Cost Accounting: Meaning and Limitations

In this article we will discuss about:- 1. Meaning and Terminology of Cost Accounting 2. Objectives of Cost Accounting 3. Limitations of Cost Accounting.

Meaning and Terminology of Cost Accounting:

Cost:

‘Cost’ may be defined as:

(i) The amount of expenditure (actual or notional) incurred on or attributable to a given thing; or

(ii) To ascertain the cost of a given thing.

Cost represents the resources that have been or must be sacrificed to attain a particular objective. Sacrifice may be direct or indirect. In other words, cost is the amount of expenditure, actual or notional, incurred on or attributable to a given product or service. Cost is the amount of resources used for something, which must be able to be measured in terms of money.

Costing:

Costing may be defined as “the techniques and process of ascertaining costs”.

Costing involves in classification, recording, allocation, appropriation of expenses incurred to facilitate the determination of cost of the product or service.

Weldon defines “costing is the classifying, recording and appropriate allocation of expenditure for the determination of cost of products or services and for the presentation of suitably arranged data for purposes of control and guidance of management. It includes the ascertainment of every order, job, contract, process, service units as may be appropriate. It deals with the cost of production, selling and distribution”.

Cost Accounting:

Chartered Institute of Management Accountants, London (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”.

Cost Accounting primarily deals with collection, analysis of relevant cost data for interpretation and presentation for various problems of management. Cost Accounting accounts for the costs of a product, a service or an operation. It is concerned with actual costs incurred and the estimation of future costs.

Cost Accountancy:

CIMA defines Cost Accountancy as “the application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and the ascertainment of profitability as well as presentation of information for the purpose of managerial decision making”.

Cost Accountancy 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.

Cost Unit:

CIMA defines Cost Unit as “a quantitative unit of product or service in relation to which costs are ascertained”. A ‘cost unit’ is a unit of product or unit of service to which costs are ascertained by means of allocation, apportionment and absorption. It is a unit of quantity of product, service or time or a combination of these in relation to which costs are expressed or ascertained.

For example, specific job, contract, unit of product like fabrication job, road construction contract, an automobile truck, a table, 1000 bricks, etc. The relation between ‘cost centre’ and ‘cost unit’ is that the costs of a function or activity are classified to the cost centre. The cost units which pass through the cost centre, the direct and indirect costs of the cost centre are charged to the units of production by means of an absorption rate.

The unit of output in relation to which cost incurred by a cost centre is expressed is called ‘cost unit’. It is a useful measurement of costs for comparative purposes. Cost unit can be anything for which it is possible to ascertain the cost.

The cost unit selected in each situation will depend on a number of factors including the purpose of cost ascertainment exercise and the amount of information available. Cost units can be developed for all kinds of organizations, whether manufacturing, commercial or public utility services.

Some of the examples of cost units are given below:

In case of service organizations’ a composite cost unit is used such as ton-kilometer, kilowatt-hour, patient-day etc. to be more meaningful.

Cost Object:

Colin Dury defined cost object as “any activity for which a separate measurement of costs is desired”. Sometimes the uses of accounting information are interested in knowing cost of something, which is called as ‘cost object’.

For example, ascertainment of cost of a particular branded product, particular function in production process, particular area of sales, servicing a particular customer, operating a particular account, maintaining a particular item of stock in stores, manufacturing a particular item of product etc. Cost object requires all costs relating to it to be traced and accumulated.

Objectives of Cost Accounting:

The prime objectives of Cost Accounting are as follows:

(a) To ascertain the cost per unit of production.

(b) To help in determining the selling price.

(c) To help in cost control and cost reduction.

(d) To ascertain the cost and profitability of each division, unit, activity, centre etc.

(e) To assist the management in decision making.

(f) To provide a basis for operating policies.

(g) To inform about inefficiency and carelessness.

(h) To inform the real situation of production activity.

(i) To provide the principles and procedures to be followed in Costing System.

(j) To provide basis for comparative analysis through data collection.

(k) To facilitate cost estimation.

Limitations of Cost Accounting:

The Cost Accounting is subject to the following limitations:

(a) It presents the base for taking the best decisions, but it does not give outright solution to the problem.

(b) Cost varies with purpose. Therefore, cost called for a certain purpose will not be suitable for other purposes.

(c) Cost Accounting is not an exact science. It involves inherent elements of judgment.

(d) It lacks a uniform procedure.

(e) A suitable system is to be devised for each individual concern and it would be time consuming and expensive.

(f) Existence of numerous methods for apportionment and absorption of overheads, segrega­tion of fixed and variable costs, division of costs into controllable and non-controllable costs, classification of costs into normal and abnormal costs, valuation of stocks, provision for depreciation etc. may lead to cost differences and it is difficult to ascertain true cost of product or service.

(g) Most of Cost Accounting Techniques are based on some presumed notions.

(h) Different views are held for inclusion of certain items of cost in ascertainment of total cost.

(i) Many formalities are to be observed to obtain benefit from Costing System. Small and medium concerns may not be in a position to install a costing system.

(j) If the system is not revised as per the changing circumstances, it will become a matter of routine forms and statements.