What Cost Accounting Is For, and What It Is Not
Chapter One
Syllabus topic 2, "Difference between Financial and Cost Accounting"
Pages 1 to 2 of 82
In one line
Financial accounting says what the business as a whole earned; cost accounting says what each thing it made or did actually cost.
The question that makes the subject necessary
A firm makes three products and its profit and loss account shows a profit of Rs 14,00,000. That is a true and useful figure, and it answers to the shareholder, the bank and the tax department.
It cannot answer any of these:
- Which of the three products makes money and which is carried by the others?
- Should we accept an export order at a price below our usual one?
- Was this month's wastage worse than last month's?
- What should we quote for a job we have never done before?
Every one of those needs a cost per unit, and the profit and loss account has none. It is arranged by nature of expense - wages, rent, power - and not by what the money was spent on.
Cost accounting rearranges the same expenditure so that each rupee is attached to a cost object: a product, a job, a batch, a process, a service.
Three words to fix now
Cost object. The thing whose cost is being ascertained. A shirt, a repair job, a kilometre run by a bus, a patient-day in a hospital.
Cost unit. The unit of quantity in which the cost is expressed. Per shirt, per job, per tonne-kilometre, per patient-day. Choosing it is the first decision in any service costing question.
Cost centre. A location, person or item of equipment against which costs are gathered before being charged onward. A department, a machine, a foreman.
What cost accounting is NOT
It is not a second set of books that contradicts the first. It uses the same expenditure. Where the two profits differ, the difference is explainable item by item, and reconciling them is a topic of this very module.
It is not only for factories. MU names the provision of services expressly in her third concept, and a hospital, a transport company and a college all have cost units.
It is not estimation. A cost sheet is built from recorded figures. Estimating comes later, and it rests on the same technique.
It is not statutory in the way financial accounting is. Nobody files a cost sheet with the Registrar. It is prepared because management needs it - which is why its form is flexible and its logic is not.
Where the Cost Accounting Standards fit
The Institute of Cost Accountants of India has issued 25 Cost Accounting Standards, CAS-1 to CAS-25. They standardise how particular costs are determined, so that two accountants given the same facts reach the same figure.
What Cost Accounting Is For, and What It Is Not
Four of them bear on this paper, and each is named in the chapter it governs: CAS-1 Classification of Cost, CAS-4 on the cost of production and of the provision of services, CAS-6 Material Cost and CAS-7 Employee Cost, with CAS-10 Direct Expenses and CAS-25 Valuation of Inventory beside them.
They are not law. They are issued by the Institute and the Central Government has not notified them, so they bind a cost accountant professionally rather than binding everybody by statute. This book states what each requires, in its own words.
Quick revision
- Cost accounting attaches expenditure to a cost object, so a cost per unit can be found.
- Cost object, cost unit, cost centre - fix all three now.
- Financial accounting is arranged by the nature of expense; cost accounting by what it was spent on.
- The two profits differ for reasons that can be listed, and reconciling them is a topic of this module.
- CAS-1 to CAS-25 are issued by ICAI; six of them touch this paper; they are professional standards, not statute.
Test yourself
1. What can a cost account tell management that a profit and loss account cannot? The cost of each cost object separately - each product, job, batch, process or service - and therefore which of them is profitable, what to quote, and whether an order at a given price is worth accepting.
2. Define cost unit and give one for a transport business. The unit of quantity in which cost is expressed; for transport, the tonne-kilometre or the passenger-kilometre.
3. Is cost accounting confined to manufacturing? No. MU's own concept names the provision of services, and services have cost units of their own.
4. Are the Cost Accounting Standards law? No. They are issued by the Institute of Cost Accountants of India and have not been notified by the Central Government, so they bind professionally rather than by statute.
Answer in one sentence
What is cost accounting? It is the branch of accounting that classifies, records and allocates expenditure to cost objects so as to ascertain the cost of each product, job, process or service and to present that information for managerial planning, control and decision-making, as distinct from financial accounting, which reports the result of the business as a whole.
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.