Department of Business Administration

BBA Program
Cost Accounting (ACC4705)
Chapter 1: Introduction to Cost Accounting
After completing BBA, if you set up a small manufacturing business, say manufacturing of
plastic goods, a problem will arise. What price of each unit you should charge to the
buyers? Many factors are considered while fixing the price of a product, such as
competitors' price, cost of production, etc. Cost is essential not only to fix price but also to
ascertain the margin of profit. Knowledge of cost determination is also necessary to keep a
check on the cost of production, control of wastages, etc. The accounting used to study the
various aspects of cost is known as cost accounting. In this chapter, you will learn the
meaning, importance, limitations, and some other theoretical issues of cost accounting.

1.1. MEANING OF COST ACCOUNTING

Cost accounting is the process of determining and controlling the cost of products (goods or
services). It also covers collection, classification, analysis and interpretation of cost data, and
preparation of statements and reports for managerial decision making. In other words, cost
accounting may be defined as the process of measuring, analyzing, computing, and reporting the
cost, profitability, and performance of operations. Cost information is necessary to calculate the
profit margin and also to fix the selling price.
Costing includes the methods and techniques of ascertaining costs. There are mainly two
methods of costing known as Job costing and Process costing. The techniques include the day-to-
day routine of determining costs within the method of costing (either job or process) adopted by
a business. Within such techniques, there could be historical costing, marginal costing,
absorption costing, variable costing, standard costing, contract costing, etc.
Usually, the terms costing and cost accounting are used interchangeably. However,
costing refers to the process of ascertaining costs. On the other hand, cost accounting refers to
the process of recording various costs systematically to ascertain the cost of products and also to
control cost.
In conclusion, costing or cost accounting is a branch of accounting that deals with
recording, classifying, and allocating expenditures to determine the cost of products and also
presenting arranged data for managerial control and guidance.

1.2. OBJECTIVES OF COST ACCOUNTING

Cost accounting has the following objectives to serve:
1. To Determine Product Costs: The main objective of cost accounting is to determine the
cost of products. The total product cost and cost per unit are important in making inventory
valuation, fixing the selling price of the product, and taking managerial decisions.

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 Md. Tahidur Rahman, Associate Professor, BAIUST

2. To Control Cost: Another objective of cost accounting is to control cost by using various
techniques such as budgetary control, standard costing, and inventory control. Each item of
cost (material, labor, and overhead) is budgeted at the beginning of the period, actual
expenses incurred are compared with the budget, variations are computed, and thus actions
are taken to control cost.
3. To Assist Planning and Control: Providing useful cost data and information for planning
and control by management is another objective of cost accounting. Management evaluates
different alternative plans in terms of associated costs and benefits. Control over business
operations aims to establish a balance between actual and budgeted performances.
4. To Supply Information for Decision Making: Cost accounting provides data and special
analysis for short and long-run decisions such as: make or buy an item, shut down or
continue an operation, repair or replace a machine, etc.
5. To Facilitate Preparation of Financial and Other Statements: Cost accounting helps produce
financial and other statements. The financial statements are prepared on a yearly, half-yearly, or
quarterly basis. To operate a business efficiently, management need to review production, sales,
and operating results from time to time. Cost accounting provides daily, weekly or monthly
statements of units produced, accumulated cost with analysis as per the need of management. It
also provides immediate information regarding the stock of raw material, semi-finished, and
finished goods required for the preparation of financial statements.

1.3 IMPORTANCE OF COST ACCOUNTING TO MANAGEMENT

Because of the many limitations of financial accounting, management has realized the
importance of cost accounting. Cost accounting provides invaluable help to management.
However, it is difficult to indicate where the work of cost accountant ends and managerial
control begins. The importance of cost accounting to management is as follows:
1. Ascertainment of Cost: Cost accounting helps management in the ascertainment of cost of
products or services by using different techniques under Job costing and Process costing.
2. Fixing Selling Prices: It helps the management in the fixation of selling prices of products
by providing detailed cost information. Information about demand and supply, activities of
competitors and market conditions are also considered in price fixation.
3. Cost Reduction: Cost can be reduced in the long-run when a cost reduction program and
improved methods are introduced to reduce costs.
4. Elimination of Wastage: As it is possible to know the cost of the product at every stage, it
becomes possible to identify the forms of wastage, and thus management can eliminate it.
5. Identifying Unprofitable Activities: With the help of cost accounting, unprofitable
activities are identified so that corrective actions can be taken.
6. Checking the Accuracy of Financial Accounting: Cost accounting helps in checking the
accuracy of financial accounting through reconciliation of the profit as per financial
accounting with the profit as per cost accounting.
7. Inventory Control: Cost accounting helps management maintaining an optimal amount of
inventory in respect of stock of material, work in progress, and finished goods through
applying different controlling mechanisms.

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8. Helpful to Estimate Reliably: Costing records provide a reliable basis upon which tenders
are prepared and estimations are made.
9. Database for Operating Policy: Cost accounting works as a database, which forms the
basis of formulating policy regarding day-to-day business operations and decisions.

1.4 CAUSES BEHIND THE DEVELOPMENT OF COST ACCOUNTING

The evaluation of cost accounting has been a natural process through the growing necessity of
information about organizations, which the traditional financial accounting system fails to
supply. The main causes behind the development of cost accounting are given below:
1. Financial accounting can give the net result of trading during a particular period. It does not
provide the product-wise picture, which is very essential for management.
2. Financial accounting does not find out the cost of goods manufactured; hence it cannot help
some important business activities like price-fixing, price-cutting during depression,
formulating market policies, etc.
3. Financial accounting never aims at making an effort for converting a losing unit into a
profitable unit through cost control.
4. Financial accounting does not provide a means for controlling different elements of cost,
reduction of expenses, elimination of wastage, measurement of efficiency, etc.
5. Financial accounting presents the total cost incurred during a period usually determined at
the end of a period. It does not present the costs incurred on daily basis. In the absence of this
day-to-day information, proper control is not possible.
6. Financial accounting cannot properly guide the management in respect of making decisions
on various matters, such as winding-up a business, closing down a unit facing loss,
introducing a new product, going for dumping in foreign markets, etc.
7. Financial accounting fails to locate the disease that causes a loss in an organization. In other
words, it fails to point out the exact spot of inefficiency, which may remain in any of the
factors – material, labor, plant, and equipment, or management.
8. The above limitations of financial accounting have created the scope of emerging and
evolving cost accounting.

1.5 COST ACCOUNTING VERSUS FINANCIAL ACCOUNTING

Although cost accounting and financial accounting are important branches of accounting, there
are some differences between them. Some important differences between cost accounting and
financial accounting are given below:
1. Nature: Financial accounting classifies records, presents, and interprets all transactions in
terms of money. In contrast, cost accounting classifies, records, presents, and interprets costs,
such as material, labor, and overheads.
2. Objective: The objective of financial accounting is to provide information about the overall
financial performance and financial position of a business. Whereas the objective of cost
accounting is to provide per-unit cost and other information for controlling and decision
making.

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 Md. Tahidur Rahman, Associate Professor, BAIUST

3. Users of Information: The users of financial accounting statements are mainly external to
the business enterprise such as shareholders, creditors, financial analysts, government
authorities, etc. On the other hand, the information generated by cost accounting is used only
by the members of management at different levels.
4. Accounting System: Financial accounting follows the double-entry system for recording,
classifying, and summarizing business transactions. But cost accounting is not restricted to
the double-entry system.
5. Accounting Principles: Financial accounting data is primarily meant for external users. That
is why the Generally Accepted Accounting Principles (GAAP) are important in financial
accounting. GAAP is strictly followed in recording, classifying, summarizing, and reporting
business transactions. On the contrary, cost accounting is not bound to use GAAP. It can use
any accounting technique or practice that generates useful information.
6. Unit of Measurement: All information under financial accounting is presented in terms of
money. In contrast, cost accounting applies any measurement unit that is useful in a
particular situation. In addition to the monetary unit, cost accountants may find it necessary
to use measures, such as labor hours, machine hours, and product units for analysis and
decision making.
7. Time Span: Financial accounting data and statements are developed and presented at regular
time intervals, such as annually, half-yearly, quarterly, or monthly basis. However, cost
accounting reports and statements are prepared whenever needed.
Despite the above differences, both financial accounting and cost accounting are in agreement
regarding actual cost data.

1.6 LIMITATIONS OF COST ACCOUNTING

Like other branches of accounting, cost accounting is not an exact science but is a combination
of art and science. The branch of accounting has developed through theories and accounting
practices based on reasoning and common sense. These practices are not static but change with
time. The limitations of cost accounting are as follows:
1. Cost accounting lacks a uniform procedure. There is no common system of cost
accounting applicable to all industries. There are widely recognized cost concepts, which are
understood and applied differently by different industries.
2. Due to its expensive nature, a separate cost accounting department can be maintained
only by big enterprises. It is expensive because analysis, allocation, and absorption of
overheads require a considerable amount of additional work.
3. Cost accounting results, in some cases, differ from those shown in financial accounting.
Frequent preparation of reconciliation statements is necessary to verify their accuracy. This
leads to an unnecessary increase in workload.
4. It is unnecessary because it involves duplication of work. Some industrial units are
functioning efficiently without a separate cost costing department.
5. The costing system itself does not control costs. If the management is alert and efficient, it
can control cost without the help of cost accounting. Therefore, critics consider cost
accounting unnecessary.
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