Cost Accounting Essentials: Benefits, Challenges, and Key Concepts
Limitations of Cost Accounting
Lack of Uniformity
Cost accounting is not an exact science; therefore, there is a lack of uniformity in costing procedures and practices. Cost accountants may compute costs using different bases. It is possible that two equally competent cost accountants may obtain different results from the same information provided to them.
Costly System
The development of a cost accounting system requires technical personnel and expert accountants. Firms need to pay more to their employees. The installation and maintenance costs of a cost accounting system are high.
Complex System
The cost accounting process involves many steps in deriving costs. It records all expenses from source documents, classifies them into different categories, and maintains detailed account books. Its procedures also require numerous forms and documents, making cost accounting complex.
Not Suitable for Small Firms
Cost accounting systems (CAS) require extra investment. This method involves many forms and statements. Firms need to update their forms and standard costs periodically. Small firms often have limited employees, making it difficult to train them on such a complex system.
Does Not Follow Double-Entry Bookkeeping
Cost accounting does not strictly follow the double-entry bookkeeping system. This can result in inaccuracies. It can also lead to incomplete records and imbalanced accounts. This makes it challenging to track costs accurately, detect errors, and ensure reliable financial reporting.
Financial Accounting vs. Cost Accounting: Key Differences
Cost Accounting (CA): Records both monetary transactions from the past and projected costs for the future.
Financial Accounting (FA): Records only monetary transactions that have taken place in the past.
Cost Accounting (CA): Different organizations might have different standards and formats for cost estimation.
Financial Accounting (FA): The double-entry bookkeeping system is universally followed.
Cost Accounting (CA): Inventory is valued at the cost of production.
Financial Accounting (FA): Inventory is valued at the cost of the product or market price, whichever is lower.
Objectives of Cost Accounting
Cost Estimation for Products or Services
Cost estimation for future performance is a primary objective of cost accounting. Cost estimation involves the pre-determination of product or service costs before actual operations begin. It reflects expected standards regarding price, quantities, and scale of operation.
Determining Selling Price
Another key objective of cost accounting is to determine the selling price of products or services. Cost accounting helps accumulate all cost elements, such as materials, labor, and overheads, involved in producing a product or providing a service. Management can then determine the selling price by adding a desired profit margin to the total cost.
Valuing Stock and Income Reporting
One objective is to provide information about the cost per unit of output by accumulating all cost elements (materials, labor, and overheads). Cost accounting helps determine the value of closing stock by compiling manufacturing costs of output.
Planning and Cost Control
Cost accounting is a vital tool that facilitates the preparation of both day-to-day operational and long-term plans for an enterprise. Generally, information from a cost accounting system is combined with other data, analyzed, and used to formulate future strategies for the enterprise.
Assisting Managerial Decisions
A crucial aspect of managerial functions is making the right decisions at the right time. Managerial decisions, such as whether to manufacture or buy a component, accept or reject an order, or purchase or hire assets, are made by considering cost-benefit analyses.
Allocation vs. Apportionment of Overheads
Allocation: Overhead expenses are directly assigned to a specific department or cost center. This method is relevant when overhead expenses are solely attributable to one department. It forms the basis for distributing overheads directly to the concerned department or cost center.
Apportionment: Overhead expenses are distributed among two or more departments on an equitable basis. This method is relevant when overhead expenses relate to multiple departments. It serves as the basis for distributing overheads to two or more cost centers or units in the most equitable manner.
Advantages of Cost Accounting
Identifying Profitable and Unprofitable Operations
Cost accounting assists in providing information about the production cost of a product or service by gathering all cost elements like material, labor, and overheads. This helps managers take steps to eliminate or reduce unprofitable projects and invest more resources in profitable ones.
Assisting in Price Fixing
Cost accounting is an important tool that facilitates the fixing of product prices. It helps accumulate all cost elements, such as materials, labor, and overheads, involved in producing a product. Managers can determine the selling price by adding a desired profit margin to the total cost.
Inventory Control
Cost accounting helps calculate the most ideal and economic re-order levels and quantities. This ensures that the firm is never overstocked or understocked. Additionally, cost accounting allows management to monitor raw materials, Work-In-Progress (WIP), and finished goods.
Budgeting and Forecasting
Cost accounting provides detailed cost information, helping businesses create accurate budgets and predict future financial performance. By analyzing past costs and trends, companies can allocate resources more effectively and plan for upcoming expenses.
Cost Control
Cost accounting helps reduce costs by providing detailed analysis of expenses, allowing businesses to identify inefficiencies. It also helps estimate the standard cost of a product before actual production, enabling timely corrective actions to reduce costs.
Uses of Accounting Software
Accounting software is a fundamental tool that manages financial data within a database. Its key uses include:
Bookkeeping
Recording and tracking financial transactions such as sales, purchases, payments, and receipts.
Invoicing and Billing
Generating invoices, managing accounts receivable, and tracking payments from customers.
Payroll Processing
Calculating employee salaries, wages, taxes, and deductions, and generating payroll reports.
Financial Reporting
Creating balance sheets, income statements, cash flow statements, and other financial reports to provide insights into the financial health of the business.
Bank Reconciliation
Matching and reconciling bank statements with accounting records to ensure accuracy and identify discrepancies.
Understanding Cost Types
Fixed Costs
A cost that does not change in the short term, irrespective of the volume of production or sales, is called a fixed cost. This cost remains constant and generally cannot be avoided. Fixed costs influence the total cost of a product and, consequently, the profit or loss incurred by the business. They usually occur at regular intervals. For example, rent, salaries, insurance, and depreciation.
Variable Costs
A cost that varies as the total output changes is called a variable cost. These costs change in direct proportion to the variation in output. The total amount of variable cost will increase or decrease with production. For example, direct expenses, direct labor, and direct materials.
Semi-Variable Costs
A cost that comprises both fixed and variable components is called a semi-variable cost. These costs are fixed up to a certain level of output and then become variable when the volume of output increases. For example, telephone bills, electricity charges, and water charges.
Understanding Overhead Types
Variable Overheads
Variable overheads are expenses that vary with business activity levels, increasing or decreasing with different levels of output. They increase as the volume of output increases and vice versa. For example, fuel, power, and indirect materials.
Fixed Overheads
Fixed overheads are costs that remain constant for a certain interval, despite changes in the total output produced. They do not change and remain the same even if there is no production. For example, salaries, rent, and insurance.
Semi-Variable Overheads
Semi-variable overheads involve both variable and fixed components. These costs change with the volume of output but not in direct proportion. Generally, they remain constant up to a certain level of output and then change in a variable manner. Examples include telephone expenses, water charges, and electricity bills.
Applications of Computers in Accounting
Record Keeping
In a computerized accounting system, records can be maintained easily and effectively for extended periods. It allows for systematic organization of financial data, making it easy to track transactions, manage accounts, and generate reports.
Decision Making Support
Computers play a crucial role in accounting decision-making by providing timely and accurate financial information. With advanced data analysis capabilities, businesses can evaluate performance, identify trends, and forecast future outcomes. This helps managers make informed decisions.
Inventory Management
Computers can track inventory levels in real-time, preventing shortages or over-purchasing of goods. By monitoring inventory levels and usage, computers help control costs and optimize inventory management.
Payroll Management
Computers automate the calculation of employee salaries, bonuses, benefits, and deductions within an organization. This involves ensuring that employees are paid accurately and on time, while complying with legal requirements such as tax laws.
Auditing and Compliance
Computers can maintain detailed records of transactions and changes to financial data, ensuring transparency. This facilitates both internal and external audits.
Controllable vs. Uncontrollable Costs
Controllable Costs
Controllable costs are those costs that can be influenced, even to a limited extent, by the actions of a firm. Such costs depend upon the actions of a specific authority within an organization. The controllable costs of a particular cost center will be influenced and controlled by the actions of the responsible manager. For example, telephone charges, labor costs, and electricity charges.
Uncontrollable Costs
Uncontrollable costs are those costs that cannot be influenced by the actions of a departmental manager or the responsible authority of a cost center. Top-level management typically allocates such costs to different activity centers and responsible authorities. For example, rent, salaries, and insurance.