A cost accounting system is a system that accumulates costs, assigns them to cost objectives and reports cost information. It ascertains product profitability and helps management in planning and control of business operations.
A system has to be designed to suit the needs of an organisation. Costing can be employed in any industry whether it is manufacturing industry or other industries like public utility, public services, construction companies, agriculture, mining etc.
As a system designer, the cost accountant should be able to perceive the needs of the management at various levels and design such a system as will meet those needs promptly, effectively and efficiently. The “needs” are concerned with the following:
- The objective: The system will naturally differ according to what is expected from the costing system. The system will be simple if the objective is merely to fix prices; it will have to provide detailed information if the aim is to measure efficiency, control, etc. If the law requires installation of the costing system, the legal requirements must obviously be kept in mind.
- Decision-Making Points: The levels of management which require information will determine the quantum and format of information that the costing system will have to provide. The periodicity of the various reports will be similarly determined.
- Significant Operations: Costing must obviously pay greater attention to those areas which account for the bulk of expenditure. Mostly, it is production but, in quite a few cases, selling and distribution, accounts for greater expenditure than production; in such a case the system must devote greater care to selling and distribution.
- Uncontrollable Items: Sometimes the law provides for a certain course of action; for example sugar must be packed in new gunny bags. Costing must not try to change this. Sometimes managements may decide to adopt a particular course for various reasons, for example, purchasing an item only from a particular firm. Obviously, it will be no use trying to alter this.
To install a sound costing system in an organization is not an easy task. The costing for each firm must be so designed as to meet its earlier needs. It should be ensured first that the following pre-requisites for installing a sound costing system are present in the organization:
- The organizational set up should be clear cut regarding authority and responsibility of different individuals.
- The management of the organization should extend full support to the system.
- The co-operation of the members of the staff and of the workers in general should be ensured. They should have the real spirit and enthusiasm to operate the system.
- If financial records can yield all the necessary costing information, it is not necessary to have a separate costing department. Usually, however, a separate costing department is essential or desirable but its strength will depend upon the needs of the management and the volume and complexity of transactions or events to be recorded and handled.
The following are the essential considerations which would govern the installation of a sound costing in an organization in general:
Executive Side: The memorandum and articles, organization chart, delegation of powers etc.
Accounting Side: Financial accounting records, last audited accounts etc.
Internal Control Side: The existing forms, registers, number of copies etc.
Technical side and Others
- The size, layout and organisation of the factory should be studied.
- The methods of purchase, receipt, storage and issue of materials should be examined and modified if necessary.
- The method of paying wages should be studied.
- The management requirements and their attitude towards cost accounting should be kept in view.
- The cost of installing and operating the system should be economical.
- The nature, method, process and stages of production, the quantities and qualities of each product should be examined.
- The system should suit the organization.
- Forms and records should involve minimum clerical work and cost.
- The system should enable prompt reporting to the various levels of management.
- The system should so designed that cost can be effectively controlled.
- The staff in the cost accounting department should have the ability to produce required cost data. The persons using the reports should be able to understand and use the information.
- The adoption of cost accounting systems and practices followed by other firms in the industry facilitates inter unit and inter-firm comparisons.
- A suitable unit of cost should be selected so that the cost is meaningful. For example, in a steel mill, the unit is “tone” and in a company producing refrigerators, the unit is each refrigerator. In a transport company, the unit is “tone-km” i.e., the effort in hauling one tone of goods for one kilometer.
- External factors e.g. government regulations affect the frequency, volume and structure of the cost accounting system.
Any proposed changes should suit other departments and should dislocate production schedule. Other points to be noted are:
- Accuracy: Cost accounts must be accurate and correct otherwise they will prove to be misleading.
- Equity: Allocation of indirect expenses to a particular class of output, department or job should be fair and equitable.
- Simplicity: As cost accountants are highly analytical, there is a tendency towards complexity. Needless, elaboration should be scrupulously avoided and care must be taken to keep them as simple as possible. Careful choice should be made of the cost unit i.e. the quantity for which cost will be computed e.g. tone of steel, a kg. of yarn etc.
- Elasticity: The cost accounting system should be elastic and capable of adapting itself to altered circumstances.
- Comparability: The records must be maintained in such a manner that the result of one period can be compared with the results of any other period. The records of the past must act as a guide for the future.
- Promptness: Prompt recording of the relevant figures in analytical form is the sine qua non of costing. Arrangements should be made for the prompt supply of records by the various departments relating to raw material, stores, labour etc., and the data thus obtained, are promptly analyzed and recorded.
- Observance of instructions: The costing staff must carefully obey the instructions given to them and even slight deviations must be permitted.
- Periodical results: In order to derive maximum benefit, it is advisable to have the results prepared periodically so that actual cost can be compared with estimated costs.
- Reconciliation with financial accounts: The whole system should be so maintained as to make reconciliation with financial accounts easy and simple.
