Cost Accounting and Financial Accounting Compared
Chapter Three
Syllabus topic 2, "Difference between Financial and Cost Accounting"
Pages 7 to 8 of 82
In one line
Financial accounting reports the result of the whole business to outsiders under rules; cost accounting reports the cost of each thing to management, in whatever form is useful.
The points of difference
| Financial accounting | Cost accounting | |
|---|---|---|
| Purpose | To report the result and position of the business | To ascertain the cost of each cost object and control it |
| For whom | External - shareholders, lenders, tax authorities, regulators | Internal - management |
| Compulsory? | Yes for a company, under the Companies Act 2013 | Voluntary, except where cost records and audit are prescribed |
| Form prescribed? | Yes - Schedule III sets the form of the statements | No. The form follows the need |
| Basis of classification | By nature of expense: wages, rent, power | By function and traceability: direct, indirect, factory, office |
| Period | Usually annual, and historical | Continuous - monthly, weekly, per job or per batch |
| Unit of measure | Money only | Money and quantity - units, hours, kilograms |
| What it reports on | The business as a whole | Each product, job, process or service separately |
| Stock valuation | At the lower of cost and net realisable value | At cost, on the method the firm has adopted |
| Abnormal items | Included in profit, being real losses | Excluded from cost and charged to profit and loss |
| Estimates and standards | Records what happened | Also uses standards and estimates, for control |
Eleven points is more than any answer needs. Six or seven, each with its reason, is a full answer; the rest are there so the reader can pick the ones a particular question invites.
The four differences that cause the reconciliation
Three rows of that table are the whole of the reconciliation topic, and it is worth seeing that now.
Stock valuation differs. Financial accounting takes the lower of cost and net realisable value; cost accounting takes cost on the chosen method. Where they differ, the two profits differ.
Abnormal items are excluded from cost. An abnormal loss of material, an abnormal idle time, a loss by fire: cost accounting leaves them out because including them would make the product look expensive for a reason that has nothing to do with making it. Financial accounting includes them because they really happened.
Purely financial items appear in one set of books only. Interest received, dividend received, profit on sale of an asset, donation paid, loss on sale of an investment. They are neither a cost of making anything nor a revenue from selling it, so cost accounting does not see them.
And overhead is absorbed in cost accounting at a rate, so the amount charged to production is rarely the amount actually incurred. The difference is the over- or under-absorption, and it is the fourth cause.
Cost Accounting and Financial Accounting Compared
What it does NOT mean
Cost accounting is not less rigorous. Its freedom of form is not a freedom of arithmetic, and its figures come from the same records.
They are not two sets of books. In most firms they are one ledger looked at two ways, or two ledgers reconciled - which is why reconciliation is a topic at all.
"Voluntary" is not "unregulated". Where the Central Government prescribes cost records and cost audit for an industry, they are compulsory for it.
Financial accounting is not only annual. It is usually annual for reporting; the contrast is with cost accounting's continuous, job-by-job rhythm.
Quick revision
- Purpose: result of the business, against cost of each object.
- Audience: external, against internal.
- Compulsion: statutory, against voluntary but prescribed for some industries.
- Form: Schedule III, against whatever is useful.
- Classification: by nature, against by function and traceability.
- Period: annual, against continuous.
- Measure: money, against money and quantity.
- Stock: lower of cost and net realisable value, against cost.
- Abnormal items: included, against excluded from cost.
- Those last four rows are the causes of difference the reconciliation topic works with.
Test yourself
1. Give four points of difference between cost and financial accounting. Purpose - the result of the business against the cost of each object; audience - external against internal; classification - by nature of expense against by function and traceability; and stock valuation - the lower of cost and net realisable value against cost.
2. Why does cost accounting exclude abnormal losses? Because including them would make the product appear to cost more for a reason unconnected with making it, and the cost per unit would then be useless for pricing and control. They are charged to profit and loss instead.
3. Is cost accounting compulsory? Not generally. It is voluntary except where the Central Government prescribes the maintenance of cost records and cost audit for a particular class of companies.
4. Name the four causes of difference between the cost profit and the financial profit. Different stock valuation; abnormal items excluded from cost; purely financial items appearing in the financial accounts only; and over- or under-absorption of overhead.
Answer in one sentence
Distinguish cost accounting from financial accounting. Financial accounting records and reports the result and position of the business as a whole to external users, in a form prescribed by statute, classifying expenditure by its nature and valuing stock at the lower of cost and net realisable value; whereas cost accounting ascertains the cost of each product, job, process or service for internal management in whatever form is useful, classifying expenditure by function and traceability, measuring in quantity as well as money, valuing stock at cost, and excluding abnormal items from cost altogether.
The rest of this subject
These notes are cut from the University's printed syllabus. Open the syllabus itself, or the past papers, for the same subject.