chapter 1 cost accounting PDF

Joseph Anbarasu
Basics of
Cost Accounting
CHAPTER 1
COST ACCOUNTING
Cost Accounting

Joseph Anbarasu
INTRODUCTION
1. Why should there be costing in the field of business?
Costing is a branch of accounting. It helps us to classify, record, and allocate the
expenditure for the determination of costs of product. Expenditure involved in
business has to be ascertained to fix the price of a product produced. The
expenditure is to be understood in terms of material, labour and other direct and
indirect expenses. The major purpose of such classification is to estimate the profit
and to understand its relationship with costs and price. The three elements of a
transaction i.e., cost, profit and price are necessary components of any business
activity.
Example:
A mobile phone factory introduces a new device. The factory incurs Rs. 400
for material, Rs.400 for labour and Rs.200 for overhead on every mobile
phone produced and supplied in the market. The total cost comes around
Rs.1000. If the price of the device is Rs. 1500, the profit per device is Rs. 500
(1500-1000).
The management requires all information as seen in the example for each product
produced. The above estimation is done for the purpose of planning, cost control
and decision-making. The existing system of financial accounting does not provide
the necessary information to do similar estimation. Such deficiency of financial
accounting has given rise to the need of cost accounting.
2. Define cost accounting.
The word ‘Costing’ refers to the technique and process of ascertaining costs. There
have been certain rules and principles in the field of costing developed over years
by our forefathers. These rules and principles help us to ascertain the cost of
products produced. The term 'Cost Accounting’ refers to the recording of all
incomes and expenditures and ends with the preparation of periodical statements
and reports for ascertaining and controlling costs.
Definitions of Cost Accounting.
According to the Terminology used by the Institute of Cost and Management
Accountants, “Cost accounting is the part of management accounting which
establishes budgets and standard costs and actual costs of operations,
processes, departments or products and the analysis of variances,
profitability or social use of funds.”
3. What are the difference between financial accounting and cost accounting?
Both accounting are complementary to each other. Preparation of both
accounts is helping the organisation to the smooth running of the
business. The difference between Cost Accounting and Financial
Accounting is given below:
Cost Accounting

Joseph Anbarasu
Cost Accounting Financial Accounting
1) It helps us to ascertain the cost of
goods produced.
It helps us to know operational results
and financial position of business.
2) It provides required information to
the management.
It provides information parties
involved in business internally and
externally.
3) It need not be followed by a system of
external audit
Audit is a statutory obligation
4) It classifies the costs into material,
labour, fixed overhead and variable
overhead.
Transactions are divided into debit
and credit terms.
5) Cost sheet is main format of cost
accounting
Trading and Profit & Loss Account and
Balance Sheet are two consolidated
financial statements.
6) It does not form a basis for tax
assessment.
It forms a basis for deciding the tax
liabilities of the business.
7) Variance analysis is to identify the
favourable and adverse difference
between standard cost and actual
cost.
It records only actual transactions
occurring in the course of business
operations
8) Cost accounting facilitates the
presentation of cost information at
regular intervals.
Financial statements are annually
presented.
9) Profit or loss is estimated on specific
product, branch, department or job.
It presents operational results of the
entire business.
10) It is an effective control device Financial accounting is not a control
device. Rather, accounting ratios can
be computed with financial
accounting.
11) Unit wise accounting is also prepared. Monetary units alone are yardstick of
financial accounting.
4. Bring out the difference between financial and management accounting.
There are two broad types of accounting information:
Financial Accounts: It is geared toward external users of accounting information
Management accounts: It aims more at internal users of accounting information
Although there is a difference in the type of information presented in financial and
management accounts, the underlying objective is the same - to satisfy the
information needs of the user.
Cost Accounting

Joseph Anbarasu
Financial Accounts Management Accounts
Financial accounts describe the
performance of a business over a specific
period and the state of affairs at the end
of that period. The specific period is
often referred to as the “Trading Period”
and is usually one year long. The period-
end date as the “Balance Sheet Date”
Management accounts are used to help
management record, plan and control the
activities of a business and to assist in
the decision-making process. They can
be prepared for any period.
Companies that are incorporated under
the Companies Act 1956 are required by
law to prepare and publish financial
accounts. The level of detail required in
these accounts reflects the size of the
business with smaller companies being
required to prepare only brief accounts.
There is no legal requirement to prepare
management accounts.
The format of published financial
accounts is determined by several
different regulatory elements:
 Company Law
 Accounting Standards
 Stock Exchange
There is no pre-determined format for
management accounts. They can be as
detailed or brief as management wishes.
Financial accounts concentrate on the
business as a whole rather than analysing
the component parts of the business. For
example, sales are aggregated to provide
a figure for total sales rather than publish
a detailed analysis of sales by product,
market etc.
Management accounts can focus on
specific areas of a business’ activities.
For example, they can provide insights
into performance of:
 Products
 Separate business locations (e.g.
shops)
 Departments / divisions
Most financial accounting information is
of a monetary nature
Management accounts usually include a
variety of non-financial information. For
example, management accounts often
include analysis of:
- Employees (number, costs, productivity
etc.)
- Sales volumes (units sold etc.)
 Customer transactions (e.g. number of
calls received into a call centre)
Cost Accounting