Cost Accounting – Concept, Objectives, Advantages, Limitations, General Principles and Cost Sheet

Introduction

Preparatory measures for profit and loss account, balance sheet and the trading account is the focus of financial accounting. The actual financial position of a firm can be seen with the help of its balance sheet. In the same way, its net profit can be seen through profit and loss account.

There are various functions which are served by financial accounting. It fulfils the tasks related to administration, production and finance. Although financial accounting carries these functions, it does not focus on a company’s operational efficiency.

There are also few limitations of financial accounting if all these activities are kept aside. The method of cost accounting system is created to acquire systematic operations of a firm and repress certain limitations.

Concept of Cost Accounting

Cost

Cost is referred as the monetary value which is used for production and is a common term used for various activities. In business,it is deemed as one of the acquisitions in which certain amount of money is invested.

In simple words, it is considered as a monetary estimate which is defined in 5 parts.

1. Material
2. Resources
3. Risks incurred
4. Effort
5. Consumption of utilities and time

Costing

Categorising, allotting and recording the expenses to determine the charge of a service or product is cited as costing.

Cost Accounting

Cost accounting is a process of controlling the cost through various methods like analysing, recording, categorising, summarising, assessing different courses of action, and funds distribution.

The motto of using cost accounting is to guide the management to take a suitable course of action. The suggestion is based on capability and cost efficiency.

According to ICWA (The Institute of Cost and Works Accountants),it includes implementation of price control methods and statistical data preparation. It recognises the profitable activities which are planned beforehand.

Cost accounting can also be defined as the combined implementation of cost accounting principles and costing, and practising to control the cost and determine profit for an organisation.

Objectives of Cost Accounting

1. Cost Accounting is used for estimating the profit and loss of every operation. It also helps to determine the management about the unit cost of service, department or job and product.
2. It is used for taking necessary financial decisions by collecting and contributing appropriate data.
3. For fixing an accurate selling price of a product, cost accounting provides necessary instructions.
4. It helps in the administration of future production policies.
5. Cost Accounting helps the administrative body to prepare and take important steps regarding the budget. It also assists them to execute budget control measures for their company.
6. It provides distinguished cost audit services.
7. Cost Accounting helps in interpreting and presenting data related to planning, performance appraisal and control, assisting the administrative body.
8. It helps the management steer towards proposed capital projects and future expansion programmes.
9. Along with various departmenth eads, it helps to combine the cost reduction programme.

Advantages of Cost Accounting

1. Cost Accounting is very advantageous to the government.
2. Every information on the basis of which tenders and estimates rest, is due to cost accounting.
3. It helps in revealing both moneymaking and unprofitable activities of a firm.
4. It supports an organisation by providing appropriate guidance for reducing prices even less than the total cost.
5. It helps management take apropos decision regarding expenditure towards machineries and labours.
6. Cost Accounting assists the management (administrative body) to make steadfast checks on the precision of a financial account.
7. It also helps in detecting losses in a business and also various reasons for the loss.

Limitations of Cost Accounting

There are certain limitations regarding cost accounting. Some of the main limitations are stated below.

1. The price is very high

Installation and maintenance of cost accounting system require a huge amount of money and also more manpower. For keeping records of cost accounting, two account books are required to be maintained. In case of manpower, cost accounting can only be done by people who have exceptional knowledge in costing. All of these areas of cost accounting require funds in large quantity.

2. Complex system

Cost accounting is used for identifying various expense types and the distribution of funds. For identification, it requires different formulas and forms for collecting data and preparing reports. Also, there are numerous steps involved in determining the details. Due to all these various reasons, it makes the system complicated.

3. Incompetency of costing system

Although cost accounting is not considered as a useless system, many times it has been unsuccessful in producing expected outcomes.

4. Pointless application

The development of cost account has been recent, and many firms are also progressing with its support. But there are also various companies who are running their business without this application and faring well. Cost accounting isn’t that impactful for every industry.

5. Estimations based on previous data

Cost accounting does not use current or actual data. It only uses indirect cost estimations and statement of past data.

6. Use of numerous statements and forms

Abundant forms and statements are used for sending information of costing to the authoritative body. It simply means that unnecessary paperwork is required in the costing system.

General Principles of cost Accounting

There are certain cost accounting principles that are very important. Some of the principles of costing are given below.

1. Previous costs should not be included in any part of the future costing.
2. Cost accounting should cause effective relationship.
3. The practice of farsightedness should be ignored in cost accounting.
4. It is preferred and suggested by every firm to follow the double entry principle. It simply means keeping two sets of accounting books which will have transaction records.
5. Anomalous cost should be excluded from cost accounts.

Cost Sheet

To find out the total cost of a particular product, a statement is needed to be prepared. This prepared statement is referred to cost sheet.

Cost sheet is used for showing a specific accounting period when a product had been manufactured. It also shows any breakup of costs included in that period.

The spending which had been subjected to the production period is listed on a statement after it’s extricated from financial books. This financial statement is defined as cost sheet when confined to the revelation of provided price of production during the accounting period.

Important Purposes of Cost Sheet

1. When a product is manufactured at a specific period, cost sheet is used for showing cost per unit of the manufactured products and its total cost.
2. Selling price is fixed with the help of it.
3. It acts as a guiding help to the capitalists for reducing the cost of production.
4. It helps the management to understand the various elements involved in the present cost and also assists them in comparing it to the estimated cost and result of the previous one.
5. Solid production policy can be developed with its help.

Detailing related to different Expenditures

1. Factory Overheads

• Lubricants
• Salary of a factory manager
• Oil and water
• Reimbursement of timekeeper
• Factory lightening
• Salaries
• Expendable stores
• Electricity
• Transportation of the materials
• Maintenance of Plants (stationaries used in business units)
• Various taxes and insurance
• Various factory expenditures
• Depreciation in plant and factories
• Consumable Stores
• Factory rent

2. Management Expenses

• Telephone bills
• Depreciation related to Office Building
• Rent for office
• Remunerations of Office Staffs
• Bank invoices
• Electricity bill associated to office premise
• Salary of manager
• Telegrams and postages
• Insurance
• Taxes and rates
• Salary of director
• Office maintenance and restorations
• Stationaries required in an office

3. Expenditure related to selling and circulation

• Rent of storehouse
• Travelling Expenses
• Expenses used for packing materials
• Wage of a Sales Manager
• Sales Promotion
• Income of sales crew
• Carriage Outward
• Publicity
• Sales Commission
• Salaries and Overheads
• Expenses connected to delivery van
• Delivery van’s depreciation

Due to the financial nature of the expenses other than its costing nature, the given expenses are omitted from cost accounts. Those omitted expenses are as follows.

• Paid Dividend
• Transfer to Reserves
• Discount on Shares Written Off
• Paid Income-tax

Questions

1. Define Cost.
2. What can you understand by Cost Accounting?
3. Explain Cost Accounting.
4. State the objectives of cost accounting in brief.
5. What do you understand by Costing?
6. What is the purpose of preparing a cost sheet?
7. State the elements of cost.
8. What are the benefits of Cost Accounting?
9. What are the limitations associated with Cost Accounting?
10. State the various principles of Cost Accounting.
11. Show the different elements of cost by preparing a financial chart.

Links of Previous Main Topic:-

• Introduction to accounting and branches of accounting
• Preparation of final accounts
• Introduction of fund flow statement
• Introduction cash flow statement
• Ratio analysis significance of ratio analysis
• Fixed assets and depreciation meaning causes objectives methods and basic factor

Links of Next Finance Topics:-

• Job costing
• Introduction process costing