Why Cost Accounting?
At this point you may be wondering if cost accounting is synonymous with regular (financial) accounting and why cost accounting is needed in the first place.
At a fundamental level, cost accounting is a managerial tool- it provides information to managers and helps take management decisions.
In fact, cost accounting emerged in response to the limitations of financial accounting:
- It does not provide a clear reason for profit or loss: Sometimes profit/loss may be more or less due to inflation or trade depression, not efficiency/inefficiency.
- It does not give the reason for the net result or show where the weakness lies- just the profit or loss.
- It does not help fixing prices: The total cost of production is shown but does not help determining the prices of products, services, etc.
- There is no classification of expenses and accounts: Data relating to costs incurred by departments/ services are not provided separately, nor are per unit cost of product lines. Similarly, expenses are also not classified (as direct/indirect, etc.) and the value added in each process is not reported.
- It does not provide data for comparison and decision-making and does not help control cost.
- It does not provide standards to assess performance and only provides historical information, not day-to-day cost information.
- No distinction is made between avoidable and unavoidable wastage and does not provide enough information for reports to outside agencies like banks, government, etc.
- Financial accounting is unable to answer questions like:
- If an order or contract is accepted, is the price obtainable sufficient to show a profit?
- Should an attempt be made to sell more products or is the company operating to capacity?
- What would the effect on net profit be if the manufacture/sale of product A were discontinued and efforts were made to increase the sale of B? Etc.