Introduction

In corporate world, every company prepares their financial statements which should be as per
companies act 2013. Financial statements provide shareholders with a transparent view of a
company's financial health, performance, and operations through audited Profit and loss , and
Balance sheet. By analysing the company's financial statements, shareholders can assess its
profitability, solvency, liquidity, and overall financial stability. But this is Financial
Accounting. For manufacturing firms it need assistance of Cost accounting. Financial
management gives an overall picture of profit or loss and costing provides detailed product-
wise analysis. Let’s Dive more into what is the major difference in using cost accounting and
financial accounting .

Financial Accounting vs Cost Accounting

Cost accounting is a branch of accounting that focuses on tracking, recording, analysing, and
managing the costs associated with producing goods or services within an organization. It
gathers and accumulate various types of costs, including direct costs and indirect costs also
known as overhead costs, which are incurred to support overall operations but cannot be
directly linked to a single product or service.

Category of Differentiation Cost Accounting Financial Accounting

Meaning Cost accounting can help find Financial accounting helps in

out the production cost or the recording the transactions
cost per unit. It can also help in company-wide. Accountants
cost controlling. use this transaction information
in preparing financial
statements. This determines the
company's financial position
and profitability.

Objective Cost accounting gives us details Indicates the company's

about the cost of production. financial position.
The administration can use this
data to calculate the product's
selling price.

Costs Types Used Cost accounting shows real Financial accounting gives
estimates and expenses. actual figures and costs.

Recording Cost accounting refers to both In financial accounting, real

cost estimation and recording of transactions are considered, and
real transactions. it does not show estimation.
Controlling The main objective of cost In financial accounting, the
accounting is to control cost. It emphasis is mainly on
uses costing tools to do this, transaction accuracy.
like budgetary control and
standard costing.

Period It is performed on demand. The reporting period in

financial accounting is
generally quarterly, semi-
annually or annually.

Reporting Cost accounting has all the Financial accounting does not
characteristics of cost per unit. record non-financial details.

Fix Selling Price Cost accounting procures the Financial accounting cannot
data that helps in specifying the help fix the price for selling
price for selling the products products and services. It shows
and services. the company’s financial
position and the revenue
generated with the selling price
that is fixed.

Report Content A cost accounting summary All information on finances is

might have both operational included in the financial report
and financial information. The as per the accounting
operational data comes from procedure.
sources that are not from the
accounting office.

Relative Efficiency Important information is There is no such information in

provided by cost accounting on financial accounting.
the relative efficiency of
machinery, plants and workers.

Regulatory Framework No regulatory body governs The system of financial

cost accounting reporting. accounting summary is
governed by IFRS or
(Generally Accepted
Accounting Principles).

Inventory Valuation Value the stock at the cost price The market price or the cost
in cost accounting. price, the lower price, is valued
by financial accounting.

Format Cost accounting does not have GAAP ( Generally Accepted

a set format. The provision for Accounting Principles) or the
cost accounting can customise IFRS (International Financial
the format. Reporting Standards) is used
 Objectives of Cost Accounting

The following are the main objectives of Cost Accounting:-

(a) To ascertain the Costs under different situations using different techniques and systems of
costing
(b) To determine the selling prices under different circumstances
(c) To determine and control efficiency by setting standards for Materials, Labour and
Overheads
(d) To determine the value of closing inventory for preparing financial statements of the
concern
(e) To provide a basis for operating policies which may be determination of Cost Volume
relationship, whether to close or operate at a loss, whether to manufacture or buy from market
and so on.
(f) To prepare comparative analysis through data collection
(g) To estimate cost
(h) To disclose and minimize the waste

Scope of Cost Accounting

The scope of cost accounting is very wide and includes the following:
1. Cost Determination: Cost accounting helps in determining the cost of producing
each product or service. This includes both direct costs and indirect costs
2. Cost Control: One of the primary objectives of cost accounting is to control and
manage costs effectively. By analyzing cost variances and deviations from budgets or
standards, organizations can identify areas where costs can be reduced or controlled.
3. Cost Analysis: Cost accountants analyze cost data to provide insights into the
efficiency and effectiveness of various business operations. This analysis helps in
making informed decisions, such as pricing, product mix, and resource allocation.
4. Budgeting and Planning: Cost accounting plays a crucial role in the budgeting and
planning process. It helps in setting cost-related targets and monitoring actual
performance against these targets.
5. Cost Audit: Cost Audit is the verification of correctness of Cost Accounts and check
on the adherence to the Cost Accounting plan. Its purpose is not only to ensure the
arithmetic accuracy of cost records but also to see the principles and rules have been
applied correctly.
6. Inventory Valuation: Cost accounting is essential for valuing inventory accurately. It
helps in determining the cost of goods sold (COGS) and the value of unsold
inventory, which is crucial for financial reporting and tax purposes.
 7. Decision Making: Cost data assists management in making various decisions, such as
make-or-buy decisions, outsourcing, capital budgeting, and investment analysis.
8. Cost Reduction: Identifying and eliminating wasteful or inefficient processes is a
critical aspect of cost accounting. It helps in achieving cost reduction and improving
overall profitability.

Elements of Cost

The cost elements help in understanding and analysing the overall cost structure of an
organization. The primary elements of cost include:
1. Direct Materials: These are the raw materials and components that are directly
consumed in the production process. Calculated using opening + purchase – closing
stock of raw material.
2. Direct Labour: This element represents the cost of labour directly involved in the
manufacturing or production process. It includes wages, salaries, and benefits of
workers who work directly on the product, such as assembly line workers.
3. Direct Expenses: These are expenses that can be directly attributed to a specific
product or project. Examples may include specific tools or equipment used
exclusively for a particular product's production.
4. Indirect Materials: Material which are part of the overall manufacturing process, are
not integrated into the final product but are still essential for the production process.
Indirect materials may include items like lubricants, cleaning supplies, or small tools
used in manufacturing.
5. Indirect Labour: Payment to workers who are not directly involved in producing
goods or supplying services. It includes salaries and wages of employees who support
the production process indirectly, such as maintenance staff, supervisors, or quality
control inspectors.
6. Indirect Expenses (Overheads): Indirect expenses, often referred to as overhead
costs, encompass all other costs that are not directly tied to a specific product or
project. These include rent, utilities, depreciation, insurance, office supplies, and
administrative salaries.
 Material Cost -Inventory control and EOQ

Inventory control, also known as inventory management, is the process of overseeing and
regulating a company's inventory of goods or products to ensure efficient and effective
operations. It involves monitoring the quantities, location, and movement of inventory items
within a business. The management may employ various method of inventory control to have
balance
a) By setting Quantitative Levels
b) On the basis of relative classification
c) Using Ratio analysis
d) Physical Control

1) By setting Quantitative Levels:

 Re-order Stock Level –
o When to Order that is it ensure that you have sufficient products on
hand to meet customer demand without overstocking, which can tie up
capital and storage space
o Enough to cover both normal and abnormal consumption situation
before placing order
o ROL = Maximum consumption x Maximum Re-order Period
 Maximum Stock Level
o Upto How much to stock
o This helps you adapt to evolving business conditions through period
view and adjust the maximum stock level
o Highest level of quantity which can be held in stock at any time
o Max stock level = Reorder level + Re-order quantity – (min
consumption x min re-order period)
 Minimum Stock Level
o At least How much to stock
o Maintaining a minimum stock level is essential for businesses to avoid
stockouts, which can result in lost sales, dissatisfied customers, and
disruptions in production.
o Lowest level of quantity which can be held in stock at any time
o Min stock level = Re-order stock level – (Avg consumption rate x Avg
Re-order period )

 Average Stock Level

o Stock normally kept ,also known as normal stock level
o It provides insights into how well a company manages its inventory
and can be used for various purposes, including cost analysis, demand
forecasting, and optimizing order quantities
o Avg stock level = max stock level + min stock level
2
  Danger Stock Level
o While "danger stock level" isn't a standard term, it's crucial for
businesses to understand and monitor their minimum stock levels,
reorder points, and safety stock to ensure that inventory doesn't fall to a
point where it jeopardizes operations. Proper inventory management
helps strike a balance between avoiding excess stock and preventing
stockouts
o Kept for emergency requirement
o Danger level = Avg consumption x lead time for emergency purchase

 Buffer Stock
o a quantity of inventory that a business holds in excess of its average
demand.
o It acts as a buffer to protect against fluctuations in demand, lead time
variability, and supply chain disruptions.
o Buffer stock is an essential part of effective inventory management to
ensure that products are available when needed that is to meet sudden
demand or contingency

2) ABC Analysis:
ABC analysis categorizes inventory items into three groups based on their value and
importance. "A" items are the most valuable and require tight control, while "C" items are of
lower value and may have less stringent control. It helps businesses allocate resources and
focus their efforts on managing inventory more effectively by recognizing that not all items
have the same impact on costs or operations.
1. Category A (High-Value Items):
 This category represents a relatively small number of items in the inventory,
but they account for a significant portion of the total inventory value.
 These items are typically high-value or high-cost products.
 Close attention and tight control are necessary for Category A items because
they have a substantial impact on overall inventory costs and profitability.
 Frequent monitoring, accurate forecasting, and efficient order management are
crucial for Category A items.
2. Category B (Medium-Value Items):
 This category includes a moderate number of items that have a moderate
impact on the total inventory value.
 B items are somewhat less critical than A items, but they still require regular
monitoring and control.
  Management practices for Category B items might involve periodic review
and reorder points to ensure that they are well-managed and do not result in
excessive holding costs.
3. Category C (Low-Value Items):
 Category C items make up the majority of items in the inventory, but they
represent a relatively small portion of the total inventory value.
 These items are typically low-cost or low-value products.
 While these items have less impact on overall inventory costs, they should not
be entirely neglected. Inventory control for Category C items may involve
more relaxed policies and occasional reviews.

It helps mitigate risks associated with managing inventory, especially for high-value or high-
demand items that can significantly impact operations and financial performance and assists
in more accurate demand forecasting for critical items, reducing the chances of stockouts or
overstocking.
 Material Cost – Economic Order Quantity

Re-order quantity represents the specific quantity of a product or item that a business should
reorder when its inventory level drops to a certain point. The reorder quantity is determined
based on a balance between the costs associated with holding inventory (carrying costs) and
the costs of ordering or replenishing inventory (ordering costs). The objective is to minimize
the total inventory costs while ensuring that the business does not run out of stock when
needed

Economic order quantity is a formula which is used to determine the ideal quantity to be
placed at a time to minimize the ordering cost and carrying cost. It helps businesses
determine how much of a product to order each time to achieve cost-efficiency while
ensuring an adequate supply to meet demand.

Where,
 Annual Requirement (A) - It represents demand for raw material or Input for a year.
 Cost per Order (O) - It represents cost of placing an order for purchase.
 Carrying Cost (C) - It represents cost of carrying average inventory on annual basis
The calculation of economic order of material to be purchased is subject to the following
assumptions:
a) Ordering cost per order and carrying cost per unit per annum are known and they are
fixed.
b) Anticipated usage of material in units is known.
c) Cost per unit of the material is constant and is known as well.
d) The quantity of material ordered is received immediately ie. the lead time is zero.

By using the EOQ formula and calculating the optimal order quantity, businesses can reduce
unnecessary holding costs and ordering costs, leading to more efficient inventory
management and improved financial performance.

Graphical Representation of
Economic Order Quantity =>
Example :
Calculate the Economic Order Quantity from the following information. Also state the
number of orders to be placed in a year. Given that:
Consumption of materials per annum : 10,000 kg
Order placing cost per order : ₹ 50
Cost per kg. of raw materials : ₹ 2
Storage costs : 8% on average inventory
Solution:

Bibliography

Source of information:
 Ca Intermediate – Material costing
 https://old.mu.ac.in/wp-content/uploads/2017/01/Cost-Accounting.pdf
 https://icmai.in/upload/Students/Syllabus2016/Inter/Paper-8-New.pdf
 https://en.wikipedia.org/wiki/Inventory_control