Chapter 1.p65

1.1. Accounting —An InformationSystem

Accounting system is designed to producefinancial information on economic activitiesof an organisation. Accounting is a businesslanguage. Every language has a grammar andit is necessary to have a good command overthe grammar to understand a language.Accounting has also its grammar, generallycalled accounting principles. It is essential to

At a Glance

Accounting— An Information System Branchesof Accounting Financial Accounting Vs.Management Accounting Cost Accounting Vs.Financial Accounting Cost Accounting Vs.Management Accounting

Section—I : Nature and Scope of Cost Accounting

Evolution of Cost Accounting Development ofCost Accounting Nature of Cost Accounting

Scope of Cost Accounting Concept of Cost Cost,Expense and Loss Concept of Costing Conceptof Cost Accounting Concept of Cost Accountancy

Inter-relationship between Costing, CostAccounting and Cost Accountancy Differencebetween Costing and Cost Accounting Differencebetween Cost Accounting and Cost Accountancy

General Principles of Cost Accounting Objectivesof Cost Accounting Methods of Costing

Techniques of Costing Cost Centre Cost Unit Difference between a Cost Centre and a Cost Unit Installation of a Cost Accounting System Advantages of Cost Accounting Limitations of

Cost Accounting Cost Accounting—relationshipwith other branches of Accounting Assignment

Section—II : Nature and Scope of ManagementAccounting

Concept of Management Accounting Nature of Management Accounting Scope of

Management Accounting Objectives ofManagement Accounting Functions ofManagement Accounting Limitations ofManagement Accounting

be acquainted with the accounting principles to read and understand accounting statements.Accounting is defined as a system for collecting, summarising, analysing, presenting and

reporting, in monetary terms, any relevant information about the enterprise. The overallobjective of an accounting information system is to provide information to various users. Theinputs for an accounting system are usually economic events. The output of the accountinginformation system serves as the basis for users' actions. As a business language, accountingcommunicates about business transactions and its results on various interested parties.

Flow Chart Showing Accounting Mechanisms

Recording of Transactionsfrom Documents

Audit of AccountingBooks

Presentation of FinancialStatements

Summarisation ofTransactions

Transactions Supportedby Documents

Classification of Transactionsunder appropriate heads

Vouchers

Ledger Accounts

Trial Balance

Books of PrimeEntry (Journal, DayBook)

Final Accounts(P&L A/c & BalanceSheet, etc.)

Audited FinalAccounts

1

1.2 Advanced Cost Accounting

1.2. Branches of AccountingThe three main branches of accounting are :(1) Financial Accounting ;(2) Cost Accounting; and(3) Management Accounting.

1.2.1. Financial Accounting : Financial Accounting records monetary transactions, preparesnecessary accounts, analyses and interprets financial statements. It reveals thefinancial position of a business over a particular period of time. It helps to assess theoverall performance of the organisation, efficiency in the utilisation of resources,financial solvency and weaknesses of the organisation. Financial Accounting ishistorical in approach. In Financial Accounting, statements are presented in standard,well-defined and accepted forms.The main purposes of Financial Accounting are :(i) To record the transactions affecting the business;

(ii) To prepare the necessary accounts and balance sheet;(iii) To evaluate the results of operation over a particular period;(iv) To report results on a year-to-year basis;(v) To furnish information on both the operating and non-operating activities;

(vi) To provide information to various interested parties for taking proper decisions.1.2.2. Cost Accounting : Cost Accounting may be regarded as a specialised branch of

accounting which involves classification, accumulation, assignment and control ofcosts.Cost accounting is accounting for costs. Cost Accounting is a discipline concernedwith the measurement and communication of cost information. It is the science, artand practice of a Cost Accountant.The main purposes of Cost Accounting are :(i) To accumulate cost data for determining the product (or service) costs;

(ii) To provide cost data to the management for the preparation of budgets and fixingstandard costs;

(iii) To assist the management in their decision-making;(iv) To ascertain the cost of products, activities, functions, processes, etc.;(v) To apply various cost control techniques;

(vi) To improve efficiency in order to control and reduce costs.1.2.3. Management Accounting : Management Accounting is concerned with the

presentation of accounting information to management in such a way as to assistthem in their managerial functions of decision-making, planning and control. Thus,Management Accounting deals with accounting and other information for managerialdecision- making purposes. Management Accounting acts as a decision-support systemfor providing right information (both financial and non-financial) to the managementat the right time. It guides management's action and helps managers to run theirorganisations smoothly.The main purposes of Management Accounting are :(i) To provide management with financial data, cost data and other qualitative

information for planning and decision-making;(ii) To express financially the plans in terms of individual responsibilities for all

levels of management;(iii) To get an insight into the profitability, solvency, liquidity, etc., of the organisation;

Basic Concepts on Cost and Management Accounting 1.3

(iv) To measure and interpret the results of operations at all levels of managementwith necessary comments and conclusions;

(v) To report on the effectiveness of the organisation as regards utilisation ofresources;

(vi) To meet the changing needs of management functions.

1.3. Financial Accounting & Management Accounting—A comparative studyFinancial Accounting records monetary transactions and prepares necessary accounts

concerning the business. Thereafter, it analyses and interprets financial statements to servethe interests of various parties. Management accounting is concerned with the presentationof accounting information (both financial and cost) and other relevant qualitative facts tothe management to assist them in their managerial functions of decision-making, planningand control.

Management accounting has its roots in financial accounting. Management Accountingdata are mostly derived from financial accounting. Both financial and management accountingstudy the impact of business transactions and interpret the results thereof. However, thedifferences between financial and management accounting are enumerated below :

Differences between Financial Accounting and Management Accounting

1.4. Cost Accounting and Financial Accounting—A comparative studyCost Accounting and Financial Accounting rest on the same principles concerning

debit and credit and have the same sources of recording transactions. Both of these branchescollect, record, classify and summarise transactions and report these results in monetaryterms to the appropriate authority. However, there are important differences between thetwo, which are as follows :

Points of Distinction

(i) Basic function

(ii) Party to be served

(iii) Format of reports

(iv) Objectivity of reports

(v) Auditing of reports

(vi) Publication of reports

(vii) Period of coverage

(viii) Availability of reports

(ix) Unit of study

(x) Governed by

Management Accounting

Supporting decisions of the managementby providing relevant information.

For use of internal parties only.

Format is tailored to the requirement,suitability and convenience.

Reports may contain both the objective andsubjective figures.

Management reports are not subject tostatutory audit.

Management reports are meant for internaluse only.

As required by the management.

Confidential in nature.

Detailed study of a segment.

Needs of managers.

Financial Accounting

Recording of monetary transactions andpublication of financial statements.

For use of external parties (may also be usedby internal parties).

Format is specified by the relevant provisionsof the Companies Act.

Report is supported by relevant figures. It laysemphasis on objectivity of data.

Financial reports are subject to statutoryaudit.

Annual reports are to be published forcirculation among external parties.

Usually one year.

Publicly available.

Overall performance of the organisation.

Companies Act.


Differences between Cost Accounting and Financial Accounting

Points of Differentiation

(i) Applicability

(ii) Principles followed

(iii)Scope of measurement

(iv) Requirements served

(v) Periodicity of reporting

(vi) System of control

(vii) Scope of correction

(viii) Party to be served

(ix) Nature of approach

(x) Valuation of stock

(xi) Statutory need

(xii) Analysis of profit

(xiii) Control aspect

(xiv) Nature of analysis

Financial Accounting

Financial Accounting is applicable to alltypes of accounting entities.

It adheres to Generally AcceptedAccounting Principles (GAAP).

It measures the financial performance of theentity as a whole during a particular period.

Financial Accounts are prepared accordingto the requirements of the Companies Actand Income Tax Act.

Financial reports (Profit & Loss A/c; BalanceSheet, etc.) are prepared periodically,usually at the end of an accounting period.

It does not attach importance to controlduring transactions.

It does not bring out areas which needcorrection and improvement.

It is mainly meant for providing informationto shareholders, creditors, government,employees, etc.

It deals mainly with actual figures and, thus,it is historical in approach.

Stocks are valued at cost or market pric,whichever is lower.

It is compulsory to meet the requirementsof the Companies Act, Income Tax Act, etc.

It fails to show profit for each product,department, process, etc.

It does not provide for adequate control onexpenses.

It is concerned with historical transactionsonly (i.e. post-mortem analysis).

Cost Accounting

Cost Accounting is applicable tomanufacturing concerns.

It adheres to costing concepts andprinciples.

It measures the cost of each product line,department, process, etc.

Cost Accounts are kept as per the requirementof Management.

Cost reporting is a continuous process and itmay be prepared as and when desired (eitherdaily or weekly or monthly, etc.)

It provides for a detailed system of controlswith the help of certain special techniques (likeStandard Costing, Budgetary Control, etc.)

It helps in the measurement of shortfall andfailure which need immediate managementaction.

It is mainly meant for providing detailed costinformation to the management. Therefore,cost information are not meant for outsiders.

It deals partly with actual figures (i.e., historicaldata) and partly with estimates.

Stocks are always valued at cost.

It is not compulsory [except for companieswhere Section 209 (1) of the Companies Actcan be applied].

It reveals the profit (or loss) of each product,department, process, etc.

It provides for a detailed system of control oncosts.

It is concerned not only with historical costsbut also with estimated costs.

1.5. Cost Accounting and Management Accounting—A comparative studyManagement Accounting provides management with accounting information for the

purpose of planning and running a business. It is developed because of management'sdemands for information on past and present operations to predict future trends. It dealswith accounting and other information for managerial decision-making purposes. It integrates


Cost and Financial Accounting information for analysing and interpreting past and presentresults and providing forecasts for the future. Therefore, the scope of ManagementAccounting is broader than that of Cost Accounting.

However, the differences between Cost and Management Accounting are enumeratedbelow :

Differences between Cost Accounting and Management Accounting


(i) Principles and practices followed

(ii) Nature of approach

(iii) Scope of study

(iv) Primary objective

(v) Main emphasis

(vi) Contents of report

(vii) System of recording

(viii) Basis of work

(ix) Statutory verification

(x) Utility of reports

(xi) Type of data used

(xii) Accounting period

(xiii) Coverage of data

(xiv) Derivation of data

(xv) Term of Planning

(xvi) Installation of the system

Management Accounting

It uses the principles and practices of bothCost and Financial Accounting.

It looks ahead through long-term planningapart from current operations.

It is an extension of managerial aspects ofCost Accounting.

The primary object is to provide the relevantinformation to the management to take anappropriate decision.

The main emphasis is on the efficientoperation of business.

Management Accountant not only makesvariance analysis but also suggests theways and means for improving operations.

Double entry system is not adopted whilesubmitting reports to the management.

Management accountant should extend hisactivities wider. He should concentrate hisattention on matters relating to finance,profitability and productivity.

Management reports are not subject to anystatutory audit.

Management reports are useful only to themanagement.

It uses both quantitative and qualitative data.

It does not follow any specific accountingperiod as such.

It deals with both cost and finance-related data.

It derives data from both financial recordsand cost records.

It is equally concerned with short-term andlong-term planning.

It cannot be installed without a proper costaccounting system.

Cost Accounting

It uses the principles and practices of CostAccounting.

It generally deals with current operations.

It is a complement of Management Accounting.

The primary object is to ascertain the cost ofa product (or service) and to control the costafter careful analysis.

The main emphasis is on cost determinationand cost control.

Cost Accountant compares Actual Cost withStandard Cost and submits reports to themanagement regarding variances forappropriate action.

Double entry system of recording transactionscan be adopted.

Cost accountant is to work through setroutines, budgets and standards.

Cost accounts and reports are subject tostatutory verification (i.e. cost audit).

Cost reports are meant for management andeven useful to external parties.

It uses quantitative cost data only.

It is done for a specific accounting period.

It deals with cost data only.

It derives data from financial records.

It is concerned with short-term planning.

It can be installed without managementaccounting system.


SECTION–I : NATURE AND SCOPE OF COST ACCOUNTING

1.6. Evolution of Cost AccountingThe origin of accounting can be traced back to the blurred pages of history. It has

developed over years. Till the end of the 19th Century, conventional accounting flourishedmainly to show the true state of affairs of a business at the end of a particular period oftime. It was designed to provide financial information on the basis of which the users ofsuch information take decisions or form judgements about the allocation of economicresources of a business and their utilization.

But traditional accounting in that form soon failed to cater to the different forms ofinformation required according to the needs of the hour. Industrialisation, economicdevelopment of countries and changes in the objects and pursuits of businesses widenedthe need. In the competitive market, every business requires information well in advancefor its survival and future development. This contributed to the emergence (or evolution)of a separate branch of accounting known as Cost Accounting. In the latter half of the 14thCentury, the merchants of Venice knew of Cost Accounting for gaining accounting control.But the use was not wide-spread. In 1875, John Walker published ''Prime Cost keeping forEngineers, Iron Founders, Boiler and Bridge Makers".

It emphasized the recognition of Cost Accounting as a separate and important branch.At the end of the industrial revolution, Cost Accounting became indispensable in Englandto cope with the new-found factory system. Between 1915 and 1930, Cost Accountingbecame widely recognised as a tool of ascertainment of costs of goods produced (or servicesrendered) and control of such costs. It was specially developed to provide differentinformation related to costs to the management for policy framing, decision-making andexercising control. Since then, Financial Accounting and Cost Accounting have beendeveloping side by side. Financial Accounting is necessary to measure and disclose theend-results of trading activities of a business during an accounting period. Cost Accountingis entrusted with the task of ascertaining the costs of goods produced (or services rendered)and providing information for controlling business activities.

The concurrent existences of Financial Accounting and Cost Accounting have evenproved themselves insufficient to keep pace with the modern trend of development colouredwith a wide spectrum through the advent of globalisation. Management Accounting hasemerged as a more improved branch of knowledge. It collects necessary information fromFinancial Accounting and Cost Accounting. It uses its own tools and techniques to make ananalysis and interpretation of such information and finally provides such information to themanagement, which the latter requires for discharging its managerial functions.

1.7. Development of Cost AccountingThere is no doubt about the fact that the limitations of Financial Accounting to

provide all necessary information led to the emergence of Cost Accounting as a separatebranch of knowledge.

As already said, the concept of Cost Accounting was in the minds of some people evenin the 14th century. But there was no development of its concept at that stage. Thepre-second world war period [that is, before 1945] mainly observed its ramifications. Moredeveloped concepts of Cost Audit and Cost Control are also rather new. In the words ofE. L. Kohler, Cost Accounting is now found to exist as ''the branch of accounting dealingwith the classification, recording, allocation, summarisation and reporting of current andprospective costs."


1.8. Nature of Cost AccountingThe nature of cost accounting can be enumerated in the following ways :(i) Branch of accounting : Cost accounting may be regarded as a specialised branch

of accounting. It involves collection, classification, accumulation, assignment andcontrol of costs. It is an organised body of knowledge consisting of its ownprinciples, concepts and conventions. It analyses and interprets cost informationand presents cost reports to the management for necessary action.

(ii) Science, art and practice of cost accountants : Cost accounting is a social scienceas it is a body of systematic knowledge. It is an art in the sense it requires skillson the part of cost accountants in applying the principles, methods and techniquesof cost accounting. It is a practice in the sense that a practical application of thetheoretical knowledge is a constant pursuit for cost accountants.

(iii) Regarded as a profession : Cost accounting is a profession as it is a body ofspecialised knowledge consisting of principles, concepts and techniques that canbe applied to practical situations. Professional knowledge on this subject can beacquired through formal education and training programmes. In India, theInstitute of Costs and Works Accountants of India (ICWAI) renders professionalassistance to qualified cost accountants. It formulates a code of behaviour for itsmembers.

(iv) Providing cost information : Cost accounting is concerned with the measurementand communication of cost information. It presents relevant cost information tothe management derived from various cost records for the purpose of theirmanagerial decision-making. Cost information (with proper interpretation) isprovided to the management through cost reports. Therefore, cost accountingserves as the supplier of cost information for managerial decision-making andcontrol purposes.

(v) Means of controlling cost : Cost accounting is a means of control of costs. Costcontrol is exercised through a variety of techniques (such as standard costing,budgetary control, inventory control, quality control). Cost control helps in utilisingthe available resources in the best possible manner by reducing various wastagesand losses. Operating efficiency of a manufacturing concern can be improved toa significant extent through proper cost control. Cost control improves quality ofproducts and profitability of the concern by eliminating unprofitable operations,minimising idle elements and regulating critical activities.

(vi) System of foresight : Now-a-days, cost accounting is used for forecasting the costof the goods to be produced (or services to be rendered). The estimated cost of aproduct (or service) can be ascertained after careful consideration of the presentcost data and future trends. Cost accounting helps in the preparation of budgetedcost statement on the basis of pre-determined cost estimates. It also helps in thefixation of minimum tender prices for submission to outside parties. It helps themanagement in fixing the selling price of the product by adding the requiredprofit element to the cost of sales.

1.9. Scope of Cost AccountingThe scope of cost accounting refers to the various areas of study under the purview of

cost accounting as follows :(i) Cost classification : This refers to the grouping of homogenous items of cost into a

common group. Cost classification is a process of arranging the items of cost into


certain categories on the basis of defined criteria. Three common bases of costclassification are : (a) element-wise classification; (b) function-wise classification;(c) behaviour-wise classification.

(ii) Cost recording : This refers to the posting of cost transactions into the variousledgers maintained under a cost accounting system. This involves recording ofcost data according to a pre-arranged classification.

(iii) Cost allocation : This refers to allotment of costs to various departments orproducts on a pre-determined basis. Cost allocation is that part of cost attributionwhich charges specific costs to a cost centre or cost unit.

(iv) Cost determination : This refers to the determination of cost of products (orservices), departments and other segments of operation of a manufacturingconcern. Cost is ascertained in two ways, namely, (a) Statement method (popularlyknown as cost sheet or cost statement); (b) Account method (i.e., Production accountis prepared under the double entry principle).

(v) Cost comparison : This involves comparison of the cost of alternative products,activities and areas of operation in the field of production.

(vi) Cost control : Cost control is a device for regulating the cost of output (or operation)by careful use of the techniques of cost accounting. Cost control is exercisedthrough a variety of techniques (such as standard costing, budgetary control,inventory control, quality control). Cost control helps in utilisation of resourcesin the best possible manner.

(vii) Cost reporting : This refers to furnishing of relevant cost information to themanagement on a regular basis so as to meet the requirements of management.It is a formal system designed to ensure timely supply of pertinent costinformation to the management for their policy-making and operating decisions.

(viii) Cost reduction : Cost reduction represents achievement of real and permanentreduction in the unit cost of goods manufactured and services rendered. Costreduction may be brought about by the elimination of wasteful and non-essentialelements in design of products. The final aim of cost accounting is the reductionof real costs of goods (or services) on a permanent basis through maintaining (orimproving) quality and utility.

1.10. Concept of Cost

Cost is an expenditure that has actually been incurred or that can be notionallyattributed to a specified thing or activity.

According to CIMA [Chartered Institute of Management Accountants, London], Costis ''the amount of expenditure (actual or notional) incurred on, or attributable to, a specifiedthing or activity."

The above definition clarifies that a cost may be an actual cost that has been incurredand ascertained after it has been incurred. For example, the expenditure on materials incurredand ascertained in the process of producing any commodity, is a cost.

A cost may also be a notional cost for which there has not been any cash payment (oroutflow of cash) but whose benefit has been enjoyed in the process of production of acommodity (or rendering of a service). Rent on own premise, interest on own capital, etc,are examples of notional costs. Thus, a cost refers to a payment which can be associatedwith a commodity or service. It need not necessarily be a cash payment. For this reason, the


American Accounting Association has defined it as '' a foregoing, measured in monetaryterms, incurred or potentially to be incurred to achieve a specific objective."

Anthony and Welsch defined cost as ''a measurement, in monetary terms, of the amountof resources used for some purposes."

J. L. Hanson, gave a comprehensive definition to the term 'Cost'. According to him,''The cost of producing a certain output of a commodity is the sum of all the payments tothe factors of production engaged on the production of that commodity."

Thus, we may summarise 'Cost' as —

(1) A cost is a payment which has been incurred and ascertained. [Actual Cost](2) It may also be a hypothetical costs, attributable to a specified thing or commodity.

[Notional Cost ](3) It is a foregoing which can be measured in monetary terms. Actually, it is a

benefit foregone or resource sacrificed which is measurable in monetary terms.(4) A cost should always be studied in relation to its purpose and condition. By adding

different adjectives to costs, we try to convey some definite meaning that isrequired to measure and analyse costs. For example, we say Fixed Cost, VariableCost, Imputed Cost, Sunk Cost, etc., to differentiate between the nature andpurpose of costs.

(5) A cost is measured and recorded on the basis of some historical or pre-determinedstandard.

(6) Cost ascertainment, cost analysis and cost control are the main objects ofCost Accounting. A proper understanding of cost is a pre-requisite to all these.

1.11. Cost, Expense and Loss'Cost' should be distinguished from 'expense' and 'loss', though the terms cost and

expense are used synonymously.

Cost : It is the amount of cash (or equivalent resources) given to acquire the goods orservices. Cost is incurred (or potentially to be incurred) to achieve a specific objective. It isthe resources sacrificed (or benefits foregone) measurable in terms of money. It is theamount of resources given up in exchange for goods and / or services. C.I.M.A. (London)defines cost as ''the amount of expenditure actual (or notional) incurred on or attributableto a specific thing or activity".

Cost includes both expired cost and unexpired (or deferred) cost. Expired cost representsan expenditure from which no further benefit is expected. Expired cost may be either an'expense' or a 'loss'. Expired cost which brings in matching economic benefit, is termed asan 'expense' (or utilised expired cost). In other words, expired cost becomes an expensewhen the asset (or service) is used up. Therefore, an expense is that part of expired cost, thebenefit (or utility) of which is directed towards the productive activities. On the contrary,expired cost which does not bring in a matching economic benefit, is termed as 'loss' (orunutilised expired cost). Therefore, loss is that part of expired cost, the utility of which is lostbefore it is being used for productive purposes.

On the other hand, unexpired (or deferred) cost refers to the cost for which expenditurehas been incurred but the economic benefit has not been received during the currentaccounting period (for example, prepaid rent, prepaid insurance, unutilised part of asset,etc.). Unexpired (or deferred) cost does not form part of product cost. It is shown as anasset in the Balance sheet.


Cost

Expired Cost Unexpired (or Deferred) Cost[It is shown as an asset in the Balance sheet]

Expense Loss(or utilised expired cost) (or unutilised expired cost)[It is charged to P/L A/c] [It is written off to P/L A/c]

Expense : An expense may be defined as an expired cost with a matching economicbenefit (such as postage paid, rent paid, depreciation, etc.). Expense is that part of expiredcost, the benefit (or utility) of which is directed towards productive activities. Expense mayalso be referred to as utilised part of expired cost. An expired cost becomes an expense whenthe asset (or service) is used up for economic benefit. Thus, expense represents sacrifice ofresources for an economic benefit. Expense is matched (or charged) against revenue inorder to arrive at the profit or loss of the period. Normally, expense forms part of productcost and is charged to the Profit & Loss Account for that period.

[Important points to remember : Sometimes, the term 'expense' is used in a narrowsense in Cost Accounting. According to the element-wise base of classification of cost, any costis composed of one or more of the three elements of costs (i.e., material cost, labour costand expenses). Therefore, expense is a specialised term used to signify the cost of servicesprovided to an undertaking (such as : rent, rates, taxes, cost of postage, cost of lighting andheating, insurance, maintenance costs, etc.)]

Loss : Loss may be defined as an expired cost without any matching economic benefit(such as : loss of stock by fire, abnormal idle time, etc.). Loss is that part of expired cost, theutility of which is lost before it is being used for productive purposes. Loss may also bereferred to as unutilised part of expired cost. Loss can also be termed as the difference betweenthe expenses and revenue (when expenses exceed revenue) for an accounting period. Loss isthe net effect of any unfavourable transaction, event or situation. Normally, loss does notform part of product cost. Loss is written off by transferring it to the Profit & Loss Account.

1.12. Concept of CostingAccording to the *Institute of Cost and Management Accountants (ICMA), London,

costing refers to : ''The techniques and processes of ascertaining costs.''

Techniques are related to principles and rules governing the ascertainment of the costof products or services. Techniques are dynamic in nature and are found to change with thepassage of time.

The techniques of costing involve two basic steps. These are—

(i) Collection and classification of expenses according to the cost elements; and

(ii) Allocation and apportionment of expenditure to cost centres and cost units.

[These are going to be discussed later]

Techniques are used as principles and rules for the ascertainment of cost. For example,Marginal Costing, Standard Costing, Budgetary Control, Uniform Costing, etc., are appliedas techniques.

A process is used to lead to the method (or procedure) of ascertaining costs. For example,Job Costing, Batch Costing, Process Costing, Operating Costing, Operation Costing, etc., are


used as methods of costing. Different methods and techniques embodied within costing areapplied depending upon the nature of the product, production procedure, etc.

Wheldon gave a broader definition of 'Costing'. According to him, ''Costing is theclassifying, recording and appropriate allocation of expenditure for the determination ofcosts of products or services.'' So costing is supposed to include :

(a) Collecting costs which can be attributed to an output or a service;

(b) Classifying the collected costs in different groups;

(c) Recording the costs properly;

(d) Computing the total costs of products and services.

* ICMA was renamed as CIMA [Chartered Institute of Management Accounts]. The definition of Costing given byICMA in Terminology of ICMA, has not been advocated by CIMA. The latter has dealt with the term ''Standard Costing".

1.13. Concept of Cost AccountingCost Accounting means accounting for costs. It is regarded as a specialised branch of

accounting that involves classification, accumulation, assignment and control of costs. It isconcerned with the measurement and communication of cost information. It starts with therecording of all costs related to the manufacturing process and ends with the presentationof cost reports to the management. It encompasses the preparation of statistical data forthe determination of costs, the application of cost control techniques and finally theascertainment of profitability. It is a mechanism applied for the determination and controlof costs of products and services. CIMA, London defines Cost Accounting as ''an applicationof costing principles, methods and techniques for determination of costs and the analysis ofdeviations (favourable or adverse) as compared with standards."

Eric. C. Kohler feels that Cost Accounting should deal further with the presentation andexplanation of cost information to the management. The management uses such informationfor deciding and guiding current and future operations. He defines Cost Accounting as''that branch of accounting dealing with the classification, recording, allocation,summarisation and reporting of current and prospective costs." So, Cost Accounting rendersinformation for the guidance of the management for proper planning, operations, controland decision-making.

1.14. Concept of Cost AccountancyCost accountancy is a subject which is related to the accounting of goods produced or

services rendered. It involves the application of costing and cost accounting principles,methods and techniques to the practice of cost control and the ascertainment of profitability.It also covers the presentation of information derived thereform for the purpose of managerialdecision-making.

CIMA (London) defines Cost Accountancy as ''the application of Cost Accountingprinciples, methods and techniques to the science, art and practice of cost ascertainmentand control. It includes the presentation of cost information derived thereform for thepurpose of managerial decision-making."

It is a science so far as it involves the possession and application of a systematic body ofknowledge. It is an art so long as it involves some skill for its application. It is a practice aspractical application of theoretical knowledge is a constant pursuit for the Cost Accountant.


1.15. Inter-relationship of Costing, Cost Accounting and Cost Accountancy

Costing = Methods and techniques of ascertaining costs.

Cost Accounting = Costing + Application of cost control techniques.

[Therefore, Costing is an integral part of Cost Accounting]

Cost Accountancy = Cost Accounting + Presentation of relevant information to the management for

decision-making.

[Therefore, Cost Accountancy covers a wider field than Cost Accounting]

1.16. Differences between Costing and Cost Accounting


1. Basic concept

2. Accounting mechanism

3. Application of accounting principles

4. Coverage

5. Procedure

Cost Accounting

Cost Accounting is concerned with theaccounting for costs. So, it pre-supposesthe set up of an accounting system.

It involves accounting for costs. Startingfrom collection of data, it ends with thepresentation of reports. Throughout theprocess, the presence of accountingbecomes necessary.

It requires the application of accountingprinciples.

It encompasses a much wider field. It hasto deal with the presentation andinterpretation of cost data to themanagement for proper planning, operation,control and decision-making.

It involves analysis of costs for thepreparation of necessary information. It isrelated to reporting of current andprospective costs.

Costing

Costing is related to the techniques andprocesses of ascertaining costs of goodsproduced or services rendered.

It does not necessarily require formalaccounting. Even arithmetical computations orpreparation of statements may help it.

It does not necessitate the application of allaccounting principles.

It is an integral part of Cost Accounting so faras it is related to computation of costs anddetermination of profits.

It involves classification of expenses accordingto cost elements. It also deals with theallocation and apportionment of costs to thecost centres and cost units.


1. Basic concept

2. Applicability

Cost Accountancy

It is an application of costing and costaccounting principles, methods andtechniques to the practice of cost controland ascertainment of profitability.

It covers a much wider area.

Cost Accounting

It is an application of costing principles,methods and techniques for the determinationof costs and analysis of deviations fromstandards.

Its field of application is limited.

1.17. Differences between Cost Accounting and Cost Accountancy


1.18. General Principles of Cost AccountingThe following principles are generally observed in Cost Accounting :(i) Application of double entry principle : Cost ledgers and cost control accounts are

maintained on a double entry principle. Double entry principles should be appliedstrictly wherever necessary. However, cost sheets and cost statements are not basedon a double entry principle although these are widely used for cost ascertainmentand guidance to the management.

(ii) Charging relevant costs to products (or services) : Products (or services) should becharged with costs actually incurred (i.e., actual costs) and costs notionallyattributable (i.e., hypothetical costs), if any. For example, a product which is in thefactory, should not be charged with selling and distribution costs. Selling anddistribution costs can be charged only to products which have been sold.

(iii) Not to charge abnormal costs to production : Abnormal costs (such as losses due tofire, abnormal idle time, excessive bad debts, etc.) are not charged to production.Only normal costs incidental to production (or service) are charged. Abnormalcosts are transferred to Costing Profit & Loss Account.

(iv) Excluding expenses and appropriation of a purely financial nature : Financial expenseswhich have no relationship with Cost Accounting are excluded from costcomputations (such as : penalties, fines, interest on bank loans, interest ondebentures, discount on issue of shares and debentures, loss on sale of fixed assets,etc.). Again, items of appropriation of profits (such as income tax, transfer toreserves, payment of dividends, etc.) are excluded from cost accounts.

(v) Excluding incomes of a purely financial nature : Purely financial income items(such as, profit on sale of fixed assets, interest received on bank deposits, dividendreceived, fees received, etc.) are excluded from cost accounts.

(vi) Not to charge past costs to current period : Past costs are those costs from which nomore benefit is to accrue. Past costs are not taken into the current period (unlesssuch costs are not recovered in full). Past costs are likely to influence the currentresults if such costs are included in the current period.

(vii) Ignoring the concept of conservatism : The concept of conservatism is important infinancial accounting, but it has no place in cost accounting. For example, in financialaccounting, the closing stock is valued 'at cost price or market price, whichever islower' but in cost accounting, valuation of closing stock is done at 'cost price' only.Therefore, in cost accounting, there is no tendency to show reduced profit bycreating secret reserves.

(viii) Relating cost to its cause only : A cost should always be studied in relation to itspurpose and condition. A cost should be related to its cause as closely as possible.For example, rent for the factory cannot be charged to office overheads. It should


3. Objective

4. Coverage

Cost Accountancy

Its objects are cost determination, costcontrol, preparation of relevant informationnecessary for the purpose of decision-making.

It denotes a body of knowledge involving ascience, an art and a practice of CostAccounting.

Cost Accounting

Its objects are determination of costs andcontrol of costs.

It is an integral part of cost accountancy.


be treated as a part of factory overheads. Similarly, common costs should be apportionedto different departments (or products or services) on some rational basis.

(ix) Resorting to assumptions in some cases : Certain assumptions are always made inascertaining costs to suit a particular situation. Generally, assumptions are madewith regard to selection of a particular method of valuation of inventories (such asLIFO, FIFO, Average cost, etc.), method of charging depreciation (such as Straightline method, Diminishing balance method, etc.). As a result, the accuracy in costaccounting is relative. Thus, cost statements presented by two Cost Accountantsmay not always be identical.

1.19. Objectives (or purposes) of Cost AccountingThe main purposes of cost accounting are enumerated as follows :(i) Ascertainment of costs : Cost ascertainment means computation of actual costs

after they have been incurred. The primary objective of cost accounting is toascertain the costs of various products, jobs, activities, services, etc. Ascertainmentof cost is a pre-requisite for cost control and for furnishing cost information to themanagement for its decisions. Generally, costs are ascertained by using principlesof different methods of costing. It ensures that all items of cost which are incurred(or attributed) to a particular product or activity, are absorbed properly into thecost of that product or activity.

(ii) Estimation of cost : Estimated cost is a futuristic concept. It is the process ofdetermining in advance the cost of products, jobs, activities, services, etc. In costestimation, an allowance is generally made for anticipated fluctuation in the pricesof different elements of cost (such as material cost, labour cost and overheads).Cost estimation serves the following purposes :(a) It is required for offering quotation of prices, sending tenders, bidding for

contracts, etc.;(b) It is useful in the preparation of various budgets;(c) It is helpful in the evaluation of projected performance;(d) It facilitates preparation of projected financial statements;(e) It forms the basis for controlling actual cost of production.

(iii) Control of cost : Cost control is the regulation of operating costs of an undertakingby executive action. Cost control aims at improving efficiency by controlling andreducing costs. Budgetary control and standard costing are two important techniquesused to control cost. Cost control improves efficiency by achieving maximum outputat minimum cost. The cost accountant identifies the areas wherein the companyhas to improve its efficiency, reduce costs, wastages, etc,. These will be brought tothe attention of the management for taking remedial measures.

(iv) Reduction of cost : Cost reduction means real and permanent reduction in the unitcost of goods manufactured (of services rendered). It is a genuine saving of cost bythe elimination of wasteful and inessential elements from the design of the product.Under a cost reduction scheme, standard costs must be constantly challenged formore and more improvement. Cost reduction must arise from continuous scientificresearch. The areas of cost reduction are vast, which include product design,production method, marketing, administration, finance, etc,. Cost reduction beginswhere cost control ends. The functions of cost reduction begin after achievingeverything that cost control demands.


(v) Preparation of cost statement : A cost statement is prepared to show the differentcomponents of total cost. It generally shows total cost, per unit cost, output producedand sold, units and value of closing stock, etc. It is essential to have a frequentreview of production, sales and operating results in order to run the business at ahigh level of efficiency. Cost accounting provides information on daily, weekly,monthly, quarterly and yearly volumes of goods produced, accumulated costs alongwith appropriate analysis. Properly developed cost accounting system can provideready information regarding cost of production, value of stock, etc., as and whenrequired.

(vi) Helping in managerial decisions : Cost accounting is designed primarily to servethe needs of the management. Cost accounting provides useful, timely and relevantinformation to the management to take various decisions such as—(a) productdiversification, (b) fixing of selling prices, (c) make or buy decisions, (d) selectionof profitable product-mix, (e) determination of alternative methods of manufacture,(f) dropping a product line, (g) suspending activities of a region, (h) factory shutdown decisions, (i) scarce resource (key factor) allocation decisions, (j) effect ofchange in selling prices, (k) level of activity planning, (l) opening of extra shiftwork, (m) selection of optimum volume of production, etc,.

1.20. Methods of Costing

Costing methods refer to the systems of collating and presenting costs for the purpose ofproduct costing (or service costing). Several methods of costing have been designed to suitthe needs of individual business conditions. In other words, different methods are usedbecause business enterprises vary in their nature and in the type of the products theyproduce (or services) they render. The basic principles of ascertaining costs are the same inall methods, but the way of analysing and presenting such costs vary from industry to industry.

Basically, there are two principal methods of costing, namely,

(1) Job Costing (2) Process Costing

Variations of Job Costing are : Variations of Process Costing are :

(a) Batch Costing (a) Operation Costing

(b) Contract Costing (or Terminal Costing) (b) Operating Costing

(c) Composite Costing (or Multiple Costing) (c) Single (or Output) Costing.

1.20.1. Job Costing / Specific Order Costing / Production Order Costing / Lot Costing : Thisrefers to a system of costing in which costs are ascertained in terms of specificjobs or orders which are not comparable to each other. Industries manufacturingproducts (or rendering services) against specific orders, use the Job Costing method.In the Job Costing method, an order or a lot or batch of a product may be taken asCost Unit (i.e. a Job). In Job Costing, all costs of direct materials, direct labour andother direct expenses are directly charged to the specific job or product.

Applicability : Job Costing is used by organisations whose products or services canreadily be identified by individual units or batches. Industries where this methodof costing is generally applied are Printing presses, Repair shops, Ship-building,House-building, Automobile garages, Engine and machine construction, Furnituremaking, Hardware and machine manufacturing, Consulting engagements, Researchprojects and several such industries where jobs or orders can be kept separate.


(a) Batch Costing : This method is also a special type of Job Costing. Batch Costingrefers to that method of costing which determines the cost of a group of identicalproducts. It is then used to determine the unit cost of the articles producedby dividing the total cost of the batch by the total batch quantity. It should,however, be noted that the articles produced should not lose their identity inmanufucturing operations.In batch costing, a batch constitutes the cost unit for which costs are compiled.Separate Job Cost Sheets are maintained for each batch of componentsmanufactured and for the assembly of finished products. The cost of eachbatch is determined separately by charging with its own costs.Applicability : Batch Costing can be applied to companies engaged inmanufacturing radios, televisions, V.C.R.s, watches, electronic goods, biscuits,cars, medicines, toy making, readymade garments, etc.

(b) Contract Costing / Terminal Costing / Construction Costing : Contract Costing isa variant of the Job Costing method. The basic principles applied in ContractCosting are the same as those used in Job Costing. In Contract Costing, aspecific contract becomes the Cost Unit. A particular contract is treated as awhole job and the cost of the contract is determined accordingly. Therefore,Contract Costing is that form of Job Costing which applies where work isundertaken to a customer's special requirements and each order is of longduration. It is also known as Terminal Costing since the job cost is completedwith the completion of the work.Applicability : Contract Costing is used in Ship building, Building construction,Civil engineering work, Air craft manufacture, etc.

(c) Composite Costing / Multiple Costing : Multiple Costing is a combination ofvarious methods of costing. The manufacture of certain products involves a lotof complexities. Therefore, any one of the basic methods cannot be used forcollating and presenting product costs. In other words, in multiple costing weexperience application of various costing methods. Multiple Costing is usedwhere there are a variety of components separately produced and subsequentlyassembled in the complex production.Applicability : Multiple costing is applicable to manufacturing concernsproducing Motor cars, Machine tools, Radios, Sewing machines, Aeroplanes,Cycles, Typewriters, Locomotives, etc.

1.20.2. Process Costing : Process Costing is used to ascertain the cost of the product ateach process, operation or stage of manufacture. The finished goods of the earlierprocess becomes the raw materials for the latter process. Costs are identified foreach process and charged to that process. The cost of each process is determinedseparately. In process costing, production follows a series of sequential processes.It is suitable for organisations which manufacture goods on a continuous basis.Applicability : Process Costing is generally adopted in Textile Industries, ChemicalIndustries, Oil refineries, Soap manufacturing, Paper manufacturing, Paints, Foodprocessing, Steel, Rubber industries, etc.(a) Operation Costing : A manufacturing process may sometimes be divided into a

number of parts, each of which is known as an operation. Operation Costingrefers to the determination of cost of operations. It is a special type of processcosting. The cost unit is the 'operation' instead of the process. The per unit


cost is calculated by dividing the total cost of an operation by the number ofunits completed in the operation centre. For large undertakings, it is frequentlynecessary to ascertain the cost of various operations. The procedure for costingof operations is broadly the same as for process costing. Cost Control can beexercised more effectively with operation costing.

(b) Operating Costing : This method of costing is applicable to undertakings whichprovide services. Here, the cost of all the services rendered is ascertained.Thereafter, total costs of the operation are divided by total units and per unitcost of service is calculated.Where an undertaking or a department within an undertaking provides services,the costing method used is termed as Operating Costing. Service organisationsare those that do not make or sell tangible goods. Service organisations includetransport companies, hospitals, schools, etc.Applicability : Operating Costing is applicable to :(i) Transport concerns (railways, motor, shipping and air transport);(ii) Public utility concerns (electricity, gas, hospitals, telephones, schools,

colleges, etc.);(iii) Catering establishments (hotels, canteens, hostels, etc.).

(c) Single (or output) Costing : This method is used where a single article is produced(or a service is rendered) by continuous manufacturing activities. The cost of thewhole production cycle is ascertained as a process. The per unit cost is obtainedby dividing the total cost by the total number of units manufactured. The unit ofcost is chosen according to the nature of the product, e.g. for coal and iron orethe cost unit is ''per ton"; for bricks, cost unit is "per thousand bricks" etc.Applicability : This method is suitable for industries like brick-making, cementmanufacturing, collieries, flour mills, etc.

1.21. Techniques of CostingCosting techniques refer to the manner in which it is decided to present cost information

to the management. The following five basic techniques are commonly used by CostAccountants :

(1) Marginal Costing : This is an important technique used for decision-making. It refersto the ascertainment of marginal costs by differentiating between fixed costs andvariable costs and the effect on profit of the changes in volume. In marginal costing,there is no room for semi-variable costs. Semi-variable costs are split up into variableand fixed elements. The variable portion of semi-variable costs is added to variablecost and fixed portion of semi-variable cost is added to fixed cost.In marginal costing, only variable costs are charged to products (or opreations), whilefixed costs are attributed to the business in general (i.e. fixed costs will be written offin full in the period to which they are attributable). In other words, fixed cost is notallocated to cost units.

(2) Standard Costing : The Standard Costing technique is used as an effective tool forplanning and control of costs. It is a technique where standard costs are determinedin advance. After the production, actual costs are compared with standard costs todevelop variances. Once the variances (favourable or adverse) are determined, themanagement finds out the reasons for such variances for taking remedial measures.Standard Costing provides the base for control through variance accounting. Ithelps the management to maintain maximum efficiency in production.

Cost --- 2


(3) Budgetary Control : Budgets should be viewed as an activity plan. Budgets areprepared for each and every function and accordingly targets are fixed for eachexecutive who is responsible for achieving results.Budgetary control should be viewed as a feedback system. Actual performancesare continuously compared to budgets and variance reports are issued, as a feedbackto executives at all levels.Budgetary Control is defined as, ''The establishment of budgets relating toresponsibilities of executives to the requirements of a policy, and the continuouscomparison of actual results with budgeted results either to secure by individualaction the objective of that policy or to provide a basis for its revision ."

[C.I.M.A.; Official Terminology]Budgetary Control refers to :(a) Establishment of a budget for a defined period of time;(b) Continuous comparison of actual results with budgeted results;(c) Investigation into the deviations (variances) arising out of such comparison;(d) Finding out the causes of variances;(e) Taking corrective action to remedy the causes in order to achieve the defined

objectives;(f) Planning again by considering feed back.Budgetary control is an aid to the management for controlling costs and maintainingmaximum efficiency in production.

(4) Historical Costing (or Absorption Costing) : This refers to the ascertainment ofcosts after they have been incurred. This is also termed as traditional costing. Thistechnique takes into account the total costs of running an enterprise. An effort ismade to absorb the entire cost into the individual units. This technique is alsocalled ''full costing". This technique does not help to exercise control on costs.

(5) Uniform Costing : Uniform Costing is the use by several undertakings of the samecost accounting principles and/ or practices. Uniform Costing promotes operatingefficiency by ensuring inter-unit and inter-firm comparisons. Here, a number ofmanufacturers under common control, may lay down definite and detailedinstructions regarding uniform procedures to be adopted. It helps to increaseproductivity and locates the 'Weakest Spots' of member concerns.

1.22. Cost Centre

A cost centre is the smallest segment of activity (or area of responsibility) for which costsare ascertained. Such a sub-division helps in the collection of costs and absorption of costs tocost units.

Cost Centre may be a location, person or item of equipment (or group of these) in respectof which cost may be ascertained and used for the purpose of cost control. So, a cost centremay be a depot (or warehouse), an individual, a machine in the factory.

CIMA, London, defines a Cost Centre as "a production or service location, function,activity or item of equipment whose costs may be attributed to cost units." It may be alocation (such as, department, section, storeyard, sales area); a person (such as a salesman,a foreman, a machine operator); an item of equipment (such as a machine, a delivery van)or a group of these. These cost centres are known as "responsibility centres" as control isexercised over costs in relation to particular cost centres. For a cost centre, the person in itscharge is responsible for the control of its costs.


Cost centres help in the process of recovery of overheads. Identical machines performingsimilar work may be assigned to a cost centre. The rate of recovery of overheads may beascertained through the calculation of machine hour rates. For the correct ascertainmentand control over costs, prudent division of cost centres become necessary. Otherwise, toomany cooks may spoil the broth.

1.22.1. Types of Cost Centres

(i) Personal Cost Centre : A Personal Cost Centre consists of a person or group ofpersons.

(ii) Impersonal Cost Centre : An impersonal cost centre consists of a location or itemof equipment (or group of these). A Cost centre, determined according to location,may be an area or region of sales, a depot or warehouse.There are two main types of cost centres in manufacturing concerns.(a) Production Cost Centres : These centres are engaged in production work.

Machine shops, Assembly shops are examples of production cost centres in afactory.

(b) Service Cost Centres : These centres render valuable services to productioncentres. Only indirect costs are charged to Service Cost Centres. A few examplesof service cost centre are :(i) Administrative Centres, e.g. general office, accounts office, cash section;(ii) Material Service Centres, e.g. stores, internal transport;(iii) Personal Service Centres, e.g. labour office, canteen;(iv) Plant Maintenance Centres; e.g. tool room, carpenter shop.

1.23. Cost UnitA Cost Unit is a quantitative unit of product (or service) in relation to which costs are

ascertained (or expressed). A Cost unit differs from industry to industry. The unit selectedshould be one which is the most natural to the business and is acceptable to all concerned.

Examples : (i) Cost per kg. of sugar, (ii) Cost per 1,000 bricks, (iii) Cost per tonne ofcement, etc.

More typical examples of Cost Units are given belowIndustry or Product Cost UnitTransport Tonne-kilometre; Passenger-kilometreSteel Per tonCement Per tonPower (Electricity) Kilo-watt hourAutomobiles NumberCables Metre or KilometreGas Cubic metreMines and Quarries TonneChemicals LitreFertilizers Per tonTelevisions/Radios/VCRs Per setBuildings Per sq. ft.Nuts and bolts Gross


1.25. Installation of a Cost Accounting SystemA cost accounting system is a system that accumulates costs, assigns them to cost centres

and reports cost information. It ascertains product profitability and helps the managementin planning and controlling business operations.

Installation of a particular cost accounting system depends on the objectives to beachieved. It is impossible to prescribe a particular cost accounting system suitable for everyorganisation. Cost accounting system should be designed keeping in view the nature of theorganisation, type of product/ service and the objective to be achieved from the system.

To instal a sound cost accounting system in an organisation is not an easy task. Beforeinstalling such a system, proper care should be taken to study and take into account all theaspects involved, as otherwise, full benefit will not be derived from it. As a system designer,the cost accountant should be able to perceive the needs of the management at variouslevels. He should design such a system as will meet these needs promptly, effectively andefficiently.

The following items need careful consideration at the time of designing a cost accountingsystem :

(1) The objectives to be achieved;

(2) The size and layout of the factory should be studied carefully;(3) Nature of raw materials in use, methods of purchase, receipt, storage and issue of

materials should be examined;(4) The methods of paying wages should be studied;(5) Factory layout and production sequence should be studied;(6) The managements' requirements and their attitude towards cost accounting system

should be kept in view;(7) The cost of installing and operating the system should be economic;(8) the system should be simple and easy to operate;(9) The system should suit the organisation;

(10) Forms and records should involve minimum clerical work and cost;(11) The system should be so designed that cost control can effectively be exercised;(12) The system should incorporate a suitable procedure for communicating required

information to the various levels of management;

1.24. Differences between a Cost Centre and a Cost UnitCost Unit

1. A cost unit is a quantitative unit of product or service inrelation to which costs are expressed and ascertained.

2. A cost unit is the unit of expressing cost and is, assuch, a part related to the production or service.

3. Cost unit is used for the sub-division of costs whichmay be attributed to the products or services.

4. Application of cost units arise after the functions ofdevising cost centres are over.

5. A cost unit is assigned to one distinct product orservice.

Cost Centre

1. A cost centre is the smallest segment or activity orarea of responsibility for which costs are ascertained.

2. A cost centre is one segment of the total organisation.

3. A cost centre helps to determine costs by location,person, etc.

4. A cost centre is devised before applying the cost unit.

5. A concern which even produces only one product orrenders only one service, may have several costcentres.


(13) External factors (e.g. Government regulations) affect the frequency, volume andstructure of the cost accounting system;

(14) Various departments that are involved in the system should be well co-ordinatedso that they can function effectively;

(15) Last but not the least, before installation, the cost accounting system should bediscussed with the managers to win their confidence and full involvement. Theapproach should be participative.

1.26. Advantages of Cost Accounting(a) As an Aid to Management : The various advantages derived by the management

from a good system of Cost Accounting are as follows :

(i) A cost accounting system locates unprofitable activities, losses and anyinefficiency occurring in various forms of waste;

(ii) Cost accounting is useful for price fixation, submission of quotations and tendersetc.;

(iii) Cost accounting locates the causes for increase or decrease in the profit orloss of the organisation;

(iv) Proper cost information makes it possible for the management to distinguishbetween profitable and non-profitable operations. Profit can be maximised byconcentrating on profitable operations ;

(v) More reliable and accurate financial accounts can be prepared with the helpof a perpetual inventory system of stock control;

(vi) Inter-firm comparisons will enable the management to study the causes ofunfavourable developments. Cost comparison helps in cost control;

(vii) Adequate cost records provide the management with such data as may benecessary for preparation of Profit & Loss Account and Balance Sheet at suchintervals as may be desired by the management;

(viii) The introduction of an effective Cost Accounting system prevents manipulationand fraud.

(b) As an Aid to Creditors : Investors, banks and other money-lending institutions arebenefitted immensely by the installation of an efficient system of cost accounting.They can base their judgements about profitability and future prospects of theenterprise on the cost records.

(c) As an Aid to Employees : Employees are benefitted in a number of ways by theinstallation of an efficient system of cost accounting. They are benefitted throughcontinuous employment and higher remuneration by way of incentives, bonus plans,etc. Thus, an effective cost accounting system ensures maximum utilization ofhuman resources.

(d) As an Aid to National Economy : An efficient system of cost accounting bringsprosperity to the business enterprise, which in turn, results in increasingGovernment revenue. The overall economic development of a country takes placeas a consequence of increase in production. A cost accounting system providesready figures for use by the Government, Wage Tribunals, Trade Unions, etc., forapplication to problems like price fixation, price control, wage level fixation, paymentof dividends, settlement of disputes, tariff protection, etc.


1.27. Limitations of Cost AccountingSome objections are raised against the cost accounting system in spite of its numerous

benefits. These objections are as follows :

(i) Duplication of work : A good number of business concerns have proved themselvesefficient even without using the cost accounting system. It is argued that the costaccounting system is not necessary as it involves duplication of work. So it isunnecessary and creates a burden on the organisation.

(ii) Unsuitable for many industries : It cannot advantageously be applied to all types ofindustries. There is no such cost accounting system which can be readily appliedto all industries (especially to certain unique or special types of industries).

(iii) Failure to produce desired results : The adoption of a cost accounting system mayfail to produce the desired result in many industries.

(iv) Expensive system : The installation and operation of cost accounting system requiresa huge initial capital expenditure and high operating expenses.

(v) Stereotyped and mechanical system : It is stereotyped and mechanical as it involvesfilling in a large number of forms continuously. It degenerates into merely one offorms and rulings.

(vi) Excessive estimation : Cost computation involves a large number of conventions,estimations, arbitrary allocation of joint costs, etc,. As a result, no costs can besaid to be exact. This leads to a misleading picture on the cost statement and oncost information.

(vii) Relative approach : Accuracy in cost accounting is relative. Certain assumptionsare always made while ascertaining cost to suit a particular situation. Thus, costspresented by two cost accountants may not always be identical.

(viii) Unsuitable for all purposes : No one cost is suitable for all purposes and under allcircumstances. The computation and presentation of a particular cost depends onthe purpose to which cost data is required.

(ix) Improper analysis of notional cost : Notional cost is a hypothetical cost for whichthere is no outflow of cash (such as rent on own premise, interest on own capital,etc.). Notional cost should be properly attributed to a specific product, job, activityetc. The purpose of cost accounting cannot be fulfilled without a proper analysisand allocation of notional cost.

1.28. Cost Accounting —its relationship with other branches of accounting

1.28.1. Cost Accounting and Financial Accounting

(1) Financial Accounting is associated with the determination of profitability of abusiness as a whole. It depends mainly on historical data which may not be usedfor cost control in Cost Accounting.

Cost Accounting is associated with the ascertainment of costs of individual products,services, departments, etc.

(2) Financial Accounting gives emphasis on the ascertainment of profit or loss of aconcern. Here, business transactions are recorded, classified and analysed for thepreparation of the Profit and Loss Account for an accounting period and for thepreparation of the Balance Sheet at the end of the period.


Cost Accounting analyses the transactions with the object of planning, control ofcosts and decision-making.

(3) Financial Accounting adheres to generally accepted accounting principles but CostAccounting adheres to costing principles and concepts.

(4) Financial Accounting is applicable to all types of accounting concerns whereasCost Accounting is applicable mainly to manufacturing concerns.

(5) Financial Accounting is more or less compulsory for all trading concerns. Costaccounting is not compulsory [except for companies where Section 209(1) of theCompanies Act makes cost accounting mandatory].

(6) Financial Accounting provides information to protect the interests of owners andoutsiders having substantial interests in the business like banks, creditors, etc.

Cost Accounting helps and guides the management to discharge the managerialfunctions like planning, decision-making, etc.

(7) Financial Accounting remains confined to the current accounting period. But CostAccounting predicts future costs also.

(8) The concept of periodicity is applied to Financial Accounting. It means thatfinancial accounts are kept for each accounting period which generally comprisesa period of twelve months.

A cost accounting record is prepared for a period as required. It may be preparedyear-wise or month-wise or even for a shorter period as the management requiresit for the purpose of decision-making or for exercising controls.

Despite all these differences, these two branches are closely inter-related. Both ofthese branches collect, record, classify and summarise transactions and reporttheir results in monetary terms to the appropriate authority. The sources of collectionof data remain more or less the same in both the cases. For this reason,L.W. Hawkins felt that ''the ordinary trading account is a locked store-house of mostvaluable information to which a cost system is the key."

1.28.2. Cost Accounting and Management Accounting

In the 1950s, a new branch of Accounting revealed itself by the name of ManagementAccounting. It is related to the presentation of accounting information in a manner to helpthe management of a business to formulate policies and to discharge day-to-day activities.According to the American Accounting Association (AAA), ''It includes the methods andconcepts necessary for effective planning, for choosing among alternative business actions,for controls through the evaluation and interpretation of performance." Thus, ManagementAccounting deals with accounting information for managerial or other decision-makingpurposes.

Management Accounting is practically an extension of managerial aspects of CostAccounting. It employs different costing techniques like standard costing, marginal costingand budgetary control. It uses the cost information for managerial decision-making andcontrol purposes. So, it may be said that Cost Accounting is complimentary to ManagementAccounting.


However, the following differences exist between Cost Accounting and ManagementAccounting :

(1) Cost Accounting is associated with the ascertainment of costs of individual products(or services) and furnishing cost-related information that comes to the use of themanagement. Management Accounting is associated with identifying, measuring,accumulating, analyzing, preparing, interpreting and communicating informationthat help managers to fulfil organizational objectives. It supplies information tothe management in the modified form as required by the management.

(2) In cost accounting, data which can be expressed in terms of money is used. This isquantitative data.

The information used in Management Accounting may be quantitative as well asqualitative.

These may include both monetary and non-monetary information.

(3) Cost Accounting deals with cost data only.

Management Accounting deals with all data associated with any informationrequired by the management.

(4) In Cost Accounting, the double entry system is used.

Management Accounting does not require any particular system of accounting.

(5) Cost Accounting is applicable mainly to production or manufacturing concerns.

Management Accounting is applicable to all types of concern, that is, productionunits as well as non-production centres.

(6) Cost Accounting is mainly related to a particular period. So, it is linked to thecurrent year only.But Management Accounting is always future-oriented.


SECTION–II : NATURE AND SCOPE OF MANAGEMENT ACCOUNTING

1.29. Concept of Management AccountingManagement accounting is concerned with the presentation of accounting information

to the management in such a way as to assist them in their managerial functions of decision-making, planning and control. Management accounting is developed because ofmanagements' demand for information on past and present operations for predicting futuretrends. The management accounting system acts as a decisions support system for providingthe right information to the right people at the right time. It deals with accounting informationfor managerial decision-making purposes. Management accounting is used by themanagement to plan the activity, evaluate performance and ensure integrity of financialand cost information. It contributes to the effective performance measurement and thesystem of reporting that is linked to organisational responsibilities.

Management accounting is dynamic and forward-looking. It provides various techniquesfor solving problems, making decisions, planning and controlling the business. It aims tohelp managers to run their organisations smoothly. It is a value-adding process that guidesmanagements' action and motivates behaviour of organisational people. It creates culturalvalues necessary to achieve an organisation's strategic, tactical and operating objectives.An effective management accounting system can create considerable value to organisationalsuccess by providing timely and accurate information about the various activities required.Management accounting information can be both financial (i.e., monetary) and non-financial(such as process time, quality, customer satisfaction, employee capabilities, new productperformance, etc.). Management accounting acts as an informational source for decision-making, improvement and control in the organisation.

''Management accounting is a system of collection and presentation of relevanteconomic information relating to an enterprise for planning, controlling anddecision-making." [I.C.W.A.I., India]

''Management accounting is the application of appropriate techniques inprocessing historical and projected economic data of an enterprise to assistmanagement in taking rational decisions." [American Accounting Association]

''Management accounting is concerned with accounting information that is usefulto management." [R. N. Anthony]

''Management accounting is used to describe the accounting methods andtechniques (with special knowledge and ability) for assisting management in therealisation of desired objectives." [Prof. J. Batty]

''Management accounting encompasses techniques and processes that areintended to provide financial and non-financial information to people within anorganisation to take better decisions and enhance organisational effectivenessthrough proper control." [M. S. Wilson]

1.30. Nature of Management AccountingThe nature of management accounting can be enumerated as follows :(i) Advisory nature : It provides relevant information to the management to achieve

an organisation's strategic, tactical and operating objectives. It gets an insightinto the profitability, solvency, liquidity, etc., of the organisation and rendersadvise to the management on these matters.


(ii) Analytical in nature : Management accounting is analytical in nature. It analysesand interprets accounting and other data to make them understandable andusable to the management. Such an indepth analysis assists the management inpinpointing responsibilities and to effect necessary changes in the organisationalset up.

(iii) Interpreting results of operation : It measures and interprets the results ofoperations to all levels of management with necessary comments and conclusions.It reports on the effectiveness of utilisation of resources at various levels of theorganisation.

(iv) Aid to the management : It provides both quantitative and qualitative informationto the management to assist them in their managerial functions of decision-making, planning and control.

(v) Feedback control : It expresses financially the plans in terms of individualresponsibilities for all levels of management. It develops a chain of responsibilityreporting and monitors performance against plans.

(vi) Future-oriented : Management accounting is forward-looking and dynamic. Itprocesses historical data for projecting future trends in order to take betterdecisions.

(vii) Absence of standard format : There is no standard format to present managementaccounting information. Management accountant prepares formats according tothe demands of a situation. Thus, the style of presentation of information is tailoredto the requirement of a situation.

(viii) Selective approach : It takes into account only relevant information which affectsdecision-making from voluminous financial and cost data. It provides useful andunderstandable information to the management for their proper decision-making.

1.31. Common Data Base for Cost & Management AccountingBoth cost accounting and management accounting utilise the same basic data to a

significant extent. Cost accounting gathers information about production, personnel andother facilities to determine the cost of goods sold during a period. Management accountingdraws the same data to develop budgets, performance reports and analyses this informationfor other decisions. Much of the data used to generate cost accounting reports is also usedto prepare management accounting reports. Therefore, in most of the cases, common datais used in preparing both cost accounts and management accounts. A sound cost accountingsystem manages the data base to provide both cost accounting information and managerialaccounting information. However, the management accounting data is derived both fromcost accounts and financial accounts.

Various Source Documents Common Data Base

CostAccounting

ManagementAccounting

Reporting issuesare resolved basedon relevance

Reporting issuesare resolved basedon GAAP


1.32. Scope of Management AccountingManagement accounting covers the following areas of knowledge :

(i) Financial Accounting : Management accounting data is mostly derived fromfinancial accounting. Management accounting has its roots in financial accounting.Both study the impact of business transactions and interpret the results thereof.Management accounting uses the principles and practices of financial accounting.

(ii) Cost Accounting : Management accounting involves the application of appropriatetechniques and concepts drawn from cost accounting. Management accountingcan be viewed as an extension of managerial aspects of cost accounting.Management accounting utilises the principles and practices of cost accounting.Both cost and management accounting are internal to the organisation. However,the scope of management accounting is broader than the scope of cost accounting.

(iii) Management Information System (MIS) : MIS provides relevant information tothe management for its decision-making. Computers have added a new dimensionto MIS by facilitating the processing of large volumes of data with great speedand accuracy. MIS is expected to supply information as needed at different levelsin the organisation. Proper information at the right time is crucial for strategicdecisions in an environment of intense competition.

(iv) Quantitative Techniques : Operations research (OR) technique is used bymanagement accountants to solve the existing problems in the decision-makingprocess. In a decision-making situation, all variables are quantified for the purposeof analysis. Operations research makes an attempt to diagnose and tackle a problemby optimum utilisation of resources. It is a scientific method with a quantitativebasis for decisions regarding the operations under control. Operations researchtechniques include linear programming, simulation method, queueing (or waitingline) theory, transportation theory, game theory, etc.

(v) Statistical Tools : Business forecasting refers to a statistical analysis of the pastand current movements for obtaining clues about the future trend. Time seriesanalysis, regression analysis, extrapolation, etc., are often used in managementaccounting for predicting future trends. Forecasting facilitates the planningfunction of management. Forecasting provides information about future risksand uncertainties of the business.

(vi) Just-in-Time (JIT) Technique : The JIT approach is an operational control technique.The JIT approach is used in management accounting to eliminate wastes and forthe continuous improvement of productivity. The objective of the JIT approachis to purchase, produce and deliver products just when needed. JIT createsbenefits by combining management of quality, productivity and capacity. TheJIT ensures overall qualitative improvement of the organisation. The JITphilosophy operates with zero inventory, least wastage, quality product and quickdelivery.

(vii) Total Quality Management (TQM) : Total quality is an approach to a continuousimprovement in products, services, people, processes and environment. This approachis used in management accounting to maximise an organisations' competitiveness.Quality plays a key role in keeping costs low, revenues high and profits robust. TQMaims at zero defect Products (i.e. products free from all kinds of defects). Improved


quality and customer service would result in a high reputation of the organisation.Management should try to create a quality environment to eliminate all kinds of defect.

(viii) Benchmarking Technique : Benchmarking is the process of studying and adaptingthe best practices of competing organisations to improve the organisation's ownperformance. Benchmarking helps to understand one's own performance againstthe best practice in the industry.

It measures how well an organisation and its managers are performing.Benchmarking is a modern technique for strategic improvement. This techniqueis used in management accounting for closing the performance gap between anorganisation's own practice and the best practice in the industry.

(ix) Management By Objectives (MBO) : MBO is a technique which helps a managerto achieve his objectives in an efficient manner. MBO leads to effectivemanagement by integrating the goals of an organisation and individuals. It increasesthe organisational capability of achieving goals at all levels through a high degreeof satisfaction of employees.

(x) Management Reporting : It provides relevant information to various levels ofmanagement in the forms of reports at regular intervals. It supplies data forpolicy making and operating decisions. It is the instrument for making decisionsand controls effective. Management reports are used internally and are the subjectmatter of management accounting. Management takes proper decisions on thebasis of these reports.

1.33. Objectives of Management AccountingManagement accounting acts as a decision support system for providing the right

information to the right people at the right time. The objectives of management accountingcan be enumerated from following points :

(i) Interpretation of financial results : Management accounting analyses andinterprets the financial results of the concern. Various tools (such as ratio analysis,fund-flow statement, etc.) are used by the management accountant for analysingand interpreting the financial position of the organisation.

(ii) Proper planning : Management accounting helps in the preparation of plans andpolicies of an organisation. Management accountant uses various forecastingtechniques (such as Regression analysis, Time series analysis, etc.) to predictfuture trends. Forecasting is necessary for a planning process. Planning is thestrategic area of management. It is a process of deciding what is to be done; how,when and by whom it is to be done.

(iii) Proper control : Management control is a process that assures resources areused effectively and efficiently for achieving the objectives of the organisation.Planning identifies the activities and controlling regulates those activities. Themanagement accountant uses various techniques for ensuring efficientmanagerial control (such as standard costing, budgetary control, internal audit,responsibility accounting, management audit, etc.).

(iv) Proper communication : Communication has become an essence of management.Management functions cannot be performed efficiently without an effectivenetwork of communication in the organisation. Management information system(MIS) provides information for decision-making. MIS supplies information as


needed at different levels in the organisation. This system is used by managementaccountant for supplying relevant information to various levels in the organisation.

(v) Making decisions : Decision-making is necessary for the effective functioning ofmanagement. The success of management depends upon the quality of anydecision. The management accountant helps the management in taking variousdecisions (by applying marginal costing, differential costing, etc.).

(vi) Tax planning : The management accountant helps the management in determiningvarious tax reliefs and rebates. He assists the management in tax planning,computation of different tax liabilities and reduction of burden of tax.

1.34. Functions of Management Accounting

Management accounting is called management-oriented accounting. The following arethe major functions of management accounting :

(i) Supplying relevant information : Management accounting furnishes relevant factsand figures to the managerial personnel. It assists management to take appropriatedecisions on the basis of supplied information. It presents pertinent data to themanagement whenever required and in the suitable form.

(ii) Presenting modified data : It modifies extracted data to suit the requirements ofthe decision. Relevant information is extracted from voluminous data andpresented in a suitable form as desired by the management. It modifies data toserve the needs of a decision under consideration.

(iii) Interpretation of accounts : Financial data is to be analysed and interpretedproperly to get an insight into the profitability, solvency, liquidity, etc., of theorganisation. Management accountant analyses and interprets financial data andpresents the results with necessary comments to the management.

(iv) Ensuring overall control : Management accounting identifies areas wheremanagerial control is desired. It uses various tools and techniques (such asstandard costing, budgetary control, responsibility accounting, etc.) for identifyingweak areas where appropriate managerial attention is needed. It also identifiesthe factors and personnel responsible for any poor performance. Managementcan take corrective measures on the basis of such information.

(v) Providing qualitative information : The management accountant submitscomprehensive reports to the management which include both quantitative andthe qualitative information. Qualitative information (such as performance ofemployees, motivation of workers, reputation of the concern, customersatisfaction, etc.) are also relevant to the decisions under consideration.

1.35. Limitations of Management AccountingManagement accounting suffers from the following limitations :

(i) Wide scope : The scope of management accounting is very vast. It requires theservices of cost accounting, financial accounting , operation research, statistics,production engineering, etc. It is difficult to develop a department with thosepeople who have full knowledge about all these disciplines.

(ii) High installation cost : It is necessary to make elaborate arrangements forinstalling a sound management accounting system. This requires a high initialcost. Moreover, the operating (or running) costs of a management accounting


department is also high. As a result, small organisations cannot afford to instalthis system.

(iii) Reliance on accounting data : Management accountant relies heavily on thequantitative data (i.e., financial as well as cost data). Management reporting isbased on the data gathered from financial and cost books of accounts. The entireeffort of the management accountant becomes useless when financial and costaccounts fail to provide a true and fair view.

(iv) Lack of objectivity : Management accountants use both quantitative and qualitativeinformation while preparing reports for the management. Reports (especiallyqualitative information) are influenced by personal judgements. Therefore,management reports may be subjective and lack objectivity.

(v) Inability to respond to changing environments : The traditional system of keepingrecords no longer provides accurate information about the efficiency andprofitability of internal operations. As a result, a management accounting systemfails to respond to a rapidly changing environment. It fails to support the strategicmanagement decisions of the organisation.

AssignmentTheoretical Questions :

1. Define Cost. Distinguish between Costing and Cost Accounting.2. What is Costing? What are its objects and advantages?3. Explain the following methods of Costing and state the names of industries to which

they are applicable : (i) Job Costing, (ii) Process Costing, (iii) Operating Costing,(iv) Batch Costing, (v) Operation Costing, (vi) Multiple Costing, (vii) Contract Costing.

4. Explain the following techniques of Costing : (i) Marginal Costing, (ii) StandardCosting, (iii) Uniform Costing, (iv) Historical Costing.

5. (a) What is a Cost Centre? What are its various types?(b) Define Cost Unit. Give sixexamples of Cost Unit applicable to different industries.

6. (a) Explain the utility of maintaining a Cost Accounting System. (b) As a consultant,how would you proceed to instal a suitable cost accounting system in a largemanufacturing concern?

7. " Cost Accounting has become an essential tool of management"—What are yourcomments on this statement?

8. What is the importance of Cost Accounting to the management in the discharge oftheir functions?

9. State the limitations of Cost Accounting.10. (a) Discuss the relationship between Cost Accounting and Financial Accounting.

(b) Discuss the relationship between Cost Accounting and Management Accounting.11. Discuss the nature and scope of Cost Accounting.12. Define management accounting. Discuss the nature and scope of management

accounting.13. What are the objectives of cost and management accounting?14. State the functions of management accounting.15. Discuss the limitations of both cost and management accounting.

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