Cost Accounting and Financial Accounting
Cost accounting is the branch of accounting that deals with the classification, allocation, recording, summarization and reporting of costs. It is the accounting process for cost ascertainment, cost allocation, cost distribution and accounting aspects. It is an internal reporting system by the means of which costs of products and services are controlled.
Cost accounting aims to assist the management in planning and decision-making processes. Its emphasis is primarily on collection, analysis, interpretation and presentation of cost for managerial decision makings.
According to National association of Accountants, USA, “Cost accounting is a systematic set of procedures for recording and reporting measurements of the cost of manufacturing goods and performing services in the aggregate and in details.”
Functions and Objectives of Cost Accounting
- To ascertain cost:
It is the main objective of cost accounting. Costs are the expenses that incur during the production of goods and services and it is the major objective of cost accounting to ascertain their costs. Material, labour, direct expenses, etc. are some of the examples of cost.
- To analyze cost and loss:
Another objective of cost accounting includes the analysis of the cost of each activity. It is important to analyze the cost in order to classify the costs’ variability, profitability or loss chances, relevancy, etc. Similarly, breakdown or machine damage, idle time, the effects of misuse of material, etc. are further analyzed.
- To control cost:
Cost accounting uses cost control as the technique to minimize the cost of product and services, without any compromise on their quality. Standard costing and budgetary control are some of the techniques that helps in controlling the cost.
- To aid the management:
Cost accountancy provides essential costing information to the management which helps in the planning and its implementation. This helps in the evaluation of both past activities and future planning.
- To help in selling price fixation: Almost all the above functions are performed in order to reach the objective to determine the selling price of the products or services in per unit term. After ascertaining the cost per unit of products, selling price per unit is calculated with the addition of a certain profit on the total cost amount. Various techniques such as job costing, batch costing, service costing, multiple costing, contract costing, etc. are used to fixate the selling price.
Advantages and Importance of Cost Accounting
- Helps in controlling cost:
Cost accounting controls the cost by comparing the actual cost with the standard or budgeted cost under techniques like Standard Costing and Budgetary Control. If there is the deviation in existence, the corrective actions are to be taken.
- Helps in increasing profit:
From the introduction and implementation of various cost reduction techniques to increase profit and to the disclosure of the profitability of activities helps the management in the decision making of contract continual and expansion or contract elimination, Cost accounting helps in every way possible to gain profit.
- Helpful in fixing selling price:
By ascertaining the cost per unit of products and services, Cost accounting helps in the determination of selling price by adding certain profit amount on the total cost.
- Provides essential cost information:
Cost accounting helps the management by providing necessary cost information for planning, implementation and controlling purposes. Further, it also provides some other necessary costing information to the outsiders like the suppliers, investors, the government, tax authority, etc.
- Helps to compare costs:
Comparison of costs between periods, processes, departments and volumes of output is important to take corrective actions. For this, cost accounting provides the management with reliable data and information.
- Advantages to customers:
Because the cost accounting makes sure in the rational usage of material, labour and technology, as well as different cost reduction and controlling programs, customers are provided with quality goods and services at reasonable prices.
- Advantages to government:
Fixation and control of price, formulation of foreign trade policies, determination of tax, settling minimum wages and labour disputes, etc. are some of the issues that cost accounting helps the government with.
- Advantages to the workers:
As cost accounting emphasizes on the rational use of labour and wage payment system, it is very beneficial to the workers too.
- Helpful to the investors: Cost accounting is very beneficial to the investors as well as financial institutions because it shows the financial position and profitability of the possible investments.
Limitations of Cost Accounting
- Conceptual diversity: Cost accounting is very diverse and consists of large number estimations, conventions and flexible factors which make it difficult to come up with exact costs. In such situation, it is difficult to count on cost accounting.
- Costly: While fulfilling various formalities that need observation, it becomes quite a costly business for small and medium size concerns in their establishment and running costs. Due to this, costs may be unaffordable.
- Lack of uniformity: Because Cost accounting lacks in a uniform procedure, accounting results from the same information can outlay different results. Thus, these results can be regarded as estimates.
- No double entry system: Double entry system is un-adopted under Cost accounting, thus making it unhelpful in checking the arithmetical accuracy of the transactions. Location of errors is also difficult.
- Underdeveloped: Cost accounting’s concepts, conventions and principles are still in developing stage, making it more unreliable at the time.
Differences between Cost accounting and Financial accounting
Its main purpose is to provide information on costs for planning and decision making.
Its main goal is to ascertain the profit or loss incurred as well as firm’s financial position.
It emphasizes on cost control.
Its emphasis is on recording transactions.
It provides information on the business affairs in product, service, element or activity wise.
It provides information regarding business affairs on totality.
Inventory valuation is made on cost price.
Inventory valuation is made of the cost or market price, whichever is less.
It’s not a statutory obligation for firms to maintain cost accounting.
Its maintenance is a statutory obligation for firms.
With the determination of total cost and cost per unit, selling price can be fixated.
Selling price is difficult to determine under financial accounting.
When required, costing reports are immediately provided to the management.
Reports on the financial condition and business operations are provided annually.
It tries to control costs such as material, labour and overhead.
It cannot control costs.
It is both historical and futuristic.
Because it records past transactions only, it is historic in nature.
Limitations of Financial Accounting
- It is based on past transactions and historical information which lack importance.
- It does not help in the determination of selling price of products.
- It is not helpful in disclosing the results of each product, process, departments, jobs, etc.
- Classification of the cost is unavailable.
- Its control on cost is almost absent.
- It lacks the assistance for the decision-making process.
- Due to its lack of relevant cost information, cost ascertainment of products and services is not possible.
- It lacks any standard system to measure the efficiency of the material, labour and other resources.
- It cannot explain the losses which are caused due to defective materials, idle time and plant, etc.
Koirala, Madhav et.al., Principles of Accounting -XII, Buddha Prakashan, Kathmandu
Shrestha, Dasharatha et.al., Accountancy -XII, M.K. Prakashan, Kathmandu
Bajracharya, Puskar, Principle of Accounting-XII, Asia Publication Pvt. Ltd., Kathmandu