NATURE AND PURPOSE
OF COST ACCOUNTING
Cost accounting has been
defined by many accounting scholars in various forums. There is no one
watertight definition of cost accounting, but the various definitions all point
to certain common aspects about the subject. Below are some definitions by
certain authorities:
“That 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” (Chartered Institute of Management Accountants - CIMA)
“That which identities, defines, measures,
reports and analyses the various elements of direct and indirect costs
associated with producing and marketing goods and services. Cost accounting
also measures performance, product quality and productivity” “A systematic
process of collecting, summarizing and recording data regarding the various
resources and activities in a firm so as to calculate the basis of production
costs used in financial accounting or making other relevant decisions in a firm
Cost
accounting is broad and extends beyond calculating production costs for
inventory valuation, which government-reporting requirements largely dictate.
However accountants do not allow external reporting requirements to determine
how they measure and control internal organizations activities. In fact, cost
accounting focus is shifting from inventory valuation for financial reporting
to costing for decision making.
The main
objective of cost accounting is communicating financial information to
management for planning, evaluating and controlling performance, and also to
assist management to make more informed decisions. Its data is used by managers to guide their
decisions.
Cost
Accounting and other Accounting Subjects:
Accounting
can be described as a specialized information system that is used for purposes
of decision making by the management of the organization and other users such
as tax authorities, investors, creditors and the general public. Accounting is broadly divided into two:
- Financial Accounting
- Management Accounting
Financial
Accounting:
This is the
analysis, classification, and recording of financial transactions and the
ascertainment of how such information will be reported to the various
users. It involves the development of general-purpose
financial statements largely for external reporting. These statements are developed in accordance
with standards imposed by the public (through the professional accounting
bodies such as the Institute of Certified Public Accountants of Kenya – ICPAK
and the International Accounting Standards Board – IASB) as well as the
requirements of the Companies Act Chapter 486.
Management Accounting:
This is the part of accounting that provides special-purpose
statements and reports to management and other persons inside the
organization. The information generated
by management accounting is therefore for internal uses and is not guided by
any standards or legal requirements.
Management Accounting, unlike financial accounting, is proactive i.e. it
is future-oriented. It is required in
making decisions that affect the organization.
In a nutshell,
cost accounting enables a business to not only find out what various jobs or
processes have cost, but also what they should have cost. It indicates where losses are occurring
before the work is finished and therefore corrective action can be undertaken.
From the
foregoing discussion, it is then clear that cost accounting is very closely
related to other accounting subjects especially management accounting. In fact,
most people make no distinction between management accounting and cost
accounting, as the dividing line between the two is slimmer than thin!
Relationship between cost
accounting and management accounting
Referring to
CIMA’s definition of cost accounting, we can see that cost accounting is a part
of management accounting.
CIMA defines
management accounting as “provision of information required by the management
for such purposes as formulation of policies, planning and controlling the
activities of the enterprise, decision taking on the alternative courses of
action, disclosure to those external to the entity (shareholders and others),
disclosure to employees and safeguarding assets. Cost accounting and management
accounting have basically the same functions.
Relationship of cost
accounting and financial accounting
The difference between cost and
management accounting may be highlighted using a number of questions namely;
a)
Are there any unifying concepts to which
enterprises will adhere?
For financial accounting the answer
is “YES”. There are a number of
accounting standards that are followed in producing accounting information.
These are procedures established by the accounting profession to standardize
and improve accounting methods and disclosure. For example, the
International Accounting Standard No.
1 singles out for mention fundamental
accounting concepts namely going concern, accruals and consistency.
For cost accounting and management
accounting the answer is NO. However, there are a number of techniques, which
are widely used e.g. budgeting, standard costing, marginal costing and cost-volume-profit
analysis.
b)
May management choose whether or not to use the
discipline?
The Companies Act
requires a number of accounting records which by statute must be kept and made
available. For a limited company, financial statements must be produced which
in the opinion of the auditors, provide
a true and fair view of the company’s affairs and comply with the Companies
Act, Cap 486, 1962.In the case of cost
and management accounting, the management of an enterprise may choose
whether or not to create a cost and management accounting department and the
extent to which any such department will be used.
c)
To what extent is the focus on segments of the
enterprise?
In financial
accounting, the main emphasis is on the performance of the business entity. The
balance sheet is viewing the state of the business at a specific point in time
expressed in monetary terms. The profit and loss account is comparing the
revenue and expenses of the business for a specific period. Cost and management
accounting will focus analysis by segments of the business in order to allow
examination by job, process, product or service.
d)
To what extent does the analysis of information
incorporate non-monetary measures?
In financial accounting the monetary
base is predominant. Non-monetary measures are used in the interpretation of
accounting statements. For example expressing net profit as a percentage of
sales revenue.
In cost and management accounting there
will be greater use of non monetary measures. Quantitative information may be useful
in areas such ass material losses (kilos or as a percentage input), machine
efficiency (as a percentage of a predetermined standard).
e)
To what extent is the emphasis on future trends?
In financial accounting there is the
statutory requirement for provision of historical data from which accounting
statements may be prepared.
Such statements may be used in the
forecasting of future trends for use by potential investors or investment
analysts
Cost and management accounting will tend
to focus more on the future although analysis of historical information will be
used. For example budgeting will focus on future plans but to some extent will
use past performance as a guide to the structure of such plans
f)
What Degree of accuracy is required in the
information analysis?
Basic financial
accounting records must record transactions involving cash to the nearest cent.
There will be an element of judgment however in areas such as provision for
depreciation of fixed assets or valuation of stock and debtors.
Cost and management
accounting information will tend to be as accurate as required in a given
situation e.g. Management Reports may summarize figures to the nearest thousand
shilling whereas the labour cost per product may be expressed to four decimal
places.
g)
Is accounting a means to an end or an end in
itself?
Financial
accounting is an end in itself in so far as it fulfils the statutory
requirements in relation to accounting records and the publication of financial
accounting statements. It is also a means to an end in that it provides an
overview of the business which may be interpreted by the various users of
accounting information which the Companies Act seeks to protect.
Cost and
management accounting is a means to an end. It may be used to assist
management in future planning, control and decision making required for the
efficient implementation of the objectives of the enterprise and the strategies
which will best lead to achievement of these objects.
Introduction to Cost
Accounting Terminology
Cost
It measures the economic sacrifice made to
achieve an organizations goals. For a product, cost represents the monetary
measurement of resources used such as materials, labour and overheads.
For a service, cost is the monetary sacrifice made to provide the
service. Accountants generally use cost with other descriptive terms, for
example, historical, product, prime, labour or material. Each of these terms
defines some characteristic of the cost measurement process or an aspect of the
object being measured.
REINFORCING QUESTIONS
1. Define the
following terms
a) Cost
Accounting
b) Financial
Accounting
c) Management
accounting
2. Briefly describe the purpose
of Cost Accounting.
3. Compare and contrast Cost
Accounting and financial Accounting
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