Basic concepts of cost accounting


An accounting system is to make available necessary and accurate information for all those who are interested in the welfare of the organization. The requirements of majority of them are satisfied by means of financial accounting. However, the management requires far more detailed information than what the conventional financial accounting can offer. The focus of the management lies not in the past but on the future. For a businessman who manufactures goods or renders services, cost accounting is a useful tool. It was developed on account of limitations of financial accounting and is the extension of financial accounting. The advent of factory system gave an impetus to the development of cost accounting.

It is a method of accounting for cost. The process of recording and accounting for all the elements of cost is called cost accounting.

The Institute of Cost and Works Accountants, London defines costing as, “the process of accounting for cost from the point at which expenditure is incurred or committed to the establishment of its ultimate relationship with cost centres and cost units. In its wider usage it embraces the preparation of statistical data, the application of cost control methods and the ascertainment of the profitability of activities carried out or planned”.

The Institute of Cost and Works Accountants, India defines cost accounting as, “the technique and process of ascertainment of costs. Cost accounting is the process of accounting for costs, which begins with recording of expenses or the bases on which they are calculated and ends with preparation of statistical data”. To put it simply, when the accounting process is applied for the elements of costs (i.e., Materials, Labour and Other expenses), it becomes Cost Accounting.


Cost accounting was born to fulfill the needs of manufacturing companies. It is a mechanism of accounting through which costs of goods or services are ascertained and controlled for different purposes. It helps to ascertain the true cost of every operation, through a close watch, say, cost analysis and allocation. The main objectives of cost accounting are as follows:-

  • Cost Ascertainment: The main objective of cost accounting is to find out the cost of product, process, job, contract, service or any unit of production. It is done through various methods and techniques.
  • Cost Control: The very basic function of cost accounting is to control costs. Comparison of actual cost with standards reveals the discrepancies (Variances). The variances reveal whether cost is within control or not. Remedial actions are suggested to control the costs which are not within control.
  • Cost Reduction: Cost reduction refers to the real and permanent reduction in the unit cost of goods manufactured or services rendered without affecting the use intended. It can be done with the help of techniques called budgetary control, standard costing, material control, labour control and overheads control.
  • Fixation of Selling Price: The price of any product consists of total cost and the margin required. Cost data are useful in the determination of selling price or quotations. It provides detailed information regarding various components of cost. It also provides information in
  • terms of fixed cost and variable costs, so that the extent of price reduction can be decided.
  • Framing business policy: Cost accounting helps management in formulating business policy and decision making. Break even analysis, cost volume profit relationships, differential costing, etc are helpful in taking decisions regarding key areas of the business.


Cost accounting is concerned with ascertainment and control of costs. The information provided by cost accounting to the management is helpful for cost control and cost reduction through functions of planning, decision making and control. Initially, cost accounting confined itself to cost ascertainment and presentation of the same mainly to find out product cost. With the introduction of large scale production, the scope of cost accounting was widened and providing information for cost control and cost reduction has assumed equal significance along with finding out cost of production. To start with cost accounting was applied in manufacturing activities but now it is applied in service organizations, government organizations, local authorities, agricultural farms, extractive industries and so on.

Cost accounting guides for ascertainment of cost of production. Cost accounting discloses profitable and unprofitable activities. It helps management to eliminate the unprofitable activities. It provides information for estimate and tenders. It discloses the losses occurring in the form of idle time spoilage or scrap etc. It also provides a perpetual inventory system. It helps to make effective control over inventory and for preparation of interim financial statements. It helps in controlling the cost of production with the help of budgetary control and standard costing. Cost accounting provides data for future production policies. It discloses the relative efficiencies of different workers and for fixation of wages to workers.


  • It is based on estimation: as cost accounting relies heavily on predetermined data, it is not reliable.
  • No uniform procedure in cost accounting: as there is no uniform procedure, with the same information different results may be arrived by different cost accounts.
  • Large number of conventions and estimate: There are number of conventions and estimates in preparing cost records such as materials are issued on an average (or) standard price, overheads are charged on percentage basis, Therefore, the profits arrived from the cost records are not true.
  • Formalities are more: Many formalities are to be observed to obtain the benefit of cost accounting. Therefore, it is not applicable to small and medium firms.
  • Expensive: Cost accounting is expensive and requires reconciliation with financial records.
  • It is unnecessary: Cost accounting is of recent origin and an enterprise can survive even without cost accounting.
  • Secondary data: Cost accounting depends on financial statements for a lot of information. Any errors or short comings in that information creep into cost accounts also.

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