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Friday, May 09, 2014

Costing - An aid to Management (Functions, Advantages and Limitations)


Functions of Cost Accounting
According to Blocker and Weltemer, “Cost Accounting is to serve management in the execution of polices and in comparison of actual and estimated results in order that the value of each policy may be appraised and changed to meet the future conditions”. The main functions of cost accounting are:
i)        To serve as a guide to price fixing of products.
ii)       To disclose sources of wastage in process of production.
iii)     To reveal sources of economy in production process.
iv)     To provide for an effective system of stores, materials etc.
v)      To exercise effective control on factors of production.
vi)     To ascertain the profitability of each product.
vii)   To suggest management of future expansion policies.
viii)  To present and interpret data for management decisions.
ix)     To organize cost reduction programmes.

x)      To facilitate planning and control of business activity.
xi)     To supply timely information for various decisions.
xii)   To organize the internal audit systems etc.

Advantages of Cost Accounting (Aid to Management)
a)      Helps in Decision Making: Cost accounting helps in decision making. It provides vital information necessary for decision making. For instance, cost accounting helps in deciding:
1.       Whether to make a product buy a product?
2.       Whether to accept or reject an export order?
3.       How to utilize the scarce materials profitably?

b)      Helps in fixing prices: Cost accounting helps in fixing prices. It provides detailed cost data of each product (both on the aggregate and unit basis) which enables fixation of selling price. Cost accounting provides basis information for the preparation of tenders, estimates and quotations.

c)       Formulation of future plans: Cost accounting is not a post-mortem examination. It is a system of foresight. On the basis of past experience, it helps in the formulation of definite future plans in quantitative terms. Budgets are prepared and they give direction to the enterprise.

d)      Avoidance of wastage: Cost accounting reveals the sources of losses or inefficiencies such as spoilage, leakage, pilferage, inadequate utilization of plant etc. By appropriate control measures, these wastages can be avoided or minimized.

e)      Highlights causes: The exact cause of an increase or decrease in profit or loss can be found with the aid of cost accounting. For instance, it is possible for the management to know whether the profits have decreased due to an increase in labour cost or material cost or both.

f)       Reward to efficiency: Cost accounting introduces bonus plans and incentive wage systems to suit the needs of the organization. These plans and systems reward efficient workers and improve productivity as well improve the morale of the work -force.

g)      Prevention of frauds: Cost accounting envisages sound systems of inventory control, budgetary control and standard costing. Scope for manipulation and fraud is minimized.

h)      Improvement in profitability: Cost accounting reveals unprofitable products and activities. Management can drop those products and eliminate unprofitable activities. The resources released from unprofitable products can be used to improve the profitability of the business.

i)        Preparation of final accounts: Cost accounting provides for perpetual inventory system. It helps in the preparation of interim profit and loss account and balance sheet without physical stock verification.

j)        Facilitates control: Cost accounting includes effective tools such as inventory control, budgetary control and variance analysis. By adopting them, the management can notice the deviation from the plans. Remedial action can be taken quickly.

Limitations of Cost Accounting
In spite of the various advantages claimed by cost accounting, the discipline suffers from the following limitations:
a)      Cost Accounting is costly to operate: It involves heavy expenditure to operate. The benefits derived by operating the system are more than the cost.

b)      Cost Accounting involves many forms and statements: It involves usage of many forms and statements which leads to increase of paper work.


c)       Costing may not be applicable in all types of Industries: Existing methods of cost accounting may not be applicable in all types of industries. Cost accounting methods can be devised for all types of industries, and services.

d)      It is based on Estimations: Costing system relies on predetermined data and therefore it is not reliable. Costing system estimates costs scientifically based on past and present situations and with suitable modifications for the future. This leads to accurate cost figures based on which management can initiate decisions. But for the predetermined costs, cost accounting also becomes another ‘Historical Accounting’.

e)      It is not an exact science: Like any others accounting system, it is not an exact science but an art that has developed through theories and practices.

f)       Bias Judgments: Many judgments are biased and depend on individual discretion.


g)      Difference in opinion: Different views are held by different cost accounts about the items to be includes in cost.