Cost Accounting Explained: Origins, Evolution, and Advantages

This blog post delves into the world of cost accounting, exploring its definition, objectives, and evolution. It highlights the significance of cost accounting in tracking costs, analyzing business activities, and aiding management in decision-making. The post traces the origins of cost accounting to the industrial revolution, emphasizing its role in handling complex business operations and fixed costs. It outlines the advantages of cost accounting, including its usefulness in price fixation, identifying profitable and unprofitable activities, and assisting in planning and expenditure control. The blog also explains how cost accounting helps in adapting to changing business needs and making informed decisions related to pricing and profitability. The post concludes by stressing the importance of cost accounting in providing actionable insights, guiding businesses toward financial efficiency and success.

BLOG: COST ACCOUNTING
WHAT IS ACCOUNTING COST?

WHAT IS ACCOUNTING COST?
24th June, 2019
Cost accounting refers to a branch of accounting and it is used by business organisations for
ages. This particular branch of accounting is the best way for every kind of non-profit and profit
making organisations to track their costs and the activities for which such costs are incurred by
them. Cost accounting uses to deal with the evaluation of the cost of a product or service a
company offered. It computes the cost of a product or service by considering every factor
contributing to the process of producing such product or service which include the factor related
to manufacturing or production and administrative. Cost accounting system is aimed to help a
company’s management to fix up the final price of a product or service it produces and to control
the cost associated with the production of such product or service. Moreover, it pinpoints every
sort of wastages, defects, and leakages during a company’s manufacturing process as well as its
marketing processes. Cost accounting is a highly significant and advantageous companion of
traditional financial accounting system. This accounting system involves the establishment of
actual cost or standard cost of operations, different types of budgets along with classification,
recording, and allocation of business related expenditure.
Origin of Cost Accounting
Before the emergence of industrial revolution, business organisations were small in size and they
are characterised by simple exchanges between organizations and individuals. In that period of
time, accurate bookkeeping was needed but cost accounting was not so much vital. Over the
years businesses become complex due to their distinct operating activities which evoked the need
for cost accounting. The industrial revolution age has resulted in the development of large scale
organisations and businesses and these organisations were much dynamic and complex than
previous. Such dynamic and complex nature of businesses instigated the invention of a new
brand of accounting which is called cost accounting. So the concept of cost accounting
originated and evolved due to the industrial revolution to help businessmen to track their

business related expenses and costs by keeping a record for the same. Prior to the golden era of
industrialisation, costs and expenses of a business are categorised as variable costs which include
cost of material, labour, overhead and other variable costs.
However, at the time when industrialisation came into existence, businesses had a number of
‘fixed costs’ that are not directly associated with the manufacturing or production of products or
services. These fixed costs consist of expenses related to rent, storage costs, depreciation,
insurance cost and more. As steel industry, railroads and some other large industries were
developed, the understanding of the fixed costs of businesses became vital. Allocation of these
fixed costs became significant to the business owners and managers for their business oriented
decision making, product development, and pricing. Such increasing importance of
understanding fixed costs, allocating the same in an appropriate manner, and considering these
cost elements in decision making have originated the concept of modern cost accounting.
Evolution of Cost Accounting
In today’s world, the business environment becomes very dynamic as well as complex. A
company must have the ability to navigate the complex business factors that arise from the
external business environment as the threat of new entrants, competition, uncertainty, risks, and
some other uncontrollable external factors. All these external business environment factors create
complexities and difficulties for companies to continue their business operations smoothly and to
expand their business. Before the industrial revolution, when the organisations were small in size
and scale, the external business environment was not that much complex as it is now. In order to
conduct business operation successfully by mitigating all the complex external factors
effectively, the modern business organisations require lots of processes and input which invoked
the idea of cost accounting to come into existence.
Over the times and as per the increasing complexities in business activities, only conventional
financial accounting becomes insufficient for effective management of large and medium scale
organisations. The need for improving the management system and business activities of large
and medium size companies has provoked the evolution of cost accounting system. In the past
few decades, this newly evolved branch of accounting has come through rapid growth and

evolution in the present business world. A number of new techniques and procedures were
developed in order to refine the cost accounting system and to make it most useful for
companies. The main idea behind the development of cost accounting system was to refuse the
backlogs of the conventional accounting system i.e. financial accounting system. Financial
accounting is not able to enhance a company’s efficiency and cost control system. Thus, for
enhancing operational efficiency of companies, and improving their cost control mechanism cost
accounting system developed. With time some scientific methods and standards are formulated
to increase the effectiveness and usefulness of cost accounting system.
Definition and Objectives of Cost Accounting
Cost accounting is an accounting process which is for recording all types of costs incurred by a
company or organisation for conducting their business operations in such a way which can assist
in improving its management. It is a process of collecting, classifying, recording, analysing,
summarising, and then, allocation of costs those are associated with the operational processes of
an organisation, and then developing a set of actions for controlling those costs. It is a method of
accounting that aims towards capturing the costs of a company's production process by assessing
the input costs related to each step of the company’s production process and fixed costs like
depreciation of tangible assets, amortisation of intangible assets. With the application of cost
accounting mechanism, a company become able to measure different types of costs first and then
record them individually and after that compare between the input and output (actual) results to
aid its management to measure its financial performance. This particular accounting concept is
involved with the determination of costs of production (products), processes, projects, and more
for reporting the same in the financial statements of a company with correct amounts. It also
involved in assisting a company's management in its planning and controlling and preparing
specific and relevant financial analyses which assist in decision making in the best manner.

A vital part of this accounting system involves unit cost of products for reporting the COGS (cost
of goods sold) of the manufacturer's income statement and inventory cost in the balance sheet.
Cost accounting uses to assist management to set business plans as well as to control the entire
business through preparing budgets for operations, transfer pricing, standard costing, and
reporting on variance, etc. It also helps the management in preparing capital budget for the
company in relation to business expansion. It includes some special analyses like cost behaviour
analysis, CVP (cost-volume-profit) analysis, decisions related to make or buy, final selling prices
of products, and more. The root of cost accounting system is found in manufacturing companies
though it has extended its arms to service providing companies also. For instance, a bank uses
cost accounting for determining the processing cost associated with its customers' deposits
and/or checks, cost of maintaining the account, servicing costs related to mortgage loans,
processing cost for international or domestic fund transfers and more. This, in turn, provides
guidance to the management of the bank in setting the proper price for the various services it
provides to the customers or clients.
The objectives of the cost accounting system are to ascertain per unit cost of different types of
products a manufacturing company uses to manufacture, to provide correct cost analysis of
business operations along with different cost elements in relation to the regular operating
activities of a business concern. It is also aimed to disclose the sources of production related
wastages such as wastage of raw materials, time, and fund. All the production and distribution
related wastages from raw material purchase to placing the final product to market are required
to be analysed by every manufacturing company and cost accounting system is the best option to
do so. Another objective of cost accounting system is to provide requisite data and information to
the management of a company as guidance to set the best possible price for the final product.
Furthermore, this particular accounting system’s another objective is to ascertain profitability
attached to each product and service produced by a company and advise the management
regarding the way to maximise such profitability.
Advantages of Cost Accounting

The process of cost accounting led a company to collect and interpret information for
determining how it earns and utilises funds while conducting its regular business operations. This
accounting system provides lots of actionable information in comparison to the financial
accounting system. The advantages a company uses to get for using cost accounting system are
as follows:
Helpful in price fixation: In some cases, a company is capable of fixing up the final price for
the products it tends to sell in the market as per the cost incurred for producing such products.
Here, it becomes difficult to fix a product’s final price properly if proper cost figures are
unavailable. If the final price of a product is fixed without using proper costing information, then
quoted or final price of such product might be too low or high compared to the actual production
cost of that product. If the final price of a product stands higher than the production cost then a
company losses its customers and of it stands lower than production cost then the company faces
loss. Cost accounting system reveals the exact price to be charged from customers that would be
profitable for the manufacturing company. Manufacturing companies using cost accounting
system used to get accurate information about the costs incurred for manufacturing a product or
service they deliver to customers.
Detect profitable as well as unprofitable business activities: This accounting system detects
profit generating business activities that are required to be continued by a company to stay
profitable in the market. Besides this, it also detects the unprofitable or loss making business
activities of a company that is responsible for creating negative pressure on the company's
profitability and helps the management to eliminate such activities.
Guide in price reduction: In some situations like slump or depression, it becomes very
important for a company to reduce the final price of its products, even below the products’ actual
total cost. In this situation, properly ascertained costs guide the management of a company to
reduce the final price of products to cope up with the situation.
Adaptable in nature: Managers use to appreciate the cost accounting system because it is easy
to adapt, and implemented in accordance with the changing needs and demands of a business.
Unlike the static financial accounting system, driven by the Financial Accounting Standards

Board (FASB), the cost accounting system is only concerned with internal purposes and internal
eyes of a company’s management board.
Assist in proper planning and decision making: Cost accounting system helps the
management to set financial budgets, conduct variance analysis both of which are very important
for making proper business plans. It facilitates the management by providing them detailed
information regarding available labour and machine capacity and in this way it helps in setting
proper work plan so that no department remains idle or no one is overworked. It assists in
preparing annual financial budget and capital budget which are very significant for proper fund
allocation and business expansion. It guides management to make decisions regarding the use of
labour and machine for production by indicating the profitability of using both of these of any
one of these for production.
Assist in controlling expenditure: Cost accounting is useful for controlling expenditure as it
helps to measure every single cost related to production and detects excess expenditure. By
indicating the unprofitable business activities this system of accounting helps management to
eliminate those actions or modify the same to transform it into profitable actions. Timely
detection of unprofitable activities helps to control overall cost of production from getting
increased.
Ease labour costs monitoring and controlling: Labour costs of a company are easy to monitor
as well as control if a company applies cost accounting system. Proper monitoring and
controlling of labour costs assist the management to determine productivity and efficiency of a
company’s labour force which is important while estimating marginal productivity of each
employee. It also helps management to make decision on how to enhance individual labour
productivity to increase the overall productivity of a company.
Disadvantages of Cost Accounting
Alongside the various advantages of cost accounting system there are some disadvantages of
using this accounting system. The limitations of cost accounting system are given below:

Lack of uniformity: This particular accounting system does not include a uniform process. It
often makes different cost accountants to generate separate results from the same data and
information. Due to such limitation, the results of cost accounting are used as estimates only.
Costly: For small and medium scale business organisations, the application of cost accounting
system is costly as it needs a completely separate set up for accounting. For large companies, this
accounting system is not hard to implement but it puts negative pressure on their profits.
Complex: This accounting system is quite complex to apply in comparison to financial
accounting system as it requires lots of work on the front end, along with some constant
adjustments for improvements. Segregation of different types of cost elements by considering
their nature is also responsible for making this system complex than other accounting systems.
Reliance on experienced and highly-skilled professionals: The application of cost accounting
system requires highly-skilled professional accountants and auditors. It creates dependency on
the cost accountants heavily and led a company to bear extra cost for hiring cost accountants.
After the implementation of cost accounting system, employees required to get extra training as
well as must gain the capability to cooperate with the data input sufficiently. Non-cooperation of
employees found responsible for rendering ineffective cost accounting system which is otherwise
found as a beautifully constructed accounting system.

Impact of Cost Accounting on a Company’s Success
Cost accounting system helps a company to control its all kind of cost associated with production
and marketing of products or services it delivers. Every organisation aims to reduce its operating
costs to increase its profitability and cost reduction is one of the main targets to fulfil by the
organisations to stay in the market profitably. The more a company becomes able to control its
costs the great it becomes able to invest in innovation and modification of products and in other
activities such as marketing and business expansion. The information and data provided by cost
accounting system include all types of costs associated with manufacturing a product or
delivering a service. Such information is utilised by a company's management while making
decisions on pricing, budgeting, product mix, and others to support a company's operational and
financial objectives. Cost accounting significantly helps a company to control its business
expenditure. It assists management of a company to set operational and capital budgets which
help to make long-term strategic decisions to achieve long-term organisational goals in a
successful manner.