Cost Accounting System: Necessity and Essentials

In this article we will discuss about:- 1. Introduction to Cost Accounting System 2. Necessity for Cost Accounting System 3. Reports Provided by Cost Accounting Department 4. Essentials of Good Cost Accounting System 5. Essential Factors for Good Cost Accounting System 6. Practical Difficulties in Installation of Cost Accounting System 7. Suggestions to Overcome Practical Difficulties of Cost Accounting System.

Contents:

  1. Introduction to Cost Accounting System
  2. Necessity for Cost Accounting System
  3. Reports Provided by Cost Accounting Department
  4. Essentials of Good Cost Accounting System
  5. Essential Factors for Good Cost Accounting System
  6. Practical Difficulties in Installation of Cost Accounting System
  7. Suggestions to Overcome Practical Difficulties of Cost Accounting System

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1. Introduction to Cost Accounting System:

Cost Accounting is a conscious and rational procedure by Accountants for accumulating costs and relating such costs to specific products or departments for effective management action.

Cost Accounting establishes budgets, standard costs and actual costs. Cost Accounting is a set of procedures used in refining raw data into usable information for management decision making, for ascertainment of cost of products and services and its profitability.

Cost accounting is a Management Information System which analyses past, present and future data to provide the basis for managerial decision making. Cost Accounting is a system of foresight and not a postmortem examination, it turns losses into profits, speeds up activities and eliminate wastes.

A Cost Accounting System that simply records costs for the purpose of fixing sale prices has accomplished only a small part of its mission. Cost Accounts are keys to economy in manufacture and are indispensable to the intelligent and economical management of a factory. Cost Accounting is becoming more and more relevant in the ever growing economic scenario. Cost Accounting becomes an important aid to modern management.


2. Necessity for Cost Accounting System:

A company having a proper cost accounting system will help the management in the following ways:

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1. The analysis of profitability of individual products, services or jobs.

2. The analysis of profitability of different departments or operations.

3. The analysis of cost behaviour of various items of expenditure in the organization. This will help in future cost estimation with reasonable accuracies.

4. It locates differences between actual results and expected results. Such differences can be also traced to the individual cost centres with the efficient cost system.

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5. It will assist in setting the prices so as to cover costs and generate an acceptable level of profit.

6. The effect on profits of increase or decrease in output or shutdown of a product line or department can be analyzed with by adoption of efficient Cost Accounting System.

7. The costing records serve to analyze the final accounts of a company i.e., the manufacturing, trading and profit and loss accounts, in such a way as to give a detailed explanation of the sources of profit or loss.

8. Cost Accounting data generally serves as a base to which the tools and techniques of Management Accounting can be applied to make it more purposeful and management oriented.

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9. The cost ascertainment, allocation, distribution can be efficiently made under efficient costing system.

10. Cost records are the base for the Management Information Systems.

11. The Cost System generates regular performance statements which management need for control purposes.

12. Cost Accounting System is not only applicable to manufacturing organizations or functions but also extended to service organizations and functions.

13. Cost comparisons between different departments, machines and alternative processes help management to maintain maximum efficiency is possible with the adoption of efficient Costing System.

14. The costing information will help in making reliable estimates and will also help in submission of tenders.

15. Costing checks recklessness and avoids occurrence of mistakes.

16. It provides invaluable aid to management in performing its functions of planning, evaluation of performance, control and decision making.

17. It facilitates delegation of responsibility for important tasks and rating of employees.

18. It enables to distinguish profitable and non-profitable activities.

19. It helps in determination of break-even point i.e. the level of activity where the firm reaches no profit no loss situation.

20. It aids in determining and enhancing levels of efficiency and eliminates wastage of men, materials, machines and money. All sorts of wastages are also minimized.

21. The costing information will find a way out in periods of trade depression and competition.

22. It provides data for preparation of periodical Profit and Loss Account.

23. It facilitates the assessment of Excise duty, Customs duty, Income-tax.

24. It helps the government in formulation of policies regarding industry, import, export, taxation, etc.

25. It helps the government in fixation of administered prices, tariff protection, wage level fixation etc.

26. The Costing System will aim at increase in operational efficiency and cost reduction, which helps the consumers in getting reduced prices.

27. It discloses the relative efficiencies of different workers which facilitate to frame suitable wage/reward policies.

28. The efficiency of public enterprises can be compared with the private sector if cost data is available.

29. The operation of Cost System enables Cost Audit which will bring out inefficiencies and frauds.

30. Basing on cost information, the limited resources will be allocated to maximize profitability of the organization.

31. Reliable capital investment decisions can be taken if it is supported with cost data.


3. Reports Provided by Cost Accounting Department
:

The Cost Accounting Department of a big manufacturing company provides various reports to its executives as part of management information system.

Some of such reports are:

(a) Cost sheets

(b) Material consumption reports

(c) Inventory reports

(d) Labour utilization reports

(e) Idle time reports

(f) Labour turnover reports

(g) Overhead reports

(h) Capacity utilization reports

(i) Production reports

(j) Spoilage and defective reports

(k) Statements of Comparison with budgets

(l) Statements of comparison with standards

(m) Statement of reconciliation of financial accounts and cost accounts

(n) Segmental profitability reports

(o) Product-wise profitability reports

(p) Statement of apportionment of overheads

(q) Statements of sales affected compared with budgets

(r) Statement of expenses on research and development compared with budgeted amounts


4. Essentials of Good Cost Accounting System
:

A good Costing System will consist of the following characteristics:

(a) The Costing System adopted in a particular organization must suit its nature and size of business and its information needs.

(b) The Costing System must be economical to the organization and the benefits derived from the system should be more than its cost of installation and operation.

(c) The system should be more flexible enough to take care of changing business situations and information needs of the organization.

(d) The system should be simple to understand and easy to operate. The users of costing data should be convinced of the Costing System from which the data is derived.

(e) The Costing System should be devised with the coordinated efforts of all the concerned departments and their staff. This will reduce the difficulty in implementation of Cost System.

(f) The Costing System should ensure proper accounting for materials, labour and overheads and proper classification of transactions should be done at the level of recording.

(g) Adoption of Activity Based Costing System will increase the accuracy in allocation, appor­tionment and absorption of overheads, which leads to correct ascertainment of cost per unit of product or service.

(h) Integration of Financial Accounting and Cost Accounting Systems will avoid duplication of work. The financial and cost accounts should be interlocked together and should be reconciled periodically.

(i) The Costing System should clearly mention the details of records to be maintained and the degree of accuracy of data required.

(j) Before devising a Costing System, the need and objectives of the system should be identified.

(k) Since the Costing System is for internal control purpose, it should meet the requirements of management and its information needs.

(l) The Costing System should concentrate more on ascertaining the significant variables of the manufacturing unit which are amenable to control and affect the concern. For example, wages are amenable for control whereas marketing cost is situation oriented.

(m) Before a Costing System is devised and adopted, thorough study should be conducted on production process, methods of work, wage system, input requirements, information needs, financial accounting system etc.

(n) Wherever possible, concepts like Management by exception, Responsibility accounting etc. should be adopted into the Costing System.

(o) All forms and proforma should be adopted to minimize clerical work and formulate efficient system of material control and adequate wage procedure.

(p) The Costing System must take care of the importance of comparability of data, with previous period’s data, with competitors’ data, with industry averages.

(q) The costing system should fix-up the duties and responsibilities of Costing Department staff and the cooperation that can be sought from other functions/departments.


5. Essential Factors for Good Cost Accounting System
:

In designing and installation of a good Cost Accounting System, the following factors should be given due consideration:

(a) The information needs of the management and the level of details needed.

(b) The frequency of the information to be provided.

(c) The factory layout and production process, method of production and type of process.

(d) The level of control to be exercised over production and cost centres.

(e) The nature of raw material and labour used in the process.

(f) The organization structure and degree of decentralization.

(g) The speed and accuracy in requirement of information.

(h) The information needs of different Cost centres.

(i) The relative size of the Cost units and Cost centres.

(j) The level of integration of Cost and Financial accounts desired.

(k) The requirement of uniformity of accounting for comparability of data with other units in the same industry.

(l) The level of mechanization and computerization needed.

(m) Standardization of records and accounting procedures and control systems.

(n) The level of application of Costing Techniques viz., standard costing, budgetary control and Marginal costing.

(o) Cost minimization without affecting the efficiency of information needs.

(p) The management’s intention and the cooperation of workers and staff needed in installation of Costing System.

(q) Implementation of proper wage system and inventory valuation, stores issues.

(r) The cost behaviour and element-wise classification of costs and selection of equitable basis for allocation, apportionment and absorption of overheads.

(s) Cost Accounting System should be simple and easy to operate.

(t) The expenses of the Costing System should commensurate with the benefits of its installation.


6. Practical Difficulties in Installation of Cost Accounting System
:

The practical difficulties that are expected at the time of installation of Costing System, are summarized below:

1. Lack of Support from Top Management:

The basic objective of Cost Accounting System is to provide necessary information to the internal management for the purpose of problem solving, decision making and control. Without necessary support and recognition from the top management, the very purpose of Cost System is vitiated.

2. Resistance from Existing Accounting Staff:

The existing accounting staff may resist the introduction of Cost Accounting System in the organization due to fear of loosing job recognition and importance after the implementation of the system.

3. Lack of Cooperation from other Departments:

The employees of other departments may not cooperate for the installation of Cost Accounting System due to fear of increase in work load, bring-out inefficiency etc.

4. Resistance from Operating Level Workers:

The foremen, supervisors, workers and other operating level staff may resent the introduction of cost system on the ground that it will increase their job responsibilities and paper work and may fear that it may cause change in wage structure.

5. Shortage of Trained Staff:

The installation and implementation of cost system requires trained, qualified and experienced staff which may be shortage.

6. Uneconomical Cost System:

Sometimes the detailed cost system proposed to be installed may cause substantial installation and operating cost.


7. Suggestions to Overcome Practical Difficulties of Cost Accounting System
:

The steps to be taken to avoid the above said practical difficulties while installations of a Cost System in the organization are as follows:

(a) The management should be convinced of the benefits which can derive by installation and operation of a Cost System.

(b) Non-cooperation and resistance can be overcome by explaining the simplicity and use of the system and should be ensured that the system will benefit the organization and increase its profitability. They should be given assurance that the system will not reduce the importance of existing staff.

(c) To overcome resistance, the existing staff should be properly trained to take up the responsibilities of the Costing System.

(d) All levels of staff and managers in the organization should be properly trained and made familiar with the Costing Procedures.

(e) The system should be simple to understand and easy to operate.

(f) The benefits derived from Cost System should be more than the costs incurred on its installation and operation.

(g) A qualified and experienced cost accountant should be assigned with responsibility to achieve the desired objectives of the Cost System. He should be capable of coordinating with other departments, and operating workers.

(h) The Cost System designed and installed should meet specific requirements of the concern and it should reduce unnecessary paper work of the organization.

(i) The accounting staff should be convinced that the Cost System will only supplement the Financial Accounting System and it is not going to reduce the importance of existing accounting function.

(j) Regular meetings with accounting staff and user departments will clarify all doubts about the system and eliminate ambiguity.


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