Problems of Cost System in Indian Companies

The following points highlight the seven major problems of cost system in Indian companies. The problems are: 1. Inadequate Capturing of Direct Material Costs 2. Excessive Emphasis on Labour Costs 3. Functional Classification of Overhead Costs 4. Simplistic Allocation Bases 5. Inadequate Attention to Service Departments and Service Organizations and Others.

Problems of Cost System:

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1. Inadequate Capturing of Direct Material Costs
2. Excessive Emphasis on Labour Costs
3. Functional Classification of Overhead Costs
4. Simplistic Allocation Bases
5. Inadequate Attention to Service Departments and Service Organizations
6. Limited Familiarity of Accountants with Operations
7. Narrow Role of Cost Accounting

Cost System: Problem # 1.

Inadequate Capturing of Direct Material Costs:

Accounting for the issuance of materials to jobs is frequently in-proper. Issues are booked to incorrect jobs, are not correctly shown in inventory accounts and are not priced correctly in cost records. As a result, product costs are incorrectly computed.

Cost System: Problem # 2.

Excessive Emphasis on Labour Costs:

Companies spend a disproportionate amount of time and effort in tracing labour costs to products despite the fact that the share of labour costs in the cost of production has been going down for over a decade. The excessive emphasis on labour costs distorts management’s orientation to cost control.

Cost System: Problem # 3.

Functional Classification of Overhead Costs:

Overhead costs are classified by organisational functions such as production, administration, selling and distribution. This classification is not of much use in either product costing or cost control because classification of costs by departments is too aggregated. Tracing overhead costs to cost centres is not very common.

Cost System: Problem # 4.

Simplistic Allocation Bases:

The methods of allocating overhead costs to products are too simple. Traditional bases such as machine hours and labour hours are used without much thought being given to their suitability. Combinations of allocation bases are rarely used.

Cost System: Problem # 5.

Inadequate Attention to Service Departments and Service Organizations:

Overhead expresses of service departments such as marketing, purchasing, distribution and general administration are among the most rapidly rising items in recent years. There are many more marketing researchers, product managers, purchase managers, personnel managers, development engineers and financial executives today than, say, about five years ago.

Yet, the impact of these services personnel and their departments on the cost structure of a business is generally not analysed. Furthermore, cost systems do not exist in most organisations providing services. Companies in advertising, software, banking and insurance need cost systems as much as manufacturing firms do.

Cost System: Problem # 6.

Limited Familiarity of Accountants with Operations:

With rare exceptions, accountants seem to have limited familiarity with the actual business operations of their companies. It is essential that the accountant knows his company’s value drivers. Lack of knowledge of suppliers, products, customers, markets, technology and employees on the part of the accountant will come in the way of designing good cost systems.

Cost System: Problem # 7.

Narrow Role of Cost Accounting:

Inventory valuation for the purpose of financial reporting is considered the major purpose of cost accounting in most organisations. As a result cost accounting has been assigned a narrow role. Cost information is not used much for making major business decisions.