NOTES OF COAST ACCOUNTING

1. Nature and purpose of cost accounting

er studying this chapter, you should be able to: 
•     Define cost accounting
•     Distinguish between cost accounting and other accounting subjects such as financial 
accounting and management accounting based on various aspects
•     Define the various cost accounting terminologies
•     Explain the role of a cost accounting department in an organization 
•     Explain the design and operation of a Cost and Management Accounting system
•     Explain the relationship between nature of business enterprise and cost accounting
•     Distinguish between qualitative and quantitative information
•     Explain the features of an effective cost center framework
INTRODUCTION
The purpose of this chapter is to introduce the basic concepts of cost accounting, terminologies 
and distinguish cost accounting from financial accounting. It is aimed at making it clear on what 
cost accounting is all about and introduce some of the terminologies used in the chapters that 
follow.
First, we will discuss the nature of cost accounting and budgeting and then introduce the key cost 
accounting terminologies, which will act as the base for other discussions.
DEFINITION OF KEY TERMS
Cost: Cost is simply a quantification or measurement of the economic sacrifice made to achieve 
a given objective. It is, therefore, a measurement of the amount of resources sacrificed in attaining 
a specified goal
Cost object or cost unit: This is an activity for which a separate measure of cost is desired.
Cost Accountant: He/she is a member of the accounting department responsible for collecting 
product costs and preparing accurate and timely reports to evaluate and control company 
operations.
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Cost Analysis: This is an activity that uses engineering, time and motion studies, timekeeper’s 
records and planning schedules from production supervisors.
Cost center: This may be defined as any point at which costs are gathered in order to control 
cost, fix responsibility and enable costs to be recharged on an equitable basis
EXAM CONTEXT
You must be prepared to answer questions touching on definition of cost accounting terminologies 
and distinguish cost accounting from other disciplines of accounting such as management and 
tax accounting. Questions normally set from this section are theoretical and thus you need to 
understand the theory to be able to answer them well.
INDUSTRY CONTEXT
The applicability of this topic comes in handy when holding discussions with other managers in 
a firm or during meetings. You need to understand the cost accounting terminologies and how 
it relates to other disciplines for effective relay of the messages intended for managers of other 
fields.
 DEFINITION OF COST ACCOUNTING
In gen

1.1. Definitions of terms

In general, cost accounting is a field of accounting that measures, records and reports information 
about costs. It involves the comprehensive set of principles, methods and techniques to determine 
an appropriate analysis of costs to suit the various parts of organizational structure within the 
enterprise.
There is, however, no watertight definition for cost accounting. Various authorities and scholars 
have gone ahead to give their definitions. Some of the definitions include:
“That part of management accounting, which establishes budgets and standard costs 
and actual costs of operations, processes, departments or products and the analysis 
of variances, profitability or social use of funds.” (Chartered Institute of Management 
Accountants - CIMA).
“That which identities, defines, measures, reports and analyzes the various elements of 
direct and indirect costs associated with producing and marketing goods and services. 
Cost accounting also measures performance, product quality and productivity.” (Letricia 
Gayle Rayburn).
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“A systematic process of collecting, summarizing and recording data regarding the 
various resources and activities in a firm so as to calculate the basis of production costs 
used in financial accounting or making other relevant decisions in a firm.” (Horngren 
c.T)
Cost accounting is broad and extends beyond calculating production costs for inventory 
valuation, which government-reporting requirements largely dictate. However, accountants do 
not allow external reporting requirements to determine how they measure and control internal 
organization’s activities. In fact, the focus of cost accounting is shifting from inventory valuation 
for financial reporting to costing for decision-making.
The main objective of cost accounting is communicating financial information to management for 
planning, evaluating and controlling performance, and to assist management to make decisions 
that are more informed. Its data are used by managers to guide their decisions.
From the definitions above, we can generally say that cost accounting is concerned 
with:
§     Cost planning and cost control of activities of operations since it aims at improving 
efficiency by controlling and reducing costs
§     Resource allocation decisions, for instance, production, pricing and product costing 
§     Performance measurement and evaluation of managerial performance; this is done 
through variance analysis, comparing actual output with the standard or budgeted 
output.
§     Formulation of overall strategies and long range plans; Cost accounting will be useful 
in forecasting
Cost accounting aims at providing useful information to decision makers to enable them make 
better decisions. It helps them in preparing various statements such as cash budgets and 
performance reports, cost data collection and application of costs to products and services.
Cost Accounting Terms
a) Cost
A cost is simply a quantification or measurement of the economic sacrifice made to 
achieve a given objective. It is, therefore, a measurement of the amount of resources 
sacrificed in attaining a specified goal. For a product, cost represents the monetary 
measurement of resources used such as materials, labor and overheads. For a service, 
cost is the monetary sacrifice made to provide the service. Accountants generally use 
cost with other descriptive terms, for example, historical, product, prime, labour or 
material. Each of these terms defines some characteristic of the cost measurement 
process or an aspect of the object being measured.
NATURE AND PURPOSE OF COST ACCOUNTING
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b) Cost object or cost unit
This is an activity for which a separate measure of costs is desired. Examples include 
cost of providing a service to a client or cost of manufacturing a specific product or 
undertaking a specific assignment, and cost of running an organizational segment. In 
other words, a cost object/cost unit is the quantitative unit of the product or service in 
relation to which costs are ascertained. It is determined by the nature of the business 
enterprise.
c) Cost accountant
He/she is a member of the accounting department responsible for collecting product 
costs and preparing accurate and timely reports to evaluate and control company 
operations. He/she assembles, classifies and summarizes financial and economic data 
on the production and pricing of goods and services. Some of the roles that he plays in 
the various aspects of the organization include:
§     Material cost control: this includes tracing materials issued to departments, reporting 
of the cost of material wasted (variance analysis) and provision of information about 
ordering and holding costs of stocks.
§     Labour cost control: this includes time keeping and payroll operation, establishing of 
standard labour cost for various products, monitoring productivity of labour and analysis 
of hours worked
§     Overhead cost planning and control: understanding the cost behavior of cost items, 
identifying the expenditure on overheads by various departments and establishing the 
absorption rate guides.
§     Operational efficiency: this includes ensuring that maximum output is achieved at 
minimum cost.
d) Cost analysis
This is an activity that uses engineering, time and motion studies, timekeeper’s 
records and planning schedules from production supervisors. Cost analysis techniques 
include break-even analysis, comparative cost analysis, capital expenditure analysis 
and budgeting techniques. After determining what is actually happening, accountants 
should identify available alternatives. Professional judgment is then needed to apply 
and interpret the results of each costing technique.
e) Cost benefit approach
This is the primary criterion for choosing among alternative accounting approaches. In 
a company, there is a direct relationship between the amount of time and the funds that 
management is willing to spend on cost analysis and the degree of reliability desired. 
If a company wants detailed records with a high degree of accuracy, managers should 
provide additional time and money for compiling and maintaining cost information. 
Managers should only use cost analysis and control techniques when anticipated 
benefits in helping achieve management goals exceed the cost.
f) Responsibility center
This is a part of the organization in which a manager who has a budget is made 
responsible for the plans and the resulting information on the performance of the plans. 
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Responsibility accounting is the use of budgeting with standard costing. Responsibility 
center makes it necessary for the organization to be organized with clear statements of 
the responsibilities of each manager who has a budget. The process of responsibility 
center enables management by exception principle to be practised. This is where a 
subordinate is given a clearly defined role with the requisite authority and resources to 
carry out that part of the overall plan assigned, and if activities do not proceed according 
to plan, the variations are reported to a higher authority. There are various types of 
responsibility centers, namely, cost center, revenue center, profit center and investment 
center, among others.
g) Cost center
This refers to a production or service department in an organization where costs are 
incurred for the production of goods and services. Cost centers accumulate costs directly 
incurred and apportioned in order to ascertain the total cost of a department or center 
for a particular period. Cost centers ascertain costs and relate to cost units for control 
purposes. They help in ascertaining the total cost incurred in each center, determining 
whether the cost centers are working efficiently, controlling costs effectively, allocating 
costs to appropriate departments or cost units and, planning the activities of a particular 
department and improving their performance

1.2. Roles of cost accounting in management

ROLE OF COST ACCOUNTING IN MANAGEMENT 
Fast forward:
Cost accounting is useful and applicable in business organizations and its environment in many 
ways.
Cost accounting is utilized for a number of purposes, some of which are briefly described 
in the following points:
a) Accounting for costs
This may be seen as a record keeping or score-keeping role. Information must be 
gathered and analyzed in a manner which will help in planning, controlling and decision 
making
b) Planning and budgeting
This involves the quantification of plans for future operations of the enterprise; such 
plans may be for the long or short term, for the enterprise as a whole or for the individual 
aspects of the enterprise.
c) Control of operations of the enterprise
Control may be assisted by the comparison of actual cost information with that included 
in the plan. Any differences between planned and actual events can be investigated 
and corrective action implemented as appropriate
NATURE AND PURPOSE OF COST ACCOUNTING
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d) Decision making
Cost accounting information assists in the making of decisions about future operations 
of the enterprise; such decisions making may be assisted by the information from cost 
techniques and cost-volume-profit analysis.
e) Resource allocation decisions
For example product pricing in determining whether to accept or reject jobs. This is 
based on cost and revenue implications of the relevant decisions
f) Performance evaluation
Cost accounting information is used to measure and evaluate actual performance so as 
to make a decision of the degree of optimality or efficiency of resource utilization.