Basics Of Cost Accounting System

Basic of Cost Accounting System


1.         Enumerate the main objectives of introduction of a Cost Accounting System in a manufacturing organization.


The main objectives of introduction of a Cost Accounting System in a manufacturing organization             are as follows:

                        a.         Ascertainment of cost

                        b.         Determination of selling price

                        c.         Cost control and cost reduction

                        d.         Ascertainment of profit of each activity

                        e.         Assisting in managerial decision-making


2.        What is Cost Accounting?


Cost accounting is the application of accounting and costing principles, methods and techniques in the ascertainment of costs and the analysis of savings and/or excess as compared with previous experience or with standards.


CIMA defines Cost Accounting as ”the establishment of budgets, standard costs and actual costs of operations ,processes, activities or products, and the analysis of variances, profitability or the social use of funds.”


3.         Essential factors for designing a Cost Accounting System.


The essential factors to be considered while designing a Cost Accounting System are as follows :


i.          A through understanding of – Organisational structure; manufacturing procedure ( i.e. methods of production ) and process; selling and distribution procedure; and type of cost information required.


ii.         Selection of a suitable costing technique (Standard or actual, marginal or absorption etc.)


iii.         Pricing method suitable, for the material, to be issued to production.


iv.         Method suitable for booking labour cost on jobs.


v.          A sound plan should be devised for the collection, allocation, apportionment and absorption of overheads.


vi.        Deciding on ways of treating waste, scrap and idle time.


vii.        Designing of suitable forms to be used for collecting and dissemination of Cost data/information.



4.         What are the essentials of a good Cost Accounting System ?


Ans: The essential features of a good Cost Accounting system are as follows ;-


i.          The Cost Accounting System should be tailor made, practical, simple and capable of meeting the   requirements of a business concern.


ii.          The method of costing should be suitable to the industry and serve its objectives.


iii.         The Costing System should receive co-operation and participation of executives from various departments.


iv.         The cost of installing and operating the system should justify the results.


v.          The system of costing should not sacrifice the utility by introducing meticulous and unnecessary details.


vi.        The system should consider the organisational structure of the business and it should be designed as a sub-system of the overall organisation.


vii.        There should be a harmonious relationship between costing system and financial accounts.  Unnecessary duplication should be avoided.  A single integrated accounting system would be ideal.


viii.       The system should provide adequate checks on ordering, receipts, stocking, issuing and recording of materials.  The pricing method and the issue of materials should be efficient.


ix.        The costing system should ensure proper recording of worker’s time and their wages.  Wage costs should be determined from wage analysis sheets.  Proper attention should be paid in preparing payrolls and in the payment of wages.  The treatment of idle time, over-time and holiday-pay should not be overlooked.


x.         The cost accounting system should ensure that overheads are collected, accumulated apportioned and absorbed fairly and equitably.


xi.        Introduction of budgetary control technique so that actual performance may be compared with budgetary figures, for measuring efficiency of performance.



5.         Essential factors for installing a Cost Accounting System.


The essential factors for installing a Cost Accounting System are listed as below :-


The objectives of installing a Costing System and the expectations of the management from the system should be identified first.  The system will be a simple one in the case of a single objective but will be an elaborate one in the case of multiple objectives.


It is important to ascertain the significant variable of the manufacturing units which are amenable to control and affect the concern.  For examples, quite often the production costs control may be more important than control of its marketing cost.  Under such a situation, the costing system should devote greater attention to control production cost.


A through study of the nature of business, its technical aspects, products, methods and         stages of production should be made.  This will help in selecting a proper method of costing.


A study of the organisation structure, its size and layout etc. is also necessary.  This is useful to management to determine the scope of responsibilities  of various managers.


The costing system should be evolved in consolation with the staff and should be introduced only after meeting their objections and doubts, if any.  The co-operation of staff is essential for the successful operation of the system.


Details of the records to be maintained by the costing system should be carefully worked out.  The degree of accuracy of the data to be supplied by the system should be determined.


The forms to be used by foreman, workers etc., should be standardised.  These forms be suitably designed and must ensure minimum clerical work at all stages.


Necessary arrangements should be made for the flow of information/data  to all concerned managers, at different levels, regularly and promptly.


Reconciliation of costs and financial accounts be carried out regularly, if they are  maintained separately.

The costing system to be installed should be easy to understand and simple to operate.


6.         Cost Manual


In general, costing system has the following phases :-


(I)         Cost Collection


(ii)        Cost grouping


(iii)       Cost Analysis


(iv)       Cost apportionment and allocation


(v)        Cost interpretation.


Each of the above phases may have multiple interpretation and treatment.


The Cost Manual outlines the treatment of cost data, in various and different manner, relating to all these phases -


            a.         The manual specifies how the data, should be collected,

            b.         The sources from which such data should be collected,

c.         How the cost data, so collected should be grouped for proper analysis, the methods of analysis of cost data, apportionment and allocation of indirect costs and finally how such data should interpreted for managerial control.


Cost accounting is basically quite flexible in its approaches and analysis and therefore a cost manual plays in important role in making the system useful for the purposes of managerial control. The manual serves as a reference book for all those who are connected with preparation and utilisation of cost data.


7.         Cost Center :


A cost centre is a location, person or item of equipment for which costs are ascertained and used for the purpose of control aspect in a costing system.


According to CAS-1  “ Any unit of Cost Accounting selected with a view to accumulating all cost under that unit. The unit may be a product, a service, division, department, section, a group of plant and machinery, a group of employees or a combination of several units. This may also be a budget centre.”


The determination of suitable cost centre as well as analysis of cost under cost centres is very helpful for periodical comparison and control of cost. In order to obtain the cost of a product or service, expenses should be suitably segregated to cost centre.


The manager of a cost centre is held responsible for control of cost over there.


The selection of suitable cost centres or cost object or budget centre for which cost are to be ascertained in an undertaking depends upon a number of factors such as


1.         organization of a factory,

2.         condition of incidence of cost,

3.         availability of information,

4.         requirements of costing and management policy regarding selecting a method from various choices. Cost centres may be production cost centres, operation cost centers or process cost centres depending upon the situation and classification, cost and the variable overheads.


8.         Cost Classification :


The process of grouping costs according to their common characteristics is known as cost classification. Costs may be classification according to the nature and function. Cost classification according to the nature means grouping the cost under the heads-material, labour and overheads. In summarised from, classification under.


  1. Nature  of expense : Material, Labour, Expenses
  2. Relation of  Cost  Centre : Direct & Indirect for Material, Labour, Expenses
  3. Functions / activities : Production, Administration, Research & Development, Selling & Distribution.
  4. Behaviour  wise  : Fixed ,Variable & Semi- variable.
  5. Management decision  making: Relevant , Opportunity & sunk cost ,  etc.
  6. Production Process : Batch, Process, Operating, Operation, Contract & Joint
  7. Time  period : Historical, Predetermined, Standard & Estimated

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