Cost accounting refers to a system of accounting in which cost information is recorded, summarized, and reported on a periodical basis. The prime aim of this accounting is to ascertain and control costs. It is helpful for the users of cost data in making effective decisions related to the determination of selling price, projection plans and actions, controlling costs, efficiency measurement of the labor, etc. This accounting traces the cost incurred at each level of production, i.e., from the input to the output of the material.
This is an accounting system or branch of accounting which focuses on maintaining a complete record of all monetary transactions of the company and prepares a report of them to present to the management at the end of the financial year. The users of these financial instruments can be internal as well as external. They include the employees, management, shareholders, investors, credit rating agencies, competitors, tax authorities, etc.
In financial accounting, various financial statements are prepared such as income statements, balance sheets, and cash flow statements to calculate the profitability and know the company’s financial position.
Cost accounting is a tool that is used by companies for determining the accounting and costing methods and procedures to calculate the cost. Some of the objectives of this accounting are as follows:
- It is useful in calculating the per-unit cost of various goods and services produced by the organization.
- It is also helpful in presenting an accurate report of operation as well as process costs.
- Cost accounting indicates and prepares a report for the cost of wastage in terms of raw material, time, or money used in the machinery for the production purpose.
- It helps in preparing necessary data and guidelines for calculating the cost of manufactured goods or services rendered.
- Most importantly, this accounting system is beneficial for understanding the profitability of all produced items and informing management about the ways related to profit maximization.
Financial accounting works in order to fulfill various purposes. Some of them are given below:
- It helps in maintaining a systematic record of financial transactions.
- It informs various interesting parties about the financial position of the firm by preparing books of accounting and making them available to the public. This helps the investors in making a rational decision for their investment and creditors in deciding whether to come into a contract with the company or not.
- Financial accounting is useful in ascertaining the result of business operations.
- This system is also beneficial for reporting past performance and prospects.
Cost accounting helps the business firm in maximizing the earnings and utilize the funds effectively via the process of assembling and evaluating information. Various advantages of cost accounting are as follows:
- Cost Object Analysis
Different cost objects like product line, by-product, and distribution channel can be useful in gathering expenses and revenues so that the management can understand which effective additional support is required.
- Discover Causes
It discovers the problems within a firm and finds outthe specific cause of the issue and also suggests possible ways or suggestions to the management to overcome it.
- Trend Analysis
Cost accounting tracks a trend line to determine the expenses surges.
- Determine Cost
It determines the cost during the various levelsof activity of the business. For instance, if management is thinking about the second shift, cost accounting can assume and tell the extra cost that will generate with the second shift.
This system of accounting also helps in knowing the capacity of a business to encourage improved sales levels via examining the value of excess capacity of the company.
Various items included in the financial statement of the company arerevenues, expenses, equity, assets, liabilities, etc. Some of the advantages provided by financial accounting are as follows:
- Maintenance of Business Records
It helps in keeping all the financial records of the business in a systematic order in the books of account.
- Preparation of Financial Statements
By using all the collected data or records, the company can prepare its financial statements to check its financial status.
- Comparison of Result
The financial statements are used to know the financial performance and position of the business. This information can be used to compare the current year’s performance of the company with its previous year’s performance so the profit trend in the business can be understood. The management can also compare the current year’s performance with the performance of other companies to check the competition.
- Act as Legal Evidence
In some legal issues, accurate financial statements can be used as evidence by the company. These issues (if any) can be related to tax evasion, cheating or fraud, bad debts by the company, etc.
- Boost Lenders
The information provided by the financial statements is also beneficial for the company in raising loans from the market. However, this can be possible if the company is earning a good amount of profit, has paid previous debts on time, and has great goodwill in the market.
Some of the objections raised against cost accounting are given below
Cost accounting is very expensive during the stage of the introduction or installation. At this time, double books of account sets have to be maintained which is not economical for small businesses.
- Limited Applicability
Cost accounting cannot be applied by using the same methods and techniques in all types of businesses. These methods and techniques can vary with the type of manufactured product and nature of business. Also, the system is not suitable for small-scale business firms as it is highly expensive.
- Reliance on Highly Skilled Professionals
To conduct the process of cost accounting, the companies have to higher accountants and auditors. They charge very high fees for their services. Also, the organization has to provide additional training to the employees to sufficiently co-operate with data input otherwise the system can become ineffective.
- More Complex
The process of cost accounting involves a number of steps such as collection and classification of expenses, allocation and apportionment of expenses, and so on. These steps are highly complicated and demand various forms and documents for presentation which causes delays in accounting preparation.
Some of the limitations of financial accounting are as follows:
- Not Helpful in Price Fixation
It does not play any role in the price fixation of goods and services, production orders, and lines of products in the market.
- Provides Only Historical information
Financial accounting and its information are mainly based on historical data and the costs that have already been incurred. It does not provide the information onthe day-to-day cost incurred in the business which can affect the making of the effective planning by the management.
- Technical Subject
Accounting is a technical Subject and it is very difficult for a layman to understand and analyze the financial data. Also, it is a very complicated subject with so many principles, conventions, methods, techniques, etc.
- No Analysis of Losses
Financial accounting does not analyze the losses completely. It includes the losses due to defective material, idle time, idle plant and equipment, etc. In other terms, there is no distinction is made in this accounting system between avoidable and unavoidable wastage.
Comparison Chart of Cost Accounting and Financial Accounting
|Basis of Difference||Cost Accounting||Financial Accounting|
|1. Meaning||Cost accounting is that type of accounting system in which various costs incurred during the production activity in the organization are recorded.||Financial accounting is a type of accounting system in which all the financial transactions incurred in the business are recorded to draw the true or correct picture of the financial position of an organization at a particular date.|
|2. Type of Information||Under this accounting system, the information related to material, labor, and overhead which are used during the process of production is recorded.||Under this accounting system, the information related to monetary terms or day-to-day transactions of the business is recorded.|
|3. Type of Cost Used||Cost accounting works by using both historical and pre-determined costs.||Financial accounting works by using only historical costs.|
|4. Types of Accounting||Cost accounting has mainly four types:
||Financial accounting has two types or methods:
|5. Statements Prepared||In this accounting system, only a cost sheet statement is prepared.||In this accounting system, four statements are prepared:
|6. Users||The information derived with the help of cost accounting is used by the internal management, of the company including employees, managers, directors, supervisors, etc.||The information provided by the financial accounting is used by internal as well as external parties such as creditors, tax authorities, investors, brokers, shareholders, customers, credit rating agencies, mutual funds, etc.|
|7. Valuation of Stock||The valuation of stock in this accounting is done at cost.||The valuation of stock in this accounting is done at cost or net realizable value/market price, whichever is less.|
|8. Mandatory||Cost accounting is mandatory only for the manufacturing firms, all other types of firms are free to decide whether to conduct cost accounting or not.||Financial accounting is mandatory for alltypes of business firms, i.e., not any company can refuse to maintain their financial records as per the Companies Act, 2013. This is because this accounting gives information about the business’s financial position to the interested parties.|
|9. Frequency||The information derived from the cost accounting is frequently prepared by the accountant and reported to the management.||The information derived from financial accounting, i.e., financial statements arereported to the management at the end of the financial year or accounting period which is 31st March.|
|10. Public Reporting||Cost accountants do not have to prepare or present any statement to the public.||Financial accountants have to prepare and present the statements to the public in the case of public companies.|
|11. Format||It is not necessary to follow a specific format to prepare the statements. The intention is only to record all the required details.||There are proper formalized principles such as GAAP, IFRS, Companies Act, 2013 (In India), etc., and formats applied while recording the transactions and preparing the statements.|
|12. Profit Analysis||Here, the profit is generally analyzed only for a particular product, batch, or process.||Here, the profit is analyzed for the whole organization along with income and expenditures during an accounting period.|
|13. Purpose||The main purpose of cost accounting is to reduce and control costs in the business.||The main purpose of financial accounting is to maintain complete records of the financial transactions of the business to determine the profitability and financial position of the business.|
|14. Forecasting||Here, forecasting can be done with the help of budgeting techniques.||Forecasting is not possible in the case of financial accounting.|
|15. Relative Efficiency||It provided useful information about relative efficiency of workers, machinery, etc.||It does not provide any useful information about the relative efficiency.|
|16. Coverage||It analyzes operations which are divided by divisions, segments (operational or geographical), contracts, etc.||It analyzes the operations of a company as a whole.|