COST ACCOUNTING AND FINANCIAL ACCOUNTING

meaning=Cost Accounting is an accounting system, through which an organization keeps the track of various
costs incurred in the business in production activities.++Financial Accounting is an accounting system that
captures the records of financial information about the business to show the correct financial position of the
company at a particular date.
purpose=The main purpose of Financial accounting is to prepare Profit and Loss Account and Balance Sheet for
reporting to owners or shareholders and other outside agencies, i,e., external users.++ The main purpose of cost
accounting is to provide detailed cost information to management, i.e., internal users.
statutory requirements=These accounts are obligatory to be pre- pared according to the legal requirements of
Companies Act and Income Tax Act.++ Maintenance of these accounts is voluntary except in certain industries
where it has been made obligatory to keep cost records under the Companies Act.
analysis of cost and profit=Financial accounts reveal the profit or loss of the business as a whole for a particular
period. It does not show the figures of cost and profit for individual products, departments and processes.++ Cost
accounts show the detailed cost and profit data for each product line, department, process etc.
users=Information provided by the cost accounting is used only by the internal management of the organization
like employees, directors, managers, supervisors etc.++Users of information provided by the financial accounting
are internal and external parties like creditors, shareholders, customers etc.
primary objective=Controlling and reducing cost++Towards maintaining the complete record of the financial
transactions.
Historical and predetermined costs =It is concerned almost exclusively with historical records. The historical
nature of Financial accounting can be easily understood in the context of the purposes for which it was
designed.++ It is concerned not only with historical costs but also with predetermined costs. This is because cost
accounting does not, end with what has happened in the past. It extends to plans and policies to improve
performance in the future.
Format of presenting information= Financial accounting has a single uniform format of presenting information,
i.e.,Profit and Loss Account, Balance Sheet and Cash Flow Statement.++ Cost accounting has varied forms of
presenting cost information which are tailored to meet the needs of management and thus tacks a uniform format.
Types of transactions recorded=Financial accounting records only external transactions like sales, purchases,
receipts, etc., with outside parties. It does not record interal transactions.++ Cost accounting not only records
external transactions but also internal or inter-departmental transactions like issue of materials by store-keeper to
production departments.
Types of statements prepared=Financial accounting prepares general purpose statements like Profit and Loss
Account and Balance Sheet. That is to say that financial accounting must produce information that is used by
many classes of people none of whom have explicitly defined informational needs.++ Cost accounting generates
special purpose statements and reports like Report on Loss of Materials, Idle Time Report, Variance Report, etc.
Cost accounting identifies the user, discusses his problems and needs and provides tailored information.
COST ACCOUNTING & MANAGEMENT ACCOUNTING=
1.Inherent meaning=Cost accounting revolves around cost computation, cost control
, and cost reduction.++Management accounting helps management make effective decisions about the business.
2.Application=Cost accounting prevents a business from incurring costs beyond budget.++Management
accounting offers a big picture of how management should strategize.
3.Scope – Cost Accounting vs Management Accounting++The scope is much narrower. The scope is much
broader.
4.Measuring grid=Quantitative.++Quantitative and qualitative.
5.Sub-set=Cost accounting is one of the many sub-sets of management accounting.++Management accounting
itself is pretty vast.
6.Basis of decision making=Historic information is the basis of decision making.++Historic and predictive
information is the basis of decision-making.
7.Statutory requirement – Cost accounting vs management accounting=Statutory audit of cost accounting is a
requirement in big business houses.++The audit of management accounting has no statutory requirement.
8.Dependence=Cost accounting isn’t dependent on management accounting to be successfully
implemented.++Management accounting is dependent on both cost & financial accounting for successful
implementation.
9.Used for=Management, shareholders, and vendors.++Only for management.
TOOLS AND TECHNIQUES OF MANAGEMENT ACCOUNTING: Some of the tools and techniques used
by a management accountant are as under :
(1) Standard Costing: It is a technique in which pre-determined standards of costs are set in advance and actual
performance is compared with it. Variances are ascertained through which control function becomes effective.
(2) Marginal Costing: It is a modern technique of determining cost in which costs are divided into fixed and
variable. Fixed costs are not included as a part of cost of production but recovered from the margin between sales
price and variable cost. The system is extremely useful in presenting information before management with respect
to cost, revenue and profits. (3) Budgetary Control: Business policies and plans are expressed in financial terms
under the system of budgetary control. Budgets are prepared covering every aspect of business. Actual
performance is compared with budgeted figures and co-ordination and control are made effective through budget
reports. (4) Historical Costing: Historical costing is concerned with recording and ascertaining cost after they
have been incurred. As against that in standard costing, standards for cost are set for each element of cost in
advance before manufacturing is undertaken. Historical costing is not of much use to management but may
provide basis for future planning. (5) Financial Policy and Accounting: Financial policy in concerned with
determining how business is to be financed, what types of securities are to be issued and what should be the sources
of long term and short term borrowings. Financial accounting, is the basis of management accounting. Besides, it
is compulsory for joint stock companies to publish final accounts. (6) Control Accounting: It is a technique used
in different systems. For example, variance analysis in standard costing, system of statement and report in
Budgetary Control. Internal check and internal audit etc., are the techniques of control accounting. It is in
presentation of data in this respect that the management accountant can show his ingenuity in analysis and
interpretation of data. (7) Decision Accounting: The management accountant suggests alternative courses of
action on a particular project, based on the data furnished by above systems. When decisions regarding selecting
a capital expenditure project to be taken up or in case of make or buy decisions, pricing decisions etc. the
management accountant presents the data, in analytical form and suggests the profitable course of action in the
given circumstances. The management gets considerable help in making decisions on the basis of such
information. (8) Analysis of Financial Statements: According to this tool and technique Analysis of Financial
Statements are attempted by means of Trend Analysis of Financial Statements, Comparative Financial
Statements, Ratio Analysis, Fund Flow Statement etc. By analysing financial statements management can judge
the ability to pay the liabilities of the firm, future position of the fund flow and cash flow, projected profit, future
earning capacity etc. In addition, the management accountant makes use of return on capital employed
technique, break even analysis, inter-firm comparison, operations research etc. (9) Revaluation Accounting: The
management is always interested to preserve capital intact in the business. But, during period of rising prices, the
value of capital is adversly affected in spite of calculating profits by any method. In this context, J. Batty has
promptly noted that "Revaluation accounting is used to denote the methods employed for overcoming the
problems connected with fixed assets replacement in a period of rising prices." (10) Internal Auditing: Internal
Auditing is a type of control tool which is an important evaluating activity. Internal Auditing examines accounting
and financial operations of an enterprise.
OBJECTIVES OF BUDGETARY CONTROL:
Of course, basic objective of budgetary control is to lay down the goals of business so that available resources may
be utilised most efficiently. To be more precise, the main objectives of budgetary control are as follows: business.
(1) To define in clear terms the basic goals of the (2) To inform the persons concerned of these goals.(3) To chalk
out a detailed plan of action. To co-ordinate various activities in such a manner that optimum utilisation of
resources. (5) To provide a method of evaluating the actual activity.
Let us examine the above objectives in some more detail:
1).Defining Basic Goals: In essence, budgeting implies determination of basic goals and formulation of short
term plans to achieve them. Thus, budgets establish a harmony between the long term and short term goals of the
enterprise. For the achievement of short term goals, targets are fixed. These targets help in the realisation of goals
in two ways one, through providing proper information and second, by providing effective incentives. Detailed
targets are fixed for various operations which makes it easy to know who is responsible for what. Also, the
performance of executives can be evaluated in the light of these targets. This encourages the executives to improve
their performance. The targets clarify the basic goals of the enterprise. (2) Communicating the Goals: Clear
definition of basic goals has no meaning, if the persons concerned are unaware of them. In fact, budgets are
prepared mainly to inform the executives and employees at all levels about the basic goals of the enterprise. It is
the duty of the top executives to make the low level officials aware of the work they are expected to do. Thereby,
the low level officials come to understand the basic goals of the enterprise and this understanding motivates them
to make an effort to realise them. (3) Making a Plan of Action: Budgets are prepared with a view to make a plan
of action so that it is clearly known what is to be done, how it is to be done and by whom it is to be done. This is
necessary to avoid misunderstanding on the part of excutives and employees. Moreover, the persons concerned
can have proper guidance as to the direction in which the efforts are to be made. Truely speaking budget shows
the path towards the goal of the enterprise. It represents a time bound programme showing what is to be
accomplished within a definite period of time. (4) Co-ordination Between Various Activities and Efforts:
Budgets are prepared to ensure that different departments of the enterprise do not operate inconsistently. Their
activities must be oriented towards the goal of the enterprise. The budget of the production department must not
provide for the manufacturing of a product which it is not possible for the sales department to sell. Conversely,
the sales department must not provide for the sale of a product which production department cannot produce in
required quantities. The purchase department must not purchase materials in excess of the requirements of the
production department. Budgets avoid such inconsistencies between the behaviour of different departments, and
thereby it avoids imbalances and wastage of resources. While preparing the budgets, the heads of various
departments are therefore required to keep in contact with one another constantly. (5) To Provide an Instrument
of Control: Since budget represents a detailed plan of operation, the responsibility of each department, official
and employee gets fixed making it possible to evaluate it in an objective manner. Periodically budget reports are
prepared department-wise in which actual performance is compared with the predetermined targets of the budget.
It becomes obvious to what extent the performance of an employee is upto the standard set in the budget. Of
course, while evaluating their performance, circumstantial changes need to be taken into account. The officials
might have failed to achieve budget targets due to the change in circumstances beyond their control. The effect of
change in external and uncontrollable factors must not be overlooked.
SIGNIFICANCE OF BUDGETARY CONTROL: Budgetary control is an important instrument of control with
the management. Thereby they can visualise future adversities and make provisions to face them successfully. It
helps them evaluate the working of different departments and performance of employees as well. The importance
of budgetary control may be summarised as under:
(1) Planning: Budget is a short term plan of future activities. As it gives an opportunity to make estimates of future
forces and visualise the possible contingencies, it enhances the efficacy of management. (2) Co-ordination: As a
comprehensive master budget is prepared on the basis of departmental budgets, it ensures co-ordination, and
makes all departments to co-operate in attaining the targets fixed by the budget. (3) Control: Budget targets set a
standand against which actual performance is evaluated. Thereby it reveals the degree of success achieved in the
direction of targets. If necessary, corrective measures can be devised. Thus, it makes it possible to exercise control
over each aspect of operation and also over the activities of each official. (4) Decentralisation: Budget facilitates
decentralisation of business activity and distribution of responsibilities among the officials. The business unit gets
divided into different departments. Each of these departments shoulders the responsibility to prepare and
implement the budget of its own. For this purpose, authority and powers to do so are delegated to the heads of
departments. (5) Efficiency: Before budget is prepared, all factors affecting the business operation are studied in
detail. Consequently, the management come to know in advance the possibile deficiencies on the one hand and
the scope of their removal on the other. This knowledge enhances the efficiency of business unit. (6) Co-operation:
As executives and heads of departments have to meet often to discuss the provisions of budget, they can
understand one another's problems. Consequently, the scope of conflicts is reduced and that of mutual co-
operation is increased. (7) Efficient Communication: It ensures effective communication. To give in writing the
goals, targets, programmes and responsibilities to all persons concerned is an integral part of the implementation
of the budget programme, This removes the possibility of doubts and misunderstanding as to the kind of work to
be done, the manner in which it is to be done and time period within which it is to be accomplished. As a result,
a healthy atmosphere of cordial relations is created in the unit. (8) Efficient Use of Resources: The budget ensures
optimum utilisation of available resources. Efforts of all officials and employees are directed towards the same
goal. Hence, physical and human resources can be utilised to the fullest extent and the aim of maximum profits
can be achieved.
(9) Highet Morale and Productivity: Since supervisor and employees are also called upon to take part in framing
business budgets, their morale is strengthened. A harmony is established between the goals of the enterprise and
those of the individual employees. Employees are inspired to put their heart in the implementation of budget
programmes. Consequently, productivity of the enterprise gets a boost. (10) Management by Exception: Once a
detailed programme is framed, authority and responsibilities are delegated to the departmental and sectional
heads. Top management is therefore relieved of this burden to a large extent. They can spare their time and energy
to tackle only those issues where performance falls short of targets. Thus, management is required to devote their
time and attention to exceptional cases only. (11) Easy Availability of Bank Loans: The banks do not hesitate to
advance loans to those business units wherein operations are effectively controlled through budgeting. The bankers
have trust in such units' capacity to repay loans with interest on time. (12) Fosters Calculating Attitude : The
budget compels all executives to consider carefully the impact of every proposal put-forward by them on costs.
Hence a habit to calculate gains and losses is developed among them. An atmosphere of cost and profit-
consciousness is built up in the enterprise.
LIMITATIONS OF MARGINAL Costing The system of marginal costing is of great use in times of depression
and otherwise as has been shown. But in normal times it is better to find out the total cost (variable and constant
or fixed)-if it is ascertained on the basis of normal capacity, the danger of misleading Fluctuations in the cost of
production (which is the case when costs are calculated on the basis of actual output) is avoided. The following
shortcomings can be noticed in marginal costing
1).If costs are to be used for fixing normal selling prices, obviously marginal costing is of little value. Constant as
well as variable costs should be included in the total cost of production for determining prices in the ordinary
times. (2) Marginal costing ignores the time factor entirely (only constant expenses reflect cost being connected
with time). Profitability of two jobs cannot be compared suitably unless constant expenses are included (3)
Sometimes a specially low price is quoted to a new customer. The price is based on the argument that if marginal
costs are met, it will be profitable. This may, however, lead to a general lowering of price and thus to losses. (4)
By ignoring the fixed expenses, orders may be accepted which do not permit acceptance of other but more
profitable jobs. By allocating fixed expenses total capacity can be easily kept in mind. (5) A big danger is that in
one's anxiety to maximise production by accepting orders at concessional prices the output may overstep present
limits of capacity. This will mean a big increase in fixed expenses also and this may result in a loss on additional
orders. This danger should be guarded against.
MAIN FEATURES OF MARGINAL COSTING
It may be noted that Marginal Costing is not a distinct method of ascertainment of cost such as job costing or
process costing. It is a technique of applying the existing method to bring out the relationship between profit and
volume of output which may be used in all types of costing like job and process. The main features,
in brief, of marginal costing may be narrated as below: (1) The usefulness of this technique depends upon
identification of costs with changes in output. The costs are divided into fixed and variable element. In case of
semi-variable cost, it
should also be seggregated into fixed and variable.
(i) In computing production cost only variable or marginal costs are taken into account. (ii) The values of stocks
of finished products and work-in-progress are also calculated only on variable costs. (iv) Fixed costs are absorbed
or written off during the period they are incurred and therefore they are not included in product cost or in cost of
stocks or inventories. (v) Profitability of departments or products is determined in the terms of contribution sales
less marginal cost.
IMPORTANCE OF MARGINAL COSTS
1.To aid the decision on whether additional sales at a price below full cost should be made, and generally to aid
in the formulation of pricing policy. 2. To choose between different methods of manufacturing or operating. 3. To
decide whether parts and components should be made within the business, bought outside or sub-contracted. 4.
To asses the economics of proposed capital investment e.g. plant and machinery. 5. To assess whether to initiate
or proceed with a development project. 6. To calculate the level of sales required to break-even (where there is no
profit no loss) or to achieve a given profit, or the profit likely to result from a given level of sales, or the most
economic mix of products for sale.
TECHNIQUES OF COSTING
It is the type of industry which determines which of the eight methods of casting discussed shove will be used in a
particular business However, in addition to these methods these e ta techniques of costing which are not
alternatives to the methods dixcused above use techniques may be used for special purpose of control and policy
in any business irrespective of the method of costing being used there. The techniques are briefly explained below.
1. Standard costing. This is a very valuable technique to control the cost. In this technique, the standard cost is
predetermined as a target of performance and actual performance is measured against the standard. The difference
between standard and actual costs are analysed to know the reasons for the difference to that corrective actions
may be taken 2. Budgetary control. Closely allied to standard costing is the technique of Each technique of
budgetary control. A budget is an expression of a firm's plan in scandal tom costing is used for and badgetary
control is a technique appled to the coupl of total expenditure on materials, wages and overhead by comparing
actual performance with planned a special purpose like cost control or profit planning performance. Thus, in
addition to its use in planning, the budget is also used for control and co-ordination of business operations. 3.
Marginal costing. This is a technique of profit planning. In this technique, separation of costs into fixed and
variable (marginal) is of special interest and importance. This is so because marginal costing regards only variable
casts as the cost of the products Fixed east is treated as period cost and to attempt is made to allocate or apportion
this cost to individual cost centres or cost units. It is transferred to costing profit and loss account of the period.
This technique is used to study the effect on profit of changes in volume or type of output.
4. Total absorption costing. It is a traditional method of costing whereby total costs (fixed and variable) are
charged to products. This is in complete contrast to marginal costing where only variable costs are charged to
products. Although until cerely this was the only technique employed by cost accountants, it is now-a-days
considered to have only a United application 5. Uniform costing. This is not a separate technique or method of
costing like standard costing or process casting Uniform costing simply denotes a situation in which a member of
firms adopt a uniform set of costing principles. It has been defined by CIMA as the use by several undertakings of
the same costing principles and/or practices This helps to compare the performance of one firm with that of other
firms and this to derive the benefit of anyone's better experience and performance.
BREAKEVEN POINT (BEP)
The break-even point (BEP) is the point at which total cost and total revenue are equal. There is no net loss or
gain, and one has "broken even", though opportunity costs have been paid and capital has received the risk-
adjusted, expected return. In short, all costs that must be paid are paid, and there is neither profit nor loss.
Overview
The break-even point (BEP) or break-even level represents the sales amount in either unit (quantity) or revenue
(sales) terms—that is required to cover total costs, consisting of both fixed and variable costs to the company.
Total profit at the break-even point is zero. It is only possible for a firm to pass the break-even point if the dollar
value of sales is higher than the variable cost per unit. This means that the selling price of the good must be higher
than what the company paid for the good or its components for them to cover the initial price they paid (variable
and fixed costs). Once they surpass the break-even price, the company can start making a profit. The break-even
point is one of the most commonly used concepts of financial analysis, and is not only limited to economic use,
but can also be used by entrepreneurs, accountants, financial planners, managers and even marketers. Break-even
points can be useful to all avenues of a business, as it allows employees to identify required outputs and work
towards meeting these. The break-even value is not a generic value and will vary dependent on the individual
business. Some businesses may have a higher or lower break-even point. However, it is important that each
business develop a break-even point calculation, as this will enable them to see the number of units they need to
sell to cover their variable costs. Each sale will also make a contribution to the payment of fixed costs as well. For
example, a business that sells tables needs to make annual sales of 200 tables to break-even. At present the
company is selling fewer than 200 tables and is therefore operating at a loss. As a business, they must consider
increasing the number of tables they sell annually inorder to make enough money to pay fixed and variable costs.
If the business does not think that they can sell the required number of units, they could consider the following
options:
Reduce the fixed costs. This could be done through a number or negotiations, such as reductions in rent
payments, or through better management of bills or other costs.
Reduce the variable costs, (which could be done by finding a new supplier that sells tables for less).Either option
can reduce the break-even point so the business need not sell as many tables as before, and could still pay fixed
costs.
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