Cost accounting systems


The basic economic objective of any business organization is the maximization of profits. If profit is defined as a positive difference between the selling price and the cost per unit, it can be concluded that profits, can be maximized by any or all of the following actions:

1. Reduction in the cost per unit.
2. Increase in the selling price per unit
3. Increase in the volume of production and sales.

The increase in the selling price that is action at point (2) above is within the exclusive control of the management unless it is monopoly firm with guaranteed (i.e. elastic) demand. Even in such a situation they are subject to the imposition of price controls through the government. Similarly, the volume of production and sale (i.e. above 3.action) is a situation which is mostly dictated by the outside factors. The only effective course of action within the ambit of the management is the reduction in the cost per unit (i.e. above 1. situation). The reduction in the cost presupposes the ascertainment of cost per unit. The cost accounting systems help in ascertaining the cost per unit of the production. It should be noted that the cost is ascertained for each element of cost, viz., the direct material cost, direct labor cost and the overheads. The aggregation of these three elements gives the cost per unit o-f the product.

Cost accounting is nothing but an extension of financial accounting. The cost accounting attempts to develop some meaningful information from the financial accounting records which serve as a basis for certain management decisions. In fact, the financial accounting system mostly attempts to cater the needs of the external decisions makers such as shareholders, banks, financial institutions, suppliers, other creditors, government bodies etc. While the cost accounting system strives to fulfill the needs of the internal decision makers i.e. the management. Cost accounting data provide the valuable information which help in sharpening certain basic decision like cost control, pricing policy, profit to planning, evaluation of divisional performance, break-even analysis, cost-volume profit analysis, to continue or to shut-down, to make or buy the components etc.

Cost Accounting Systems

The cost accounting systems for the manufacturing firms provide the means whereby cost information can be developed within the framework of the financial accounting records. Basically the cost systems are classified into following two groups:

1. Historical cost system.
2. Standard cost system

Historical cost system

The historical cost system records the actual costs as they are incurred. The ascertainment of the actual direct material cost and direct labor cost be easily traced to any unit of the production and hence the overheads are apportioned to the production at some predetermined rate e.g. “Job A� will be cost as under:

Direct material cost Rs.10

Direct labor cost Rs. 8

Overheads Rs. 3
(at a predetermined rate say 30%of direct material cost)

Total cost per job Rs. 21

As this system considers the actual cost incurred, it is also known as the actual cost system.

The historical cost system is further divided into two broad groups of manufacturing activities viz., job order production and continuous mass production.

Job order costing: The job order cost system ascertains the cost of each job or order. Under the job-order type of production the size of the order and the specifications of each order differ from job to job and the production is distinguishable into different lots. Job order costing is generally applicable to the manufacturing activities such as printing shops, construction companies, machine tool manufacturing, repair-shops etc.

Process costing: The process cost system is applied to the continuous mass production. The continuous mass production is characterized by the quality production of uniform standard product. The production process continues under the given machine set-up to manufacture large volume of identical products. The products are of uniform nature and so are interchangeable in size and form which are manufactured according to the standard specifications. It is true that even in continuous production, sometimes the production varies in styles with certain changes in the specification. However, for the costing purpose it is possible to maintain the records for the total number of units of each style manufactured in each process. Process cost system is applicable to the industries like textile mills, chemical plants, foundries, paper and pulp mills, dyes and color factories, tire and rubber factories, canning factories, mining, oil refineries etc.

Standard cost system: Under the standard cost system, unlike the historical cost, the cost is ascertained on the basis of the some predetermined standards for each elements of cost. The standard cost is predetermined scientifically for direct material, direct labor and overheads. The cost of the unit of production is ascertained on the basis of such present standards of each elements of cost. It is true that the actual cost will differ from the standard cost however the difference between the predetermined standard cost and actual cost is isolated in the accounts. Such differences are known as variances. Various types of variances are computed for each elements of cost and their analysis serve as the basis for managerial decision.