STUDY TEXT 1
CHAPTER 1
NATURE AND PURPOSE OF COST AND
ACCOUNTING
SYNOPSIS
The nature of cost accounting and management accounting………………. 1
Purposes or objects of cost accounts………………………………………. 2
Functions of cost accountant……………………………………………….. 3
Scope of cost accounting………………………………………………….. 6
Meaning of management accounting, scope, limitations, applications…… 8
Relationship between financial accounting and cost accounting…………. 11
Differences between cost and management accounting…………………… 13
Selection of an ideal cost accounting system……………………………… 14
THE NATURE OF COST ACCOUNTING AND MANAGEMENT
ACCOUNTING
Cost accounting can be defined within the accounting system as internal reporting for use in
management planning, control, and in making routine and non-routine decisions, and external
reporting to the extent that its product-costing function satisfies external reporting requirements for
reporting to shareholders, government, creditors, investors and various outside interested parties.
Cost is the measurement of the sacrifice of economic resources, which has already been made or is to
be made in the future, in order to achieve a specific objective. Cost management deals with estimated
future or planned costs as well as with past, historical costs. It consists of the following basic
activities, whether it is for a manufacturing or service business or for a profit or nonprofit
organization:
1. Cost recording and reporting, including classifying, summarizing, communicating, and
interpreting cost data to interested parties, internal or external.
2. Cost measurement or estimation for specific products, services, or subunits of the organization.
3. Cost planning,It involves selecting the goals of the organization and its subunits, expressed as
operating objectives, and then identifying the means of accomplishing them. Plans are
summarized in budgets which are expressed in terms of money measurements. For example, a
cost budget should be prepared so as to plan for expected expenditures. The profit budget
outlines the planned revenues and expenses of the coming time period. The production and cost
of goods manufactured budget shows planned inventory levels, units of product which the
company plans to make, and the costs of the various types of inputs which will be needed in
carrying out the production plans. A budget also achieves control through the comparison of
actual and budgeted costs resulting variance determination and analysis.
4. Cost control,It sets predetermined standards (such as standard costs and budgets) by which
performance can be measured. It then reports differences between planned and actual
performances to direct attention to what went wrong. Furthermore, cost control aids in fixing
MANAGEMENT ACCOUNTING
, STUDY TEXT 2
responsibility for departures from a plan so that corrective actions can be taken. For example, a
cost accounting report to a production department manager may show that the cost of
manufacturing one unit ofoutput is significantly higher than the standard cost. Investigation may
reveal that the higher cost is due to the inefficient labor, excessive spoilage of materials, or use
of faulty equipment and improper production methods.
5. Cost analysis, obtaining accurate product-costing data and managing it to assist managers in
making critical decisions such as pricing, product mix, and process technology decisions and
analyzing cost data, translating them into the information useful for managerial planning and
control, and for making short-term and long-term decisions. This phase involves measurement
of accurate and relevant cost data and analyzing them for decision making.
THE ROLE OF COST ACCOUNTING IN MANAGEMENT
• Ascertainment of cost of product: Cost Accounting ascertains cost of production of each job,
process, or work order by applying different methods of cost accounting, such as job costing,
process operation costing, contract costing etc. according to the suitability and needs of the
organization.
• Fixation of selling prices: Cost accounting helps to find out cost of production and fixation of
selling prices of the product or process job or operation. It also helps in preparing necessary
tenders or quotations.
• Measurement of efficiency: Cost accounting measures the efficiency of each product, process or
departments by applying standard cost method.
• Cost control procedure: Cost accounting controls cost by setting standards and compared with
the actual .The deviation between them are identified and if required necessary controlling
measures may be taken.
• Reporting to the Management: Cost accounting reports to the management periodically which
may be monthly, quarterly or half yearly. According to the reports of the cost accounting, the
management takes necessary decisions.
• Financial accounting records transactions in a subjective manner. It means according to the nature
of expenses.
PURPOSES OR OBJECTS OF COST ACCOUNTS
Costing serves number of purposes among which the following are considered to be most important.
1. Ascertainment of cost: This was considered to be the primary objective of cost accounting in the
initial stages of its development. However, in modern times this has assumed the secondary
objective of cost accounting. Cost ascertainment involves the collection and classification of
expenses at the first instance. Those items of expenses which are capable of charging directly to
the products manufactured are allocated. Then the other expenses which are not capable of direct
allocation are apportioned on some suitable basis. Thus the cost of production of goods
manufactured is ascertained. In this process, cost accounts involve maintenance of different books
to record various elements of cost. Cost of production is ascertained by using any of the costing
technique such as historical costing, marginal costing, etc.
2. Cost control: At one time cost control was considered as secondary objective of cost accounts.
But in modern times it constitutes the primary purpose because of its utmost importance in all
business undertakings. Cost control is exercised at different stages in a factory, viz., acquisition of
materials, recruiting and deployment of labour force, during the production process and so on. As
MANAGEMENT ACCOUNTING
, STUDY TEXT 3
such we have material cost control, labour cost control, production control, quality control and so
on. However, control over cost is exercised through the techniques of budgetary control and
standard costing. The control techniques enable the management in knowing the operating
efficiency of a business.
3. Determination of selling price: Every business organisation aims at maximizing profit. Total
cost of production constitutes the basis on which selling price is fixed by adding a margin of
profit. Cost accounting furnishes both the total cost of production as well as cost incurred at each
and every stage of production. No doubt other factors are taken into consideration before fixing
price such as market conditions the area of distribution, volume of sales, etc. But cost plays the
dominating role in price fixation.
4. Frequent preparation of accounts and other reports: The management of every business
constantly rely upon the reports on cost data in order to know the level of efficiency relating to
purchase, production, sales and operating results. Financial accounts provide information only at
the end of the year because closing stock value is available only at the end of the year. But cost
accounts provide the value of closing stock at frequent intervals by adopting a “continuous stock
verification” system. Using the value of closing stock it is possible to prepare final accounts and
know the operating results of the business.
5. To provide a basis for operating policy: Cost data to a great extent helps in formulating the
policies of a business and in decision-making. As every alternative decision involves investment
of capital outlay, costs play an important role in decision-making. Therefore availability of cost
data is a must for all levels of management. Some of the decisions which are based on cost are
a) Make or buy decision,
b) Manufacturing by mechanisation or automation,
c) Whether to close or continue operations in spite of losses.
FUNCTIONS OF COST ACCOUNTANT
The functions of cost accountant may be enumerated under the following:
Traditional Functions
The traditional functions comprise of the routine functions of cost accountant. Such functions are as
follows:
a) To establish various cost centres in the organisation.
b) To ascertain the cost of every product, job or process both in terms of total and per unit of
product.
c) To design suitable system for defining responsibilities and controlling cost.
d) To provide necessary data to enable management in fixing the price.
e) To prepare reports on wastages of material, loss of labour time, idle capacity of machines so
as to improve profitability of business.
f) To implement cost control techniques such as budgetary control and standard costing.
g) To prepare cost schedules to assist management in making decisions and in formulating
policies.
h) To design suitable forms for organizing an effective system of reporting which ensures
provision of adequate cost data to all levels of management.
i) To assist management in the valuation of closing stock of raw materials and work-in-progress
so that too much of capital is not locked up in unnecessary inventories.
j) To prepare periodical cost statements and profit and loss account.
MANAGEMENT ACCOUNTING
, STUDY TEXT 4
INSTALLATION OF COST ACCOUNTS
At the outset it is to be understood that a common cost accounting system cannot be installed for all
types of business undertakings. The cost accounting system depends upon the nature of business and
the product manufactured. Before a suitable system of cost accounting is installed it is necessary to
undertake a preliminary investigation so as to know the feasibility of installing cost accounting system
to such business. While introducing a system of cost accounts it should be borne in mind that cost
accounting system must suit the business. There should not be any attempt to make the business suit
the system. One more consideration that is of practical importance is that the benefits derived from
cost accounting system must be more than the investment made on it. This means the system must be
simple and it must lead to savings through the control of materials, labour and overheads when
Compared to expenses incurred in maintaining it. For the successful functioning of the costing
system, the following conditions are essential:
a) There must be an efficient system of material control.
b) A sound and well-designed method of wage payment must be set up.
c) The existence of sound basis for collection of all indirect expenses and a basis for its
apportionment to various production departments.
d) The integration of cost and financial accounts to facilitate reconciliation of profit as shown by
these two systems of accounts.
e) The use of printed forms so as to facilitate quick compilation of cost reports.
f) The duties and responsibilities of cost accountant must be made clear.
Factors to be considered before installing a cost accounting system
The following factors are to be considered before installing a cost accounting system:
1. History of business unit: The history of a business unit implies the duration of its existence,
position in the industry, the rate of growth, policy and philosophy of management and the like.
The history of business unit serves as the basis for designing the cost accounts in respect of
necessity, simplicity, and investment involved in installing cost accounts.
2. Nature of the industry: The nature of business such as manufacturing, mining, trading, etc.
determines the costing techniques to be applied. Similarly, the type of product manufactured also
determines the method of costing that is to be employed. In other words, there is no all-purpose
technique and method of costing that can be applied universally.
3. Product range: The range of products manufactured and sold also determines the method of
costing to be selected. Accordingly range of products must be analysed in terms of size, models,
fashions, area of market, competitors and whether the products are made to customer’s
specification or for stocking and selling.
4. Technical considerations: Technical considerations that influence the installation of cost
accounts are as follows:
a) Size and layout of the factory
b) The existence of production and service departments
c) Flow of production
d) Capacity of machines and degree of mechanization
e) Existence of laboratories
f) Internal transport and material handling equipments
g) Production control techniques
h) Inspection and testing of materials and finished goods.
MANAGEMENT ACCOUNTING
CHAPTER 1
NATURE AND PURPOSE OF COST AND
ACCOUNTING
SYNOPSIS
The nature of cost accounting and management accounting………………. 1
Purposes or objects of cost accounts………………………………………. 2
Functions of cost accountant……………………………………………….. 3
Scope of cost accounting………………………………………………….. 6
Meaning of management accounting, scope, limitations, applications…… 8
Relationship between financial accounting and cost accounting…………. 11
Differences between cost and management accounting…………………… 13
Selection of an ideal cost accounting system……………………………… 14
THE NATURE OF COST ACCOUNTING AND MANAGEMENT
ACCOUNTING
Cost accounting can be defined within the accounting system as internal reporting for use in
management planning, control, and in making routine and non-routine decisions, and external
reporting to the extent that its product-costing function satisfies external reporting requirements for
reporting to shareholders, government, creditors, investors and various outside interested parties.
Cost is the measurement of the sacrifice of economic resources, which has already been made or is to
be made in the future, in order to achieve a specific objective. Cost management deals with estimated
future or planned costs as well as with past, historical costs. It consists of the following basic
activities, whether it is for a manufacturing or service business or for a profit or nonprofit
organization:
1. Cost recording and reporting, including classifying, summarizing, communicating, and
interpreting cost data to interested parties, internal or external.
2. Cost measurement or estimation for specific products, services, or subunits of the organization.
3. Cost planning,It involves selecting the goals of the organization and its subunits, expressed as
operating objectives, and then identifying the means of accomplishing them. Plans are
summarized in budgets which are expressed in terms of money measurements. For example, a
cost budget should be prepared so as to plan for expected expenditures. The profit budget
outlines the planned revenues and expenses of the coming time period. The production and cost
of goods manufactured budget shows planned inventory levels, units of product which the
company plans to make, and the costs of the various types of inputs which will be needed in
carrying out the production plans. A budget also achieves control through the comparison of
actual and budgeted costs resulting variance determination and analysis.
4. Cost control,It sets predetermined standards (such as standard costs and budgets) by which
performance can be measured. It then reports differences between planned and actual
performances to direct attention to what went wrong. Furthermore, cost control aids in fixing
MANAGEMENT ACCOUNTING
, STUDY TEXT 2
responsibility for departures from a plan so that corrective actions can be taken. For example, a
cost accounting report to a production department manager may show that the cost of
manufacturing one unit ofoutput is significantly higher than the standard cost. Investigation may
reveal that the higher cost is due to the inefficient labor, excessive spoilage of materials, or use
of faulty equipment and improper production methods.
5. Cost analysis, obtaining accurate product-costing data and managing it to assist managers in
making critical decisions such as pricing, product mix, and process technology decisions and
analyzing cost data, translating them into the information useful for managerial planning and
control, and for making short-term and long-term decisions. This phase involves measurement
of accurate and relevant cost data and analyzing them for decision making.
THE ROLE OF COST ACCOUNTING IN MANAGEMENT
• Ascertainment of cost of product: Cost Accounting ascertains cost of production of each job,
process, or work order by applying different methods of cost accounting, such as job costing,
process operation costing, contract costing etc. according to the suitability and needs of the
organization.
• Fixation of selling prices: Cost accounting helps to find out cost of production and fixation of
selling prices of the product or process job or operation. It also helps in preparing necessary
tenders or quotations.
• Measurement of efficiency: Cost accounting measures the efficiency of each product, process or
departments by applying standard cost method.
• Cost control procedure: Cost accounting controls cost by setting standards and compared with
the actual .The deviation between them are identified and if required necessary controlling
measures may be taken.
• Reporting to the Management: Cost accounting reports to the management periodically which
may be monthly, quarterly or half yearly. According to the reports of the cost accounting, the
management takes necessary decisions.
• Financial accounting records transactions in a subjective manner. It means according to the nature
of expenses.
PURPOSES OR OBJECTS OF COST ACCOUNTS
Costing serves number of purposes among which the following are considered to be most important.
1. Ascertainment of cost: This was considered to be the primary objective of cost accounting in the
initial stages of its development. However, in modern times this has assumed the secondary
objective of cost accounting. Cost ascertainment involves the collection and classification of
expenses at the first instance. Those items of expenses which are capable of charging directly to
the products manufactured are allocated. Then the other expenses which are not capable of direct
allocation are apportioned on some suitable basis. Thus the cost of production of goods
manufactured is ascertained. In this process, cost accounts involve maintenance of different books
to record various elements of cost. Cost of production is ascertained by using any of the costing
technique such as historical costing, marginal costing, etc.
2. Cost control: At one time cost control was considered as secondary objective of cost accounts.
But in modern times it constitutes the primary purpose because of its utmost importance in all
business undertakings. Cost control is exercised at different stages in a factory, viz., acquisition of
materials, recruiting and deployment of labour force, during the production process and so on. As
MANAGEMENT ACCOUNTING
, STUDY TEXT 3
such we have material cost control, labour cost control, production control, quality control and so
on. However, control over cost is exercised through the techniques of budgetary control and
standard costing. The control techniques enable the management in knowing the operating
efficiency of a business.
3. Determination of selling price: Every business organisation aims at maximizing profit. Total
cost of production constitutes the basis on which selling price is fixed by adding a margin of
profit. Cost accounting furnishes both the total cost of production as well as cost incurred at each
and every stage of production. No doubt other factors are taken into consideration before fixing
price such as market conditions the area of distribution, volume of sales, etc. But cost plays the
dominating role in price fixation.
4. Frequent preparation of accounts and other reports: The management of every business
constantly rely upon the reports on cost data in order to know the level of efficiency relating to
purchase, production, sales and operating results. Financial accounts provide information only at
the end of the year because closing stock value is available only at the end of the year. But cost
accounts provide the value of closing stock at frequent intervals by adopting a “continuous stock
verification” system. Using the value of closing stock it is possible to prepare final accounts and
know the operating results of the business.
5. To provide a basis for operating policy: Cost data to a great extent helps in formulating the
policies of a business and in decision-making. As every alternative decision involves investment
of capital outlay, costs play an important role in decision-making. Therefore availability of cost
data is a must for all levels of management. Some of the decisions which are based on cost are
a) Make or buy decision,
b) Manufacturing by mechanisation or automation,
c) Whether to close or continue operations in spite of losses.
FUNCTIONS OF COST ACCOUNTANT
The functions of cost accountant may be enumerated under the following:
Traditional Functions
The traditional functions comprise of the routine functions of cost accountant. Such functions are as
follows:
a) To establish various cost centres in the organisation.
b) To ascertain the cost of every product, job or process both in terms of total and per unit of
product.
c) To design suitable system for defining responsibilities and controlling cost.
d) To provide necessary data to enable management in fixing the price.
e) To prepare reports on wastages of material, loss of labour time, idle capacity of machines so
as to improve profitability of business.
f) To implement cost control techniques such as budgetary control and standard costing.
g) To prepare cost schedules to assist management in making decisions and in formulating
policies.
h) To design suitable forms for organizing an effective system of reporting which ensures
provision of adequate cost data to all levels of management.
i) To assist management in the valuation of closing stock of raw materials and work-in-progress
so that too much of capital is not locked up in unnecessary inventories.
j) To prepare periodical cost statements and profit and loss account.
MANAGEMENT ACCOUNTING
, STUDY TEXT 4
INSTALLATION OF COST ACCOUNTS
At the outset it is to be understood that a common cost accounting system cannot be installed for all
types of business undertakings. The cost accounting system depends upon the nature of business and
the product manufactured. Before a suitable system of cost accounting is installed it is necessary to
undertake a preliminary investigation so as to know the feasibility of installing cost accounting system
to such business. While introducing a system of cost accounts it should be borne in mind that cost
accounting system must suit the business. There should not be any attempt to make the business suit
the system. One more consideration that is of practical importance is that the benefits derived from
cost accounting system must be more than the investment made on it. This means the system must be
simple and it must lead to savings through the control of materials, labour and overheads when
Compared to expenses incurred in maintaining it. For the successful functioning of the costing
system, the following conditions are essential:
a) There must be an efficient system of material control.
b) A sound and well-designed method of wage payment must be set up.
c) The existence of sound basis for collection of all indirect expenses and a basis for its
apportionment to various production departments.
d) The integration of cost and financial accounts to facilitate reconciliation of profit as shown by
these two systems of accounts.
e) The use of printed forms so as to facilitate quick compilation of cost reports.
f) The duties and responsibilities of cost accountant must be made clear.
Factors to be considered before installing a cost accounting system
The following factors are to be considered before installing a cost accounting system:
1. History of business unit: The history of a business unit implies the duration of its existence,
position in the industry, the rate of growth, policy and philosophy of management and the like.
The history of business unit serves as the basis for designing the cost accounts in respect of
necessity, simplicity, and investment involved in installing cost accounts.
2. Nature of the industry: The nature of business such as manufacturing, mining, trading, etc.
determines the costing techniques to be applied. Similarly, the type of product manufactured also
determines the method of costing that is to be employed. In other words, there is no all-purpose
technique and method of costing that can be applied universally.
3. Product range: The range of products manufactured and sold also determines the method of
costing to be selected. Accordingly range of products must be analysed in terms of size, models,
fashions, area of market, competitors and whether the products are made to customer’s
specification or for stocking and selling.
4. Technical considerations: Technical considerations that influence the installation of cost
accounts are as follows:
a) Size and layout of the factory
b) The existence of production and service departments
c) Flow of production
d) Capacity of machines and degree of mechanization
e) Existence of laboratories
f) Internal transport and material handling equipments
g) Production control techniques
h) Inspection and testing of materials and finished goods.
MANAGEMENT ACCOUNTING
