Cost Accounting Terminologies

Cost accounting, as a tool of management, provides management with detailed records of the costs relating to products, operations or functions. Cost accounting refers to the process of determining and accumulating the cost of some particular product or activity. It also covers classification, analysis and interpretation of costs.

The cost so determined and accumulated may be the estimated future costs for planning purposes, or actual (historical) costs for evaluating performance. The Institute of Cost and Management Accountant (ICMA), London, defined cost accounting as “the process of accounting for cost from the point at which expenditure incurred or committed to the establishment of its ultimate relationship with cost centers and cost units.

In its widest usage it embraces the preparation of statistical data, the application of cost control methods and the ascertainment of profitability of activities carried out or planned.”

Costing

Cost accounting and costing have distinctly different meanings. The Institute of Cost and Management Accountant (ICMA), London, defined costing as the ascertainment of costs.

Costing includes the “techniques” and “processes” of ascertaining costs. The technique refers to the principles or rules which are applied for ascertaining costs of products manufactured and services rendered. There are mainly two methods of costing job costing and process costing. The process includes the day to day routine of determining costs within the methods of costing adopted by the business enterprise. Within such a process, there could be historical costing, marginal costing, absorption costing and standard costing etc.

Objectives of Cost Accounting

There is a direct relationship among information needs of management and cost accounting objectives and techniques and tools used for analyses in cost accounting.

Cost accounting has the following three important objectives:

1. To determine the product cost. 2. To facilitate planning and control of regular business activities. 3. To supply information for short and long-run decision.

Product Costing The objective of determining the cost of products is the prime importance of cost accounting. The total product costs and cost per unit of product are important in making inventory valuation, deciding price of the product and managerial decision making.

Planning and Control

Another important objective of cost accounting is the creation of useful cost data and information for the purposes of planning and control by management. The different alternative plans are evaluated in terms of respective costs and associated benefits. The management control over business operations aims to establish balance between actual and budgeted performance. A properly designed cost accounting system includes the following steps in the control process: 1. Comparing actual performance with budgets and standard 2. Analyzing the variances between budget and standards and actual by causes, and management responsibility so that corrective actions may take place. 3. Providing managers with data and reports about their individual performances and performances of subordinates.

Information for decision

Another important objective of cost accounting system is to provide data and special analyses for short and long-run decisions of a non-recurring nature. Appropriate cost information must be accumulated to make a wide variety of short and long run decision. According to Henke and Spoede, the following are the cost information developed in cost accounting: 1. As a basis for valuing manufactured inventories and cost of goods sold in externally presented financial reports. 2. In controlling operations through the evaluation of operating results and the placement of responsibilities for the uses of organizational resources on the shoulders of specifically identifiable persons within the organization. 3. In planning operations through the establishment of cost and budgetary goals. 4. In making day- to- day operating decisions.

The cost information is used for two purposes in most organizations:

1) the cost accounting systems provide information to evaluate the performance of an organizational unit or his manager, and

2) also provide the means for estimating the unit cost of products or services that the organization can manufacture or provide to others.

a) Performance measurement: This measurement can be done by comparing current costs with those who were expected – or standard costs budgeted cost – to the degree of knowing which of them have been controlled. Deviations of expected with the current – variances – can be identified, evaluated and discussed by managers.

b) Cost of goods and services: In manufacturing companies, the costs of goods must be measured to determine the cost of items transferred from work in process inventory to finished products. To meet the demands for information, a cost system should measure all the costs of manufacturing process and allocate a portion of those costs to each unit of output. The cost to obtain, maintain and manage the manufacturing plant or building should be added to the cost of material and productive work that requires each unit. The first are called indirect costs and the two last are called direct costs.

c) Profit analysis. Information in costs is essential to analyze the profits obtained from a product or product line. The information on the cost of a product enables managers to assess the contribution margin – the difference between the price and variable costs – and the gross margin – the difference between the price and the total cost of the product.

d) Product mix. For the companies that offer more than one product or service the cost information is key to handle the mix of products or services offered to customers. With information on cost-profit, a manager can lead the effort in sales and advertising for products that generate greater value. The products that do not create any profit can be removed, have a price reassignation, or tied up with products that have greater utility.

e) Price assignation. Regardless of where prices are determined by the forces of market demand, product differentiation and advertising offer to many managers some sort of idea to assign prices to products or services. The costs of products and trends commonly offer signals to managers that prices should be changed. An example could be the change in the cost of a material or critical component which can give a signal to reassess the price of a product or service.

f) Cost of service. Many products require the seller to provide additional services to customers. In such cases, the information about the cost of service is so important for managers as the cost of production. The same for companies that offer services only, unless the cost of service is measured, there is no way to know whether providing the service is profitable or not, or whether changes in prices or advertising are needed. Looked from another angle, the uses that the administration of a company can give to the costs can be grouped into 4 categories, specified below

Method of costing As state earlier, the term costing refers to the techniques and processes of determining cost of a product manufactured or a service rendered. Different methods are applied in business enterprises to ascertain cost depending upon the nature of the product, production method and specific business conditions. For example, in a textile or steel company, raw material passes through different stages and production is done continuously. In some other industries, production is done at different customers specific orders and each job is different from the other job.