Nature and Scope of Cost Accounting [ Objective, Function, Scope, Nature, Advantages and Disadvantages ]

The term ‘Cost Accountancy’ includes Costing and Cost accounting. Its purposes are Cost-control and Profitability – ascertainment. It serves as an essential tool of the management for decision-making.

Introduction of Cost Accounting

Cost: The term ‘cost’ has to be studied in relation to its purpose and conditions. As per the definition by the Chartered Institute of Management Accountants (C.I.M.A.), London ‘cost’ is the amount of actual expenditure incurred on a given thing.

Costing: The C.I.M.A., London has defined costing as the ascertainment of costs. “It refers to the techniques and processes of ascertaining costs and studies the principles and rules concerning the determination of cost of products and services”.

Cost Accounting: It is the method of accounting for cost. The process of recording and accounting for all the elements of cost is called cost accounting. I.C.M.A. has defined cost accounting as follows: “The process of accounting for cost from the point at which expenditure is 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 the profitability of activities carried out or planned”.

Cost Accountancy: The term ‘Cost Accountancy’ includes Costing and Cost accounting. Its purposes are Cost-control and Profitability – ascertainment. It serves as an essential tool of the management for decision-making.

I.C.M.A., has defined cost accountancy as follows: “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. It includes the presentation of information derived there from for the purpose of managerial decision making”.

Objectives of Cost Accounting

a) To serve as a guide to price fixing of products.

b) To disclose sources to wastage in various operations of manufacture.

c) To reveal sources of economy in production process.

d) To provide for an effective system of stores and material.

e) To measure the degree of efficiency of the various departments or units of production.

f) To provide suitable means and information to the top management to control and guide the operations of the business organisation.

g) To exercise effective control on the costs, time and efforts of labour, machines and other factors of production.

h) To compare actual costs with the standard costs and analyse the causes of variation.

i) To provide necessary information to develop cost standards and to introduce the system of budgetary control.

j) It enables the management to know where to economize on costs, how to fix prices, how to maximize profit and so on.

Nature of Cost Accounting

The nature of cost accounting can be brought out under the following headings:

1. Cost accounting is a branch of knowledge:Though considered as a branch of financial accounts, cost accounting is one of the important branch of knowledge, i.e., a discipline by itself. It is an organised body of knowledge consisting of its own principles, concepts and conventions. These principles and rules vary from industry to industry.

2. Cost accounting is a science:Cost accounting is a science as it is a body of systematic knowledge relating to not only cost accounting but relating to a wide variety of subjects such as law, office practice and procedure, data processing, production and material control, etc. It is necessary for a cost accountant to have intimate knowledge of all these field of study in order to carry on his day-to-day activities. But it is to be admitted that it is not a perfect science as in the case of natural science.

3. Cost accounting is an art: Cost accounting is an art in the sense it requires the ability and skill on the part of cost accountant in applying the principles, methods and techniques of cost accountancy to various management problems. These problems include the ascertainment of cost, control of costs, ascertainment of profitability, etc.

4. Cost accounting is a profession:In recent years cost accounting has become one of the important professions which have become more challenging. This view is evident from two facts. First, the setting up of various professional bodies such as the Institute of Cost accountant in India, ICMAI in USA and the institute of cost and management Accountants in UK. Such professional bodies both in developed and developing countries have increased the growing awareness of costing profession among the people. Secondly, a large number of students have enrolled in these institutes to obtain costing degrees and memberships for earning their livelihood.

Scope of Cost Accounting

The term scope here refers to field of activity. Cost accounting refers to the process of determining the cost of a particular product or activity. It provides useful data both for internal and external reports reporting. Internal reporting presents details of cost data in a summarized and aggregate form. For instance, in case a company manufacturing electrical goods cost of each product.

In order that cost accounting satisfies the requirements of both internal and external reporting, the following are the different activities which are undertaken under cost accounting system:

1. Cost Determination: This is the first step in the cost accounting system. It refers to determining the cost for a specific product or activity. This is a critical activity since the other three activities, explained below, depend on it.

2. Cost Recording: Its is concerned with recording of costs in the cost journal and their subsequent posting to the ledger. Cost recording may be done according to integral or non-integral system a separate set of books is maintained for costing and financial transactions.

3. Cost Analyzing: It is concerned with critical evaluation of cost information to assist the management in planning and controlling the business activates. Meaningful cost analysis depends largely upon the clear understanding of the cost finding methods used in cost accounting.

4. Cost Reporting: Its is concerned with reporting cost data both for internal and external reporting purpose. In order to use cost information intelligently it is necessary for the managers to have good understanding of different cost accounting concepts.

Function of Cost Accounting

According to Blocker and Weltemer, “Cost Accounting is to serve management in the execution of polices and in comparison of actual and estimated results in order that the value of each policy may be appraised and changed to meet the future conditions”. The main functions of cost accounting are:

a) To serve as a guide to price fixing of products.

b) To disclose sources of wastage in process of production.

c) To reveal sources of economy in production process.

d) To provide for an effective system of stores, materials etc.

e) To exercise effective control on factors of production.

f) To ascertain the profitability of each product.

g) To suggest management of future expansion policies.

h) To present and interpret data for management decisions.

i) To organize cost reduction programmes.

j) To facilitate planning and control of business activity.

k) To supply timely information for various decisions.

l) To organize the internal audit systems etc.

Advantages of Cost Accounting

1. Helps in Decision Making: Cost accounting helps in decision making. It provides vital information necessary for decision making. For instance, cost accounting helps in deciding:

  1. Whether to make a product buy a product?
  2. Whether to accept or reject an export order?
  3. How to utilize the scarce materials profitably?

2. Helps in fixing prices: Cost accounting helps in fixing prices. It provides detailed cost data of each product (both on the aggregate and unit basis) which enables fixation of selling price. Cost accounting provides basis information for the preparation of tenders, estimates and quotations.

3. Formulation of future plans: Cost accounting is not a post-mortem examination. It is a system of foresight. On the basis of past experience, it helps in the formulation of definite future plans in quantitative terms. Budgets are prepared and they give direction to the enterprise.

4. Avoidance of wastage: Cost accounting reveals the sources of losses or inefficiencies such as spoilage, leakage, pilferage, inadequate utilization of plant etc. By appropriate control measures, these wastages can be avoided or minimized.

5. Highlights causes: The exact cause of an increase or decrease in profit or loss can be found with the aid of cost accounting. For instance, it is possible for the management to know whether the profits have decreased due to an increase in labour cost or material cost or both.

6. Reward to efficiency: Cost accounting introduces bonus plans and incentive wage systems to suit the needs of the organization. These plans and systems reward efficient workers and improve productivity as well improve the morale of the work -force.

7. Prevention of frauds: Cost accounting envisages sound systems of inventory control, budgetary control and standard costing. Scope for manipulation and fraud is minimized.

8. Improvement in profitability: Cost accounting reveals unprofitable products and activities. Management can drop those products and eliminate unprofitable activities. The resources released from unprofitable products can be used to improve the profitability of the business.

9. Preparation of final accounts: Cost accounting provides for perpetual inventory system. It helps in the preparation of interim profit and loss account and balance sheet without physical stock verification.

10. Facilitates control: Cost accounting includes effective tools such as inventory control, budgetary control and variance analysis. By adopting them, the management can notice the deviation from the plans. Remedial action can be taken quickly.

Limitations of Cost Accounting

In spite of the various advantages claimed by cost accounting, the discipline suffers from the following limitations:

1. Cost Accounting is costly to operate: It involves heavy expenditure to operate. The benefits derived by operating the system are more than the cost.

2. Cost Accounting involves many forms and statements: It involves usage of many forms and statements which leads to increase of paper work.

3. Costing may not be applicable in all types of Industries: Existing methods of cost accounting may not be applicable in all types of industries. Cost accounting methods can be devised for all types of industries, and services.

4. It is based on Estimations: Costing system relies on predetermined data and therefore it is not reliable. Costing system estimates costs scientifically based on past and present situations and with suitable modifications for the future. This leads to accurate cost figures based on which management can initiate decisions. But for the predetermined costs, cost accounting also becomes another ‘Historical Accounting’.

5. It is not an exact science: Like any others accounting system, it is not an exact science but an art that has developed through theories and practices.

6. Bias Judgments: Many judgments are biased and depend on individual discretion.

7. Difference in opinion: Different views are held by different cost accounts about the items to be includes in cost.

Characteristics of a Good Costing System

An ideal system of cost accounting must possess some characteristics which bring all the advantages, discussed above; to the business, in order to be ideal and objective. The main characteristics are:

1. Simplicity: It must be simple, flexible and adaptable to the changing conditions. And it must be easily understandable to the personnel. The information provided must be in the proper order, in right time and to the right persons so as to be utilized fully.

2. Flexibility and Adaptability: The costing system must be flexible to accommodate the changing conditions and circumstances. The expansion, contraction of changes must be adopted in the existing system with minimum changes.

3. Economy: The costing system must suit the finance available. The expenditure must be less than the benefits derived from the system adopted.

4. Comparability: The management must be able to make comparison of the facts and figures with the past figures, figures of other concerns, or other departments of the same concern.

5. Minimum Changes to the Existing one: When introducing a costing system, it may cause minimum change to the existing set up of the business.

6. Uniformity of Forms: Forms of different colours can be used to distinguish them. Forms must be uniform in size and quality. Form should contain instructions to fill, to use and for disposal.

7. Less Clerical Work: Printed forms will involve less labour to fill in, as the workers may be a little educated. They may not like to spend much time in filling the forms.

8. Efficient Material Control and Wage System: There must be a proper procedure for recording the time spent on different jobs, by workers for the payment of wages. A systematic method of wage system will help in the control of labour cost. Since the cost of material forms a great proportion to the total cost, there must be an efficient system of stores control.

9. A Sound Plan: There must be proper and sound plans to collect, to allocate and to apportion overhead expenses on each job or each product in order to find out the cost accurately.

10. Reconciliation: The systems of costing and financial accounting must be facilitated to reconcile in the easiest manner.

11. Overall Efficiency of Cost Accountant: The work of the cost accountant under a good system of costing must be clearly defined as to his duties and responsibilities to the firm are very essential.

Installation of a Costing System

The costing system of an organization should be carefully planned in order to achieve its objectives. The important steps for the installation of a costing system are discussed below:

1. Determination of objectives: The first step is to clearly lay down the objectives of the costing system. If the objective is only to ascertain the cost, a simple system will be sufficient. However, if the objective is to get information for decision making, planning and control, a more elaborate system of costing is necessary.

2. Study of the nature of business: The nature of the business and other technical aspects like nature of the products, methods and stages of production cycle should be carefully analyzed. Such an analysis is necessary to decide the method of costing to be adopted. For example, contract costing is suitable for large construction projects. Operating costing is adopted by service industries like transport.

3. Study of the nature of the organization: The costing system should be designed to meet the requirements of the organization. Hence, it is necessary to study the nature, size and layout of the organization. The factors to be considered are:

  1. Size of the organization and the size of the departments.
  2. The physical layout of the organization.
  3. The different levels of management.
  4. The extent of decentralization of authority.
  5. The nature of authority relationships.

4. Deciding the structure of cost accounts: A suitable costing system can be developed on the basis of the study of the nature of business and organization. The structure of cost accounts should be simple and in accordance with the natural production process.

5. Determination of cost rates: This step involves a thorough study of the following points for developing an integrated costing system.

  1. Classification of costs into direct and indirect costs.
  2. Grouping of indirect costs (overheads) into production, administration, selling and distribution etc.
  3. Methods of pricing issues.
  4. Treatment of wastes of all types.
  5. Absorption of overheads.
  6. Calculation of overhead rates.

6. Organization of the cost office: The cost office is responsible for the efficient operation of the costing system. The cost office, with adequate staff must be located a close as possible to the factory. The following are the major functions of the cots office.

  1. Stores accounts.
  2. Labour accounting
  3. Recording of cost data and
  4. Cost control.

Further, the role and duties and responsibilities of the cost accountant must be clearly defined. He must have the necessary authority to discharge his duties effectively.

7. Introducing the system: After completion of the above steps, the costing system may be formally introduced. Introduction of the system in an existing organization should be done gradually. Before introduction, the feature of the systems, its working and advantages must be explained to the concerned employees to secure their co-operation.

Techniques of Costing

The types and techniques of costing are as follows:

1. Historical Costing: ‘The ascertainment of costs after they have been incurred’ is called Historical costing. Such costs are, therefore, ‘postmortem’ costs as under this method all the expenses incurred on the production are first incurred and them the costs are ascertained.

2. Standard Costing: ‘The preparation and use of standard costs, their comparison with actual costs and the analysis of variance to their causes and points of incidence’ is called standard costing.

Here the standards are first set and then they are compared with actual performances. The difference between the standard and the actual is known as the variance. The variances are analyzed to find out their causes and also the points or locations at which they occur.

3. Marginal Costing: Marginal Costing involves the ascertainment of marginal costs and of the effects on profit of changes in volumes or type of output by differentiating between fixed costs and variable costs’.              The fixed costs are those which do not change but remain the same, with the increase or decrease in the quantum of production. The variables costs are those which do change proportionately with the change in quantum of production.

The marginal costing takes into account only the variable costs to find out ‘marginal costs’. The difference between Sales and Marginal costs is known as ‘Contribution’ and contribution is an aggregate of Fixed costs and Profit/Loss. So the fixed costs are deducted from the contribution to find out the profits. Marginal costing is a technique to ascertain the effect on profits. Marginal costing is a technique to ascertain the effect on profit by the change in the volume of output or by the change in the type of output.

4. Direct Costing: The practice of charging all direct cost to operations, process or products, leaving all the indirect costs to be written off against profits in the period in which they arise is called direct costing.

5. Absorption Costing: It is the practice of charging all costs, both variables and fixed, to operations, processes or products. This is the traditional technique as opposed to Marginal or Direct costing techniques. Here both the fixed and variables cost are charged in the same manner.

Methods of Costing

The methods of costing are as follows:

1. Job Costing: The job costing methods are applicable where the unit of manufacture is one and complete in itself. They include printers, job foundries, tool manufactures, and contractors, etc. the following methods are included in Job Costing:

2. Contract Costing: This method if applied in undertakings erecting buildings or carrying out constructional works, e.g., House buildings, ship building, Civil Engineering contracts. Here the cost unit is one and completed in itself. The cost unit is a contract which may continue for over more than a year. It is also known as the Terminal Costing, since the works are to be completed within a specified period as per terms of contract or agreement executed by the contractor and contractee.

3. Batch Costing: In this method, a batch of similar or identical products is treated as a job. Here the unit of cost is a batch of group of products, costs are collected and analyzed according to batch numbers and the costs are ascertained batch wise. This method is applied in pharmaceutical industries where medicines or injections are manufactures batch wise or in general engineering factories producing components in convenient batches.

4. Process Costing: Process costing method is applicable to those industries manufacturing an number of units of output requiring processing. Here an article has to undergo two or more processes for reaching the stage of finished goods and succeeding process till completion.

5. Unit costing: This method is also known as single or output costing. The objective of this method is to ascertain the total cost as well as the cost per unit. A cost sheet is prepared taking into account the cost of material, labour and overheads, Unit costing is applicable in the case of mines, oil drilling units, cement works, brick works and units manufacturing cycles, radios, washing machines etc.

6. Operating costing: This method is followed by industries which render services. To ascertain the cost of such services, composite units like passenger kilometers and tone kilometers are used for ascertaining costs. For example, in the case of a bus company, operating costing indicates the cost of carrying a passenger per kilometer.

7. Operation costing: This is a more detailed application of process costing. It involves costing by every operation. This method is used where there is mass production of repetitive nature involving a number of operations. The main purpose of this method is to ascertain the cost of each operation.

8. Multiple Costing: It is also known as composite costing. It refers to a combination of two or more of the above methods of costing. It is adopted in industries where several parts are produced separately and assembled to a single product.



Financial Accounting

Cost Accounting

1.    Nature

Financial accounts are maintained on the basis of historical records.

Cost accounts lay emphasis on both historical and predetermined costs.

2.    Use

Financial Accounting is used even by outside entities.

Cost Accounting is used only the management of the concern.

3.    System

Financial Accounting uses the double-entry system for recording financial data.

Cost Accounting does not use the double-entry for collecting cost data.

4.    Scope

Financial Accounting covers all items of income and expenditure whether related to the cost centers or not,

Cost Accounting covers all items related to a cost centre.

5.    Reports

Financial Accounting results are shown P&L A/c and balance sheet.

Cost Accounting results are shown in Cost Sheet/ Coating Profit& Loss A/c/ Reports Contract A/c/ Process A/c.

6.    Period

Financial Accounting is for a specific period.

Cost Accounting concentrates on cost centers and not on period.

7.    Stock Valuation

In financial accounts, stocks are valued at cost or realisable value, whichever is lesser.

In cost accounts stocks are valued at cost.

8.    Analysis of Profit and Cost

In financial accounts, the Profit or Loss of the entire enterprise is disclosed into.

Cost accounts reveal Profit of Loss of different products, departments separately.


Cost accounting and Management accounting are two modern branches of accounting. Both the systems involve presentation of accounting data for the purpose of decision making and control of day-to-day activities. Cost accounting is concerned not only with cost ascertainment, but also cost control and managerial decision making.


Management accounting makes use of the cost accounting concepts, techniques and data. The functions of cost accounting and management accounting are complimentary. In cost accounting the emphasis is on cost determination while management accounting considers both the cost and revenue. Though it appears that there is overlapping of areas between cost and management accounting, the following are the differences between the two systems.

1. Purpose: The main objective of cost accounting is to ascertain and control the cost of products or services. The function of management accounting is to provide information to management for efficiently performing the functions of planning, directing, and controlling.

2. Emphasis: Cost accounting is based on both historical and present data, whereas management according deals with future projections on the basis of historical and present cost data.

3. Principles and Procedures: Established procedures and practices are followed in cost accounting. No such prescribed practices are followed in Management accounting. The analysis is made and the resulting conclusions are presented in reports as per the requirements of the management.

4. Data Used: Cost accounting uses only quantitative information whereas management accounting uses both qualitative and quantitative information.

5. Scope: Management accounting includes, financial accounting, cost accounting, budgeting, tax planning and reporting to management, whereas Cost accounting is concerned mainly with cost ascertainment and control.

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