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Cost accounting

In cost accounting establishes budget and actual cost of operations, processes,

departments or product and the analysis of variances, profitability or social use of funds.
Managers use cost accounting to support decision-making to cut a company's costs and
improve profitability. As a form of management accounting, cost accounting need not to
follow standards such as GAAP, because its primary use is for internal managers, rather
than outside users, and what to compute is instead decided pragmatically.

Costs are measured in units of nominal currency by convention. Cost accounting can be
viewed as translating the supply chain (the series of events in the production process that,
in concert, result in a product) into financial values.

Classical cost elements are:

1. raw materials
2. labor
3. indirect expenses/overhead

Cost accounting has long been used to help managers understand the costs of running a
business. Modern cost accounting originated during the industrial revolution, when the
complexities of running a large scale business led to the development of systems for
recording and tracking costs to help business owners and managers make decisions.

In the early industrial age, most of the costs incurred by a business were what modern
accountants call "variable costs" because they varied directly with the amount of
production. Money was spent on labor, raw materials, power to run a factory, etc. in
direct proportion to production. Managers could simply total the variable costs for a
product and use this as a rough guide for decision-making processes.

Some costs tend to remain the same even during busy periods, unlike variable costs,
which rise and fall with volume of work. Over time, the importance of these "fixed costs"
has become more important to managers. Examples of fixed costs include the
depreciation of plant and equipment, and the cost of departments such as maintenance,
tooling, production control, purchasing, quality control, storage and handling, plant
supervision and engineering. In the early twentieth century, these costs were of little
importance to most businesses. However, in the twenty-first century, these costs are often
more important than the variable cost of a product, and allocating them to a broad range
of products can lead to bad decision making. Managers must understand fixed costs in
order to make decisions about products and pricing.

For example: A company produced railway coaches and had only one product. To make
each coach, the company needed to purchase Rs.60 of raw materials and components, and
pay 6 laborers Rs.40 each. Therefore, total variable cost for each coach was Rs.300.
Knowing that making a coach required spending Rs.300, managers knew they couldn't
sell below that price without losing money on each coach. Any price above Rs.300
became a contribution to the fixed costs of the company. If the fixed costs were, say,
Rs.1000 per month for rent, insurance and owner's salary, the company could therefore
sell 5 coaches per month for a total of Rs.3000 (priced at Rs.600 each), or 10 coaches for
a total of Rs.4500 (priced at Rs.450 each), and make a profit of Rs.500 in both cases.

Elements of cost

• 1. Material(Material is a very important part of business)

o A. Direct material
o B. Indirect material
• 2. Labor
o A. Direct labor
o B. Indirect labor
• 3. Overhead

o A. Indirect material
o B. Indirect labor

(In some companies, machine cost is segregated form overhead and reported as a separate
They are grouped further based on their functions as,

• 1. Production or works overheads

• 2. Administration overheads
• 3. Selling overheads
• 4. Distribution overheads

Classification of costs

Classification of cost means, the grouping of costs according to their common

characteristics. The important ways of classification of costs are:

• By nature or element: materials, labor, expenses

• By functions: production, selling, distribution, administration, R&D, development,
• As direct and indirect
• By variability: fixed, variable, semi-variable
• By controllability: controllable, uncontrollable
• By normality: normal, abnormal

Management accounting

Management accounting or managerial accounting is concerned with the provisions

and use of accounting information to managers within organizations, to provide them
with the basis to make informed business decisions that will allow them to be better
equipped in their management and control functions.

In contrast to financial accountancy information, management accounting information is:

• designed and intended for use by managers within the organization, instead of
being intended for use by shareholders, creditors, and public regulators;
• usually confidential and used by management, instead of publicly reported;
• forward-looking, instead of historical;
• computed by reference to the needs of managers, often using management
information systems, instead of by reference to general financial accounting


According to the Chartered Institute of Management Accountants (CIMA), Management

Accounting is "the process of identification, measurement, accumulation, analysis,
preparation, interpretation and communication of information used by management to
plan, evaluate and control within an entity and to assure appropriate use of and
accountability for its resources. Management accounting also comprises the preparation
of financial reports for non-management groups such as shareholders, creditors,
regulatory agencies and tax authorities" (CIMA Official Terminology).

The American Institute of Certified Public Accountants(AICPA) states that management

accounting as practice extends to the following three areas:

• Strategic Management—Advancing the role of the management accountant as a

strategic partner in the organization.
• Performance Management—Developing the practice of business decision-making
and managing the performance of the organization.
• Risk Management—Contributing to frameworks and practices for identifying,
measuring, managing and reporting risks to the achievement of the objectives of
the organization.

The Institute of Certified Management Accountants(ICMA), states "A management

accountant applies his or her professional knowledge and skill in the preparation and
presentation of financial and other decision oriented information in such a way as to assist
management in the formulation of policies and in the planning and control of the
operation of the undertaking." Management Accountants therefore are seen as the "value-
creators" amongst the accountants. They are much more interested in forward looking and
taking decisions that will affect the future of the organization, than in the historical
recording and compliance (scorekeeping) aspects of the profession. Management
accounting knowledge and experience can therefore be obtained from varied fields and
functions within an organization, such as information management, treasury, efficiency
auditing, marketing, valuation, pricing, logistics, etc


Cost accounting and management accounting both have the same objectives of helping the
management in planning, control and decision making. Both are internal to the organization
and use common tools and techniques like standard costing, variable costing, budgetary
control...Etc Inspite of these similarities there are certain differences between these two.

Category Cost Accounting Management Accounting

Deals with It deals with ascertainment , It deals with the effect and impact of
allocation and accounting aspect of cost on the business.
Base It provides a base for management It is derived from both cost
accounting accounting and financial accounting
Role It help in collecting costing data for It has a greater degree of relevance
the management and objectivity as the management
accountant has a clear idea of the
types of costs and items requiring
analysis and states the specific
problems of business.
Status The status of cost accountant comes Management accountant is senior in
after the management accountant position to cost accountant.
Outlook Cost accountant has a narrow Management accountant reports the
approach. He has to refer to effect of cost on the business along
economic and statistical data for with cost analysis
analyzing cost effects.
Tools & It has standard costing, variable Along with tools & techniques of
Techniques costing, break even analysis etc as cost accounting the management
the basic tools and techniques. accountant has fund & cash flow
statements, ration analysis..etc as his
accounting tools & techniques
Scope It does not include financial It includes financial accounting cost
accounting, tax planning and tax accounting, tax planning and tax
accounting. accounting
Period of It is concerned with short term It is concerned with short range and
planning planning long range planning and uses
Assistance It merely assists the management in It assists and evaluates the
its functions management performance
Approach It is historical in its approach It is futuristic in its approach
Installation It cab be installed without It needs financial & cost accounting
management accounting as its base for its installation
S.no Name of the Book/Magazine/Article Author Publisher/Source
1 S.P Jain & Kalyani Publishers
Cost & Management Accounting (5e) K.L Narang

Web sites Referred:

tutor2u.net/business/.../costmanagementaccounting/default.html -


S.NO Contents Page No

1 1-3
Cost accounting
2 Management accounting 4-5
3 6
Distinction between Cost & Management Accounting

4 7


ACADEMIC YEAR : 2009-2011


MID : 1st MID