, e.g. : (a) Pricing of issue of materials by different methods; (b) Remunerating labour on different bases; (©) Apportionment and absorption of overheads at different bases and by the application of different methods; (d) Classification of costs into direct and indirect; (e) Classification of overheads into fixed and variable; (f) Treatment of costs into normal and abnormal; . (g) Determination of standards in Standard Costing; (h) Charging of depreciation and valuation of stocks at different bases. 3. Non-inclusion of Certain Items. Certain items of expenses and incomes are not recorded in this system while they are included in the financial system. 4. No Applicability in Trading Concerns. This system is applicable to manufacturing or service rendering business units only and not to trading concerns. 5. Problems of Marginal Costing. In Marginal costing—a technique based on variable cost—only the variable cost is taken into consideration while fixed cost is excluded. Thus the marginal total cost is different from the actual total cost. Such a usage of accounting technique makes the presentation of cost, confusing to lay men. Nevertheless, the cost system has its own significance and uses recognised by the class of businessmen and accountants. Costing is an art and it has the conventions and concepts of dynamic nature which have changed with times to fulfil the needs and aspirations of the society. OBJECTIONS AGAINST COST ACCOUTING AND THEIR RECTIFICATION A number of objections are raised against cost accouting. A few of these objections are as follows : 1. Cost Accounting System is Unnecessary : When this system was not in use, the industries were operating at that time also. Hence, why should the work load of accouting be increased unnecessarily by adopting this system?Ta - ~ SAHITYA BHAWAN PUBLICATIONS Remedies : This objection reflects conservative approach and it is just like to fe that eves man can alive in darkness, what is the need of light or when man could survive with jout —— medicines, why we should depend upon these medicines. The fact is that people criticise m im medical facilities but use them when these are required. In this modern competitive age it is very important to know and analyse the cost of production so as competitive selling price may era od ting system, it increases . Cost Accounting is Expensive : If an organisation introduces cost , it ine the cpetivare boone of installation of costing system and increases use of forms, stationery, reports, ete, Therefore, the adoption of cost accounting is a wastage. Remedies : No doubt, the adoption of costing system increases the expenditure but it should be compared with the amount of increased profit. The system increases the efficiency of all the components of production and distribution system and thereby decreases the cost: of production. Moreover, the system helps in checking the wastages and spoilages and exercises effective control on various elements of cost. The expenses will be burdensome only when these are not according to the size of business. : 3. Cost Accounting System is Monotonous : Some critics argue that the system of cost accounting is monotonous because of continuous use of data, analytical documents and state- ments. Remedies : This objection is also not correct because interest and monotony are relative terms. The fact is that this system is very interesting and scientific because it provides various useful details about cost of production which do help in managerial decisions. 4. The Results of Cost Accounting are not Trustworthy : In cost accounting, the costs are calculated on the basis of estimates or predetermined rates. So they are not accurate and trustworthy. Remedies : This objections is baseless because estimated figures are used only when estimated cost of production is calculated e.g. calculation of tender price. Moreover, such estimates are also made on scientific basis of relationship of various costs. It should be remémbered that all calculations are not based on estimates but actual data are also used, CHARACTERISTICS OF AN IDEAL SYSTEM OF COST ACCOUNTING A good system of Cost Accounting should have certain characteristics to fulfil its objectives. These characteristics under study are divided into two groups, viz., (A) Subjective, and (B) Objective. (A) Subjective 1. Simplicity. The system should be simple and easily understandable. The costs should be classified, analysed and presented in a simplified form so that the costs calculated at different stages of manufacture may be understood easily and correctly. . 2. Suitability to the Business. ‘The system is meant for the business and not that the business is to be modified according to the system of Cost Accounting. The system should be such as may meet the requirements, nature, size and manufacturing conditions of the business. A system which helps the business to run efficiently and improves profitability is an ideal system. 3. Flexibility. The system should be flexible in nature. It should be flexible to the needs of the business. If the business is small, a small system of Cost Accounting should be capable to meet its requirements but as and when business grows or becomes larger, that system may be modified and enlarged to suit the changed condition. 4. Economical. The running expenses of the system should be economical and optimum to the benefits derived from the system.~ COST ACCOUNTING : AN INTRODUCTION _ 13 5. Comparability. The system should have the virtue of comparability. t should allow the present costs to be compared with the costs of previous corresponding periods to enable the management to evaluate the performances and efficiency. The system should be amenable to comparison of our factory costs with those of industry as whole. 6. Minimum Office Work. It is always better to minimise paper work. The system and procedures should entail minimum office and clerical work as regards forms used, records maintained, statements prepared, etc. B) Objective 1. Prompt Cost Information. The system should provide prompt, reliable and accurate information as and when desired by the management for the purpose of cost control, decision- making and price quotations. 2. Departmentalisation of Costs. Where the work is carried on through different depart- ments or processes, the system should be able to allocate and apportion the costs to them on rational basis so that the costs of production pertaining to each department or process may correctly be ascertained and controlled. 3. Usage of Forms & Proformas. Various forms and proformas used in the system should be properly designed and instructions for use should be printed overleaf to avoid ambiguity. The forms and proformas may be printed in different colours to distinguish them from each other. 4. Cost Ascertainment & Cost Control. The system must necessarily be such as may enable the management to ascertain cost, control cost, ascertain profitability and make decisions. 5. Efficient Control of Materials & Labour. Materials and labour are two important elements of cost, besides expenses. Thus, the system must keep adequate records and checks to exercise proper control on them. 6. Accountability. The system should make each and every one accountable to the job and responsibility assigned to him. 7. Reconciliation of Cost and Financial Accounts. Where two sets of books of accounts—one for cost accounting and the other for financial accounting—are kept, there should be reconcilia- tion of the profits shown by them. On reconciliation, accuracy of both the books can be ensured to a great extent. So the system should be amenable to reconciliation. 8. Cost Accountant's Role Defined. The system should have a defined and clear role of the Cost Accountant, to avoid overlapping. INSTALLATION OF COSTING SYSTEM Installation of a cost system is not an expense but an investment as the rewards are much greater than the expenses incurred. The cost system is for the business and not the business for a system of cost. Therefore, the system has to be so designed as to meet the specific needs of the enterprise. (A) General Considerations for Installing Costing System ‘The general considerations to be observed in installing a costing system are as follows : 1. Objective of Installation the System. Whether the objective of installing the costing system is limited to a specific area, e.g., material management, or fixing selling price, or to arrive at a certain managerial decision; or the objective is to install the system for covering all the aspects of cost affecting the business, is to be decided. The approach to install the system will be dependent on its objective. 2. Areas of Operation. Having decided the objective, the areas of operation of the system are to be studied, by which the management can be best benefited. If production is slack, attention will have to be paid to increase it; if production is good but the sales are ff Vy(ONS M4 _ SAHITYA BHAWAN PUBLICA study will have to be made to increase the sales and action taken according to the results of study and analysis. 3. Organisation of the Business. No system of cost installation would succeed until the organisation structure of the business is taken into account. ‘The organisational part would help to determine the scope of working and improvement. 4, Conception and Reception of the Idea. The idea of the installation of the cost system is to be placed before the staff and the workers in a manner that it is well received and not objected toon flimsy grounds. The success of the system would depend on the co-operation of the persons engaged in the enterprise, and the co-operation will be forth-coming only if the ideas and plans are well-conceived and received. The benefits of introducing the system to all the sections should be well-explained. 5. Collection of Data and Prompt Information. The cost data works as a base for decision. making. Therefore, a proper system should be evolved for the collection of the required cost data and information promptly. Secondly, there should be a system to verify the correctness of the data supplied, otherwise the conclusions drawn may be wrong and time spent in its working may go waste. 6. Cost Records and Cost Books. The maintenance of cost records and cost books depends on the size and nature of the business, but the basic requirements are to be provided as are needed to meet the objective of cost system in that business. The manner in which the financial accounts could be interlocked into an integral accounting system has to be studied and worked out. Proper books and records are to be kept and maintained to meet the requirements of either of the two situations mentioned above. 7. Control System for the Elements of Cost. System would have to be devised for recording and controlling costs of materials, labour and overheads, in accordance with costing principles and procedures. 8. Type and Method of Costing. The choice of method of costing would depend on the nature of production, e.g. Job Cost method or the Process Cost method. For cost control, standard costing along with budgetary control may have to be selected and applied. Similarly, for decision. making, Marginal and Differential costing techniques may be found useful. Preparations for the application of the particular method and technique/type should be made initially. 9. Responsibility Accounting, Responsibility accounting is a technique of cost control by delegating and locating responsibility for costs, on individuals or a group of individuals, departments, etc., known as responsibility centres. It has to be judged whether a particular official who had been assigned a particular function, has implemented the same or not within A ae ated an oe the responsibility has got to be fixed for failure-action of vidual persons, for the of control of cost. For thi: s ibilit accounting should be evolved. iceman a eae om (B) Specific Considerations for Installing Costing System The specific considerations as distinct from general considerati in view whil Ree cece ceo general considerations to be kept in view while 1. Size and Nature of Business. In a business of big size, i i while in a small business, the system should be within (Rapa ate rete on the installation and its working may not outweigh the utility. 2. Products. The nature of product determines the meth, i i material content of the product is more valuable, the salerial eect sis aoe be bag in comparatively more elaborate manner so as to make material cost, control ve. Si ead position with regard to labour and overheads. KO_ COST ACCOUNTING : AN INTRODUCTION 15 8. Organisation. The organisational set up for a costing system should be so modelled that the control part is exercised by the Cost Accountant, as such, the present organisational set up of the costing department needs close study to suggest necessary changes. 4. Functional Study. The functional divisions of an undertaking based on cost are (a) Manufacturing, (b) Administration, and (c) Selling & Distribution. A study of the present working of the different departments is necessary to suggest improvements. (© Principles for Smooth Working The following principles should be kept in mind while introducing the cost system : 1. The system should be simple and easy to operate. 2. The system should be flexible, so that it may be expanded or contracted as per needs of the business. 3. The existing pattern should be disturbed only as little as may be considered desirable. 4. The desired changes be introduced gradually and not in haste. 5. Confidence be created by the Cost accountant in the mind: regarding the utility of the system, so as to avoid unnecessary cri ©) Line of Action The following line of action is recommended for the installation of cost system : 1. Determination of the type of costing and the method of costing, as may be suitable for the undertaking. 2. To prepare forms, cards, report-proformas, books, ete., for keeping records of all the elements of cost, viz., material, labour and overheads. 3. To decide issues regarding material cost control, i.e., purchase, storing, issue and valuation. 4, To decide matters regarding labour cost control, i.e., job evaluation, merit rating, appointment, time recording, division of work, remuneration of labour and other allied problems like idle time, overtime, labour turnover, casual workings, etc. Where the work is carried on more by machines, proper records be kept for the machines. 5. To suggest a suitable system for the collection, classification and analysis of all types of overheads, i.c., manufacturing, administrative and selling and distributive. 6. To decide the methods of allocation and apportionment of overheads among the Produc- tion departments and Service departments which should be earlier clearly demarcated, and to decide the method of absorption of overheads. 7. To decide normal capacity of production and prepare budgets and standards. 8. To maintain books of cost control accounts based on double-entry principle. 9. To devise information system by which the costing department may communicate to other departments and receive reports and other necessary informations promptly. COST CENTRE AND COST UNIT ‘management and executives m and to obviate obstacles. Cost Centre Cost Accounting Standard-1 has defined cost centre as “any unit of cost accounting selected with a view to accmulating all cost under that unit. The unit may be a product, a service, division, department, section, a group of plant and machinery, a group of employees or a combination of several units.” It is regarded as a segment of activity or area of responsibility for which costs are accumulated. For example, production department, machine workshop, service department or a work force can be considered as a cost centre. Cost centre can be classified as :6 ___ SAHITYA BHAWAN PUBLICATIONS 1. Process Cost Centre. Process cost centre is one in which a specific process or a continuous sequence of operations is carried out on a regular basis. In this type of centre, the cost is analysed _ and related to a series of operation in sequance such as in refineries, steel rolling, chemical industries, ete. 2. Production Cost Centre. Production cost centre is one in which production activity is carried where the shape of raw material is converted into a finished product. In such centres, both direct and indirect costs are incurred. 3. Service Cost Centre. Service cost centres are those which render services to the other cost centres. For example, a maintenance & repair department, store department, ete. Only indirect costs are incurred in service cost centres and saleable products are not usually handled in these centres. 4. Impersonal Cost Centre. Impersonal cost centre is one which consists of a location or item of equipment (or group of these). 5. Personal Cost Centre. Personal cost centre is one which consists of a person or group of persons. Such centres generally follow the organisational pattern of the concern. Costs may be analysed and related to works manager, sales manager, maintenance engineer, etc. 6. Operation Cost Centre. Operation cost centre is one which consists of those machines and/or persons carrying out similar operations. Profit Centre It is an unclassified term, i.e., not included in the Terminology of Cost Accountancy of I.C.M.A. However, in common parlance, it means a centre responsible for adopting ways and avenues to earn maximum possible profit on a product or any other activity of business. For this purpose, it makes market surveys, suggests localities for publicity, helps to formulate sales policies and suggests to add more values to the product at the same or cheaper costs. Difference between Cost Centre and Profit Centre 1. Meaning : Cost centre is one of which the cost is ascertained. Profit centre is one which is responsible for maximisation of profit and which takes into consideration both the revenues and expenses. . Responsibility : Cost centre is for accounting and control of costs while Profit centre is for adopting ways and avenues to achieve their profit targets. . Autonomy : Profit centre works under the guidance of high ups in management and sometimes is autonomous in approach to achieve profit targets. Cost centre is not autonomous and it has no cost targets although efforts are made to minimise costs. 4. Coverage Areas : Cost centre has little to do with market surveys, sales promotion, etc., but Profit centre is well related with these aspects. Cost Unit According to ICMA, “A cost unit is a unit of quantity of product, service or time (or a combination of these) in relation to which costs may be ascertained or expressed.” CAS-1 has stated that “Cost unit is a form of measurement of volume of production or service. This unit is generally adopted on the basis of convenience and practice in the industry concerned.” Thus, a cost unit is a unit of product or unit of service for which costs are ascertained through means of costing process viz. allocation, apportionment and absorption. Cost unit differs from industry to industry. It can be expressed as cost per thousand bricks, cost per passenger-kilometre, cost per patient, cost per ton, etc. i 2COST ACCOUNTING : AN INTRODUCTION 7 ‘The forms of measurement used as cost units are generally the units of physical measurement such as number, weight, length, volume, etc. A few typical examples of cost units are as follows : Industry / Product Cost Unit Basis 1. Coal mine per tonne coal 2; Sugar mill per quintal sugar 3. Textile mill per metre cloth 4, Flour mill per quintal flour 5, Paper mill per kg paper 6. Steel mill per tonne steel! 7. Brick kiln per thousand bricks 8. Chemicals per litre, kilogram, tonne 9. Water supply per thousand litre 10. Power (Electricity) per kilo-watt hour 11, Transport per passenger or tonne km. Illustration 1 Specify the methods of costing and cost units applicable to the following industries 1. Nursing Home, 2. Toy Making, 3. Road Transport, 4. Cement, 5. Steel, 6. Hospital, 7. Sugar Company having its own sugarcane fields, 8. Furniture, 9. Coal, 10. Ship building, 11. Bicycle, 12. T.V., 13. Bridge construction, 14. Advertising, 15. Brick-works. Solution Industry ‘Method of Costing Unit of Cost - 1. Nursing Home Operating per Bed per day or per week 2, Toy Making Batch per Batch 3. Road Transport Operating per tonne kilometre 4, Cement Unit per tonne or per bag 5. Steel Process per tonne 6. Hospital Operating per bed or per patient per day 7. Sugar Company Process per quintal/tonne 8. Furniture Multiple each unit 9. Coal Single per quintal 10. Ship building Contract per Ship 11. Bicycle Multiple per Bicycle 12. TV. Multiple per TV. 13. Bridge Construction Contract each Contract 14, Advertising Job each Job 15. Brick-works Single or output per 1,000 bricks DEVELOPMENT OF COST ACCOUNTING IN INDIA In India, the development of this system is only of recent origin. In pre-independence days, there was insignificant industrial development in the country. It was in 1944 that ‘Indian Institute of Cost and Works Accountants’ took birth in the form of a company limited by Guarantee. This company was managing examinations and issuing certificates to the successful cost accountants. After independence in 1947, new industrial policy was adopted which gave impetus to industrial development. With the progressive industrial policies in this country and industrialisation, demand grew for cost accountants. It was in the year 1959 that ‘Cost and Works Accountant Act’ was passed by Government of India and ‘The Institute of Cost and Works Accountants of India’ came into being as an autonomous body with its Head Office at Kolkata. Its function is to promote cost accounting and to produce cost accountants of right calibre. ‘The Companies Act, 1956 as amended in 1965 provided for the maintenance of cost accounting records and audit thereof, under Section 209(1\(d) and Section 233(2) for thecompanies the Government may direct. Then Cost Audit 1 in later years), requiring the Cost Auditor to make report in the form and in accordance with the procedure laid down. At present 44 products come under the fold of Cost Audit and, companies producing these products have to maintain cost accounting records and made cost audit statutory, FINANCIAL ACCOUNTING, COST ACCOUNTING AND MANAGEMENT ACCOUNTING (1) Financial Accounting. Financial Accounting is the art or process of recording, classifying and summarising the transactions of financial nature in a systematic manner and interpreting the results thereof. This system of accounting deals with recording of business transactions in order to know the profit and loss of business activities and to assess the financial position of the organisation through preparation of financial statements. (2) Cost Accounting. Cost Accounting is the art of recording, analysing and classifying of expenditure incurred in order to ascertain total cost and per unit cost of a product or service. Cost accounting deals with the internal aspect of the organisation and provides information to the management to control cost, improve efficiencies and helps managers in the decision-making process. (3) Management Accounting. Management Accounting provides meaningful accounting information through application of various tools and techniques in order to assist management in creation of policy, making decisions and helps in future planning. LIMITATIONS OF FINANCIAL ACCOUNTING Among the three accounting systems, financial accounting is considered as the oldest system of accounting. This accounting system is regarded as historical in nature and provides post-mortem of past records. It suffers with various limitations which led to the development of cost accounting. The following are the limitations or deficiencies of financial accounting : (1) Lack of Details of Materials. Financial accounting failed to provide information about the value and quantity of direct & indirect material used in various jobs, activities or departments, the cost and quality of normal and abnormal loss of material, scrap or spoilage of material during the manufacturing process, the share of material cost in the total cost of product or job, ete. (2) Lack of Analysis of Labour Cost. Financial accounting only discloses the total amount of wages paid during the year. It fails to provide information as regards to wages paid for specific jobs, activities, department or product. Further, it does not provide information as regard to direct and indirect wages, wages for idle time, over-time, cost for inefficiencies of labour, methods of remunerating labour, etc. Financial Accounting is silent as regard to number of workers engaged in production and other activities, number of workers engaged on various jobs or departments, number of hours devoted by workers, rate of wages. It also does not provide information whether the increase in number of workers or increase in wage rate has led to corresponding increase in production or output or not. (3) Lack of Classification and Analysis of Overheads. One of the limitation of financial accounting is that it does not provide information as regards to expenses on various overheads department-wise, product-wise or activity-wise. Financial accounting even fails to provide information as regard to expenses on overheads nature-wise viz., variable overheads, semi-vari- able overheads and fixed overheads for the department, product, job or activity. These overheads are not expressed in financial statements into controllable or non-controllable overheads, basis of apportionment of overheads, etc.COST ACCOUNTING : AN INTRODUCTION _ 19 (4) Lack of Details of Costs and its Elements. Financial accounts lack in providing informa- tion as regards to ascertainment of cost of various products, jobs, activities or services rendered. It fails to provide direct and indirect cost incurred on various activities, cost at various stages of production. It also does not take into account and provide various costs, which are helpful in taking managerial decisions such as opportunity cost or imputed cost, etc. (5) Lack of Complete Information of Cost. Informations available from financial statements are considered to be inadequate and meaningless for the purpose of cost control because financial accounting does not record the cost data as required for the purpose of application of various cost control techniques viz., budgetary control or for standard costing. These techniques require information of actual and budgeted cost as regards to each element of cost viz., material, labour and overheads both in quantitative terms and monetary terms for the purpose of comparison of results. Financial Accounting system has no provision of laying down standards in regard to material, labour or overhead in order to make actual cost comparable. (6) Difficulty in Fixation of Selling Price. As financial accounting does not ascertain cost of product or activities, hence fixation of selling price of product or activities becomes rather difficult especially in changing market conditions. Various managerial decisions require infor- mation as regard to cost and selling price viz., determination, of BEP sales, quoting of tender prices, to accept or reject a special offer, fixation of minimum price, fixation of selling price while launching a new product. These decision-making become difficult from information provided by financial accounting. (7) Lack of Details of Working of Machines. Financial accounting fails to provide the number of hours worked by a machine and the number of hours it remained idle. No record is kept of the hours worked by different machines in the manufacture of a various product or the completion of a job. No proper check is applied to reduce wastage of time and materials occurring at the machines. (8) No Details of Production. In financial accounting, no proper system is adopted to control under-production or over-production. Daily/Weekly/Monthly production charts are not prepared and compared with previous periods and budgets. (9) Difficulty in Analysing Profitable and Non-Profitable Activities. The financial account- ing discloses the overall profit of the concern as a whole. It does not help in analysing the profitable and non-profitable activities, contribution made to profit by each department separately. Suppose, the profit for a year as disclosed by financial books, is Z 70,000, but if we analyse this profit department-wise, the following position is revealed : Dept.A (+) % 75,000 (Profit) Dept.B (—) % 30,000 (Loss) Dept.C (+) % 25,000 (Profit) ‘Total (+) 70,000 Profit Now on analysis, the management can either plan to close down Department B ortoimprove its working. This analysis can be done with the help of cost accounting. (10) Limitation in Analysing Efficiency. The efficiency of a department and persons involved can be judged by quantity produced, the quality of products, costs incurred and time saved. Due to lack of proper data, financial accounting does not help in rewarding the efficiency and punishing the inefficiency. The causes of inefficiency cannot be analysed and efficiency improved upon.20 SAHITYA BHAWAN PUBLICATIONS (11) Lack of Data required for Decision-making. The management has to take crucial decisions at times on several matters, such as, product selling, make or buy, plant installation, closure of departments, product-mix, etc. These decisions can be taken on the basis of relevant. and adequate data which financial accounting fails to provide in the systematic manner. It is worth mentioning to quote G. R. Glover & R. C. Williams that “The existence of an accurate system of financial accounts will reveal the general position of a business, but it will not furnish the special detailed information that is derived from an efficient costing system- information that is necessary for the internal control and management of a business.” L.W. Hawkins has rightly stated that, “The ordinary trading accounting is a locked storehouse of most valuable information to which a cost system is the key.” It means that a number of valuable informations exist in trading account but they can be understood and analysed in a useful manner only with the help of cost system. It can be explained with the help of following example : Example ‘A company manufactures and sells three products ‘ & Loss account of the company is as follows : ‘B’ and ‘C’. The Trading and Profit ‘Trading and Profit & Loss A/c (for the year ending 31st March, 2011) Particulars ‘Amount Particulars ‘Amount z z To Materials 1,50,000 | By Sales 5,00,000 To Direct Labour 1,00,000 To Direct Expenses 10,000 To Factory Expenses 80,000 To Gross Profit 1,60,000 5,00,000 To Administrative Expenses 16,000 | By Gross Profit To Selling & Distribution Expenses 44,000 To Net Profit 1,00,000 1,60,000 The summary of cost accounts is as follows : Particulars A B c Total | | z z z z Direct Materials 60,000 30,000 60,000 | 1,50,000 Direct Labour 30,000 15,000 55,000} 1,00,000 Direct Expenses oe 4,000 1,000 5,000 10,000 Prime 94,000 46,000 | 1,20,000| 2,60,000 Add : Factory overheads F EF 36,000 10,000 40,000 80,000 . | ‘actory Cost 1,24,000 56,000 | 1,60,000| 3. 40,000 Add : Administrative Overheads 6,000| _3,000| _ 7,000| _ 16,000 ; ae Cost of Production 1,30,000 59,000} 1,67,000| 3,56,000 Add : Selling & Distribution Overheads 16,000 10,000 18,000 44,000 . Total Cost 1,46,000 69,000} 1,85,000) 4,00,000 Profit 94,000 41,000 | (35,000)! 1,00,000 Sales 2,40,000 | 1,10,000| 1,50,000| 5,00,000 % of Profit on Sales 39.17% 37.27% | (23.33%) 20% nina es eS‘COST ACCOUNTING : AN INTRODUCTION 21 It is clear from the above details that the Trading and Profit and Loss Account is depicting the macro view of the company. According to it net profit (% 1,00,000) is 20% of sales (% 5,00,000), which is very much satisfactory. But the details of various products are locked in this account, which have been opened with the help of the key of cost account. The details of cost accounts are revealing that Product A and B are reasonably profitable, but Product C is running into loss of 23.33% of sales. This product has converted high rate of profit in case of product A and B into normal rate of profit of the concern as a whole. Such information will prompt the detailed analysis of following aspects : (1) What are the causes of loss in Product C? Whether its cost is high or selling price is low? (2) Is it possible to reduce the cost of Product C? (3) Is it possible to increase the selling price of Prouct C, so that it may become profitable. (4) Can the production of Product C be discontinued? () If product of C is discontinued, can its resources be diverted for the production of A and B? ‘Thus, it is clear that cost system is an important key for the analysis of profit, reduction of cost and increase in efficiency. It has been rightly stated that “Cost accounts are key to economy in manufacture and are indispensable for the intelligent and economical management ofa factory.” The key of cost accounting does help in providing the following informations : (1) Separate cost of materials for each product or process, (2) Details of normal and abnormal wastage of material, (3) Separate cost of labour for each product or process, (4) Separate calculation of gross profit for each product or service, (5) Separate calculation of net profit for each product or service, (6) Total cost and per unit cost of each product, (1) Detalied analysis of various elements of cost for the calculation of tender price, (8) Information of relative efficiency of plants, machinery, labour and various departments. SIMILARITIES BETWEEN FINANCIAL ACCOUNTING SYSTEM. AND COST ACCOUNTING SYSTEM Both the accounting systems have the following similarities : 1. The vouchers making base for accounting, e.g., Bills, Invoices, Receipts issued, ete. are the same in both the systems. .. Accounting is done on the principle of Double-Entry System in both the systems. Both the systems disclose profit/loss of the business. . Both the systems account for material, labour and expenses. Cost Accounting is supplementary to Financial Accounting. ‘The results of both the systems are reconciled with each other and the errors rectified. Both the systems help in formulating management policies. . Comparisons of past performances can be made with the present performances with the help of both the systems together. © DIFFERENCE BETWEEN COST ACCOUNTING SYSTEM AND FINANCIAL ACCOUNTING SYSTEM The following are the main differences between the two systems : Basis of Difference Cost Accounting Financial Accounting 1. Need of Accounts | Kept by business engaged either in | Kept by all types of business houses, manufacturing or in rendering |big or small, whether engaged in services where the cost per unit is to | trading, manufacturing or non-profit be ined. making associations. SAS2aAepSAHITYA BHAWAN PUBLICATIONS 14. " 10. 11. 12. Record of Expenses Availability of Information Ascertainment of’ Cost ). Period of Informa- tion }. Estimates vs. Actual . Focus Area Calculation of | Tender Price Comparison of Cost Relative Efficiency Valuation of Stock Internal vs. Exter- nal Legal Compliance Maintain full and detailed records pertaining to all the three elements of, cost, viz, materials, labour and expenses. Provide data and reports to management for cost-ascertainment, planning, control and decision- making. Ascertain the cost of each produet, job or order and then show profitfloss made on each. Provide information to management as and when desired, daily, weekly, monthly, quarterly, ete. To calculate the cost, the indirect expenses included therein are based onestimates. Greater control is exercised on materials and stores, labour and overhead costs by budgetary control and standard costing. No emphasis is given to cash-in-hand and Bank | transactions. As the cost is available, itis easier to fix selling price and quote for tendet The production costs of a period can be compared with previous corres- ponding period and the difference analysed. Provide information on the relative efficiencies of plant, machinery, labour and departments. Stocks are valued at costs. These accounts are for internal transactions and do not form the basis of receipts and payments to outside parties. The Companies Act has made it obligatory for certain industries to maintain Cost Accounting, otherwise itis voluntary to maintain cost them. Charts, graphs, diagrams, statements, ete. are much used in this system for informatory reports to management. Record all types of expenses and incomes and also items of profit appropriation. However, they do not keep detailed records of elements of cost. Provide general information 0 management and outside parties in the form of Profit & Loss A/e and Balance Sheet of the business as @ whole. Do not show profit/lloss on each product, job or order individually. Provide operating net results and financial position at the end of financial year. Show historical costs, ie., they include expenses having actually been incurred in the financial year. Greater emphasis is laid on cash and financial position. They do not attach that importance to control of materials, labour and overheads. No correct tender prices can be quoted. Such comparison of costs of individual production is not easy. The relative efficiency of workmen, plants, etc. cannot be easily judged. Stocks are valued at cost price or market price, whichever is lower. They form basis for external transactions also, and record receipts, payments and credit transactions. It is almost necessary to maintain this accounting to run business. To meet the requirements of Companies Act, and Income-tax Act, it ic obligatory to keep them. Not much use is made of suck presentation in this system.7 "COST ACCOUNTING : AN INTRODUCTION _ 23 DISTINCTION BETWEEN MANAGEMENT ACCOUNTING AND COST ACCOUNTING In the early days of its development, management accounting was confined mainly to cost, accounting and even today it is stated that “the keystone, rather the heart and soul of management accounting, is cost accounting.” But it does not mean that they are same and similar. Both the systems can be distinguished as under : (1) Origin and Development. Both these systems were evolved and developed under varying conditions. Cost accounting owes its origin to industrial revolution. In fact, financial accounting was not in a position to supply adequate information to management in respect of cost of product or services and therefore, cost accounting was developed as an important adjunct to financial accounting. Management accounting owes its origin to the management consciousness for information based decision and that too in mid-twentieth century. Thus, management accounting is of a more recent origin. (2) Objective. The primary objective of cost accounting is to record and to determine the cost of a product or a service. But management accounting emphasizes upon presentation of cost data and information in such a manner which may help the management in efficient decision- making and control. (3) Nature. Cost accounting is based primarily on past and present facts and figures relating to cost. Management accounting is mainly future-oriented. It deals with future projections and plans, of course, with reference to past and present cost data. (4) Scope. Management accounting covers a much wider field than cost accounting. The scope of cost accounting is limited to cost records and determination, while management accounting covers other accounting information and non-monetary facts also. (6) Utility. The data and information provided by cost accounting are useful to both, i.e., external parties end internal management, but the information furnished by management accounting is useful only to the management. (6) Principles, Procedures and Proformas. Cost accounting follows certain definite prin ciples, procedures and formats, while management accounting follows no set proformas and principles for reporting. The principles and procedures for presentation of facts in management accounting differ from time to time and from concern to concern. It is evident from the above points that management accounting is a wider discipline which blends not only financial accounting and cost accounting but also covers various other specialized systems of accounting. It should also be understood that management accounting is a staff function and it is not a substitute for other accounting functions. Moreover, management accounting and cost accounting both are complementary in nature. On the one hand an efficient system of cost accounting is required for the success of management accounting. At the same time, cost data and information would be of no use for the management in the absence of management accounting. In this context, now a days these two subjects are being blended in one subject, i.e, “Cost and Management Accounting”. ‘THEORETICAL QUESTIONS (® Long Answer Questions 1, What is Cost Accounting? What is the scope and its limitations? 2. Explain Cost, Cost Accounts and Cost Accounting. What are the points to be considered while installing cost system in a big manufacturing unit. 3. What do you understand by Cost Accounts? What is their utility to a producer? Describe the benefits obtained from cost accounts. 4. “Cost accounting is a branch of Financial Accounting and it has been evolved to do away the limitations of financial accounting and to meet the needs of management.” Comment. ,10. 4 _ SAHITYA BHAWAN PUBLICATIONS 5. What is meant by Cost Accounting? In what essential aspects does Cost Accounting differ from Financial Accounting? 6. “The ordinary trading account is a locked store-house of most valuable information to which the cost system is the key.” (Hawkins). Explain and state in this connection the difference between financial accounts and cost accounts. 7% ‘Cost Accountancy’, ‘Costing’ and ‘Cost Accounting’ are used to mean the same in general. Give their precise distinction and define them. 8. What are the characteristies of an ideal Cost Accounting System? Discuss. 9. Define Cost Accounting. Discuss the significance of Cost Accounting in brief. Also discuss the different methods of Cost Accounting. 10. What is the significance of cost accounting to management ? In what respect does cost accounting differ from financial accounting? 11, Explain the objects and benefits of cost accounts. What are its demerits? 12. Define Cost Accounting. Describe briefly various types of costing. 13. What is a Cost Centre? What are its different types? How does it differ from profit centre? 14. What is Cost Accounting? Explain its objectives and advantages. 15, State with reasons what methods of cost finding you would apply in the each of the following industries : (a) Electric supply, (b) Oil refining, (c) Soap manufacturing, (d) Coal mining, (©) Ship-building, and (f) Printing. 16. Describe briefly the different methods of costing and state the particular manufacturing industries to which each can be applied. 17. What is Cost Accounting? In what ways is its preparation helpful to a large manufacturing concern? 18. Explain why it is necessary to us - different methods of costing for different industries and describe the several methods employed. 19. “Cost accounting system is neither unnecessary, nor expensive, rather itis a profitable investment.” Comment. 20. It is said, “Cost accounting is a system of foresight and not a post mortem examination. It turns losses into profits, makes the activities dynamic and removes the wastages.” Discuss the statement in detail. 21. It has been said that “good costing system is an invaluable aid to the management.” Enumerate the chief points in support of this statement. 22. “Cost accounting is becoming more and more relevant in the emerging economic scenario in India” Comment. 23. “Cost accounts are key to economy in manufacture and are indispensable to the intelligent and economical management of a factory.” Discuss. I) Short Answer Questions 1. What is meant by Cost Accounts and Cost Accounting ? 2, Explain the objects of Cost Accounting. 3. What is meant by Unit of Cost? 4. Differentiate between Cost and Costing. 5. Whats the system of Cost Accounting? Or Discuss in brief the different methods of Cost Accounting. 6. What do you mean by Cost Accounting? 7. Discuss the development of Cost Accounting in India. 8. Explain the term ‘Costing’, ‘Cost Accounting’ and ‘Cost Accountancy’. 9. Define and explain with example the term ‘Cost Centre’. Discuss the significance of Cost Accounting.