Meaning and Significance of Cost Accounting and its Relationship with Financial Accounting: formula sheet

Key formulas

Costing

Costing = techniques and processes of ascertaining cost

Focus on the technique of finding cost.

Cost accounting

Cost accounting = recording + classifying + allocating + summarising + reporting costs

A process that ends in information for management.

Cost accountancy

Cost accountancy = principles, methods and techniques + their application (including control and decision support)

The widest term of the three.

Cost management

Cost management = planned actions to control and reduce cost while keeping value and quality

Forward-looking and decision-oriented.

Main objectives

Ascertain cost, control cost, reduce cost, fix prices, support decisions, help planning and reporting

Common MCQ answer list.

Purpose

Financial accounting: profit and financial position of the whole business | Cost accounting: cost, control and decisions

The most tested single difference.

Users

Financial accounting: external (shareholders, lenders, tax authorities) | Cost accounting: internal (management)

Management also uses financial accounts, but cost accounts are meant for it.

Reporting

Financial accounting: periodic, usually yearly | Cost accounting: as often as management needs

Cost reports can be daily, weekly or monthly.

Unit of reporting

Financial accounting: business as a whole | Cost accounting: product, job, process, department

Cost accounting breaks the data into parts.

Stock valuation

Financial accounting: lower of cost and net realisable value

This is the rule under accounting standards for inventories.

Legal requirement

Financial accounting: compulsory for companies and many other entities | Cost accounting: required only for specified industries under law, otherwise voluntary

Do not say cost accounting is never required by law.

Nature of data

Financial accounting: mainly historical, in money | Cost accounting: past and future, money and physical units

Cost accounting uses estimates, budgets and standards.

Cost per unit

Cost per unit = Total cost ÷ Number of cost units

Use the cost unit that suits the industry, such as tonne, passenger-km or patient-day.

Direct and indirect cost

Total cost = Direct cost + Indirect cost (overheads)

Direct cost can be traced to a cost unit economically. Indirect cost is shared and must be apportioned or absorbed.

Prime cost

Prime cost = Direct material + Direct labour + Direct expenses

Prime cost covers all direct costs only.

Total cost by behaviour

Total cost = Fixed cost + (Variable cost per unit × Units)

Fixed cost stays constant in total within the relevant range. Variable cost per unit stays constant.

Cost behaviour rule

Fixed cost: total constant, per unit falls as output rises. Variable cost: total changes, per unit constant.

Applies within the relevant range of activity.

Quick revision

• Cost accounting records, classifies, allocates and analyses costs to find cost and help control and decisions.
• Financial accounting reports profit and financial position, mainly to outside users.
• Cost accounting mainly serves management; it is for internal use.
• Financial accounting follows statutory requirements for companies; cost accounting is mainly for internal needs, unless a rule requires it.
• Cost accounting looks at costs of products, jobs or departments; financial accounting looks at the business as a whole.
• Direct costs can be traced to a cost unit; indirect costs cannot be traced economically and are shared as overheads.
• Fixed costs stay constant in total as output changes; variable costs change in total with output.
• Per unit, fixed cost falls as output rises, while variable cost per unit stays constant.
• A cost centre is a location, person or item for which costs are collected; a cost unit is the unit of measurement of cost.
• Cost control aims to keep costs within a target; cost reduction aims to lower the unit cost without hurting quality.
• Cost classification can be by nature, function, behaviour, traceability and time.

Common mistakes

• Treating costing, cost accounting and cost accountancy as exact synonyms. Fix: Use the ladder: technique, process, whole discipline with application. Exams test the difference.
• Saying cost accounting is meant only for manufacturing firms. Fix: Remember it also applies to services, trading, hospitals, transport and public bodies.
• Treating cost accounting as only a tool for finding profit. Fix: Remember cost accounting is mainly about cost ascertainment and control, and it supports pricing and decisions.
• Assigning employee benefits to management or the reverse. Fix: Ask who receives the benefit. Employees receive the reward for efficiency; management receives the control.
• Saying cost accounting is never required by law. Fix: Say cost accounting is mainly voluntary, but law requires it for specified industries.
• Saying financial accounting is only for outsiders. Fix: Say its main users are external. Management also reads financial statements, but cost accounts are designed for management.
• Treating a cost centre and a cost unit as the same thing. Fix: A cost centre is where cost is collected. A cost unit is what cost is measured per. Machine shop is a centre. Tonne is a unit.
• Saying a profit centre only collects costs. Fix: A profit centre has both revenue and cost, so its profit can be measured. A cost centre has cost only.

Exam tips

• Learn the ladder of four terms so you can answer match-the-meaning MCQs in seconds.
• For which-is-not questions, first write the objective list in your head and strike off each option that fits.
• Watch for extreme words such as only, always and never in options about scope.
• Keep cost control and cost reduction separate; examiners often place them side by side.
• Do not spend more than one minute on these theory MCQs. There is no negative marking, so always mark an answer.
• Learn the benefits in four groups: management, employees, creditors, government. Most questions test the match.
• For limitation questions, remember three words: estimates, expensive, not exact.
• In 'EXCEPT' questions, find the three true statements first.