Evolution, Importance and Advantages of Cost Accounting

Historical Development (Evolution)

The origin of cost accounting, along with the origin of bookkeeping
itself, is unknown. Attempts to keep manufacturing accounts have been traced to
the time of Henry VII and to the’ Medici The account books of Christophe
Plantin, a' French publisher, showed some understanding of job lot accounting
before the 16th century. -Manuals for double-entry bookkeeping before the 19th
century were common, but little or no mention was made" of manufacturing or
costing methods until Charles Babbage in England (approximately 1830)
presented a paper that emphasized the need for serious cost accounting. The
French, led by Anselme Pagen and Louis Mezieres, were active in the early
part of the 19th century and in 1841 Armand Malo won a prize of 1,000 fr. for
his manual of agricultural accounting for primary schools.
In the period from 1870 to 1900 engineers took the lead in developing
cost accounting methods and in 1900 Alexander Hamilton Church, president of
the Institute of Cost and Works Accountants, set forth the modern approach to
production centers and idle capacity charges. Fixed-variable analysis of
business costs is credited to Dionysius Lardner (1850) and was developed in
France by C. Adolphe Guilbault about 1865, in Great Britain by John Manger
Fells (1877) and Alfred Marshall (1890), and in Germany by Eugen
Schmalenbach (1900). Attempts to set and use standards were made in the
textile industry by G. P. Norton (1889), but developed standards date from F.
W. Taylor (Shop Management, 1903), John Whitmore (190S), and Har-
rington Emerson (1909). Fells presented profit charts and modern flexible
budgeting in 1903.
It is generally conceded that the structure of modem factory cost
accounting was established before World War I. Beginning about 1930
businessmen and economists became impressed with the magnitude of the
costs of distribution and cost accountants therefore began to extend their
factory techniques to cover the control of distribution activities. Costs are
accumulated and compared for size of order, method of delivery, line of
distribution, customer call, ton warehoused and a myriad of office activities.
The investigations of the Federal Trade commission and the passage of
the Robinson-Patman act in the United States accelerated the development of
distribution cost methods by insisting that differences in selling prices over
a large segment of business activity be justified in terms of differences in
costs. Toward the middle of the 20th century, retail stores developed' expense-
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 Evolution, Importance and Advantages of Cost Accounting
center accounting, which is a highly developed method of determining the
cost of merchandising activities, and they extended the older retail accounting
to a more comprehensive fixed-variable structure by developing merchandise
management accounting.
During World War II emphasis on cost control was reduced, and temporarily
attention returned to the older objective of compilation for billing purposes.
Postwar competition, however, led to a rapid return to cost control and to the
birth of managerial accounting with renewed emphasis on enterprise goals and
accomplishments.
The extension of cost accounting techniques and principles to
governmental units in the United States was a development of the middle
of the 20th century. Difficulties arose with regard to the measurement of
certain governmental and institutional services, and unfortunately many costs
exhibited erratic behavior, many institutions and governmental units that were
using budgets primarily as expenditure controls installed performance
budgeting, which combines financial controls with standard costing. Many
school systems, universities, hospitals and clubs rapidly adopted similar type
of performance budgeting. The problem of costing has been studied by the
government in Great Britain, particularly in relation to the cost of medical
services.
The growth or uniform cost systems has been comparatively rapid
even outside the totalitarian countries where uniform methods of costing are
necessary for effective over-all planning. In the United States uniform costing
has been sponsored by trade associations, which collect reports and compile
statistical measures that serve as norms against which each firm can appraise
its performance. These associations have been active in recommending
specific cost Systems for their members and have carried on educational work
designed to impress their member with the importance of knowing production
and distribution costs for intelligent pricing and effective control. European
productivity teams have repeatedly expressed their surprise at the interest in
costs shown by U.S. businessmen, and the display of competitive spirit
directed toward bringing their costs within budgeted aids or below those
reported by their competitors. The professional status of cost accounting is
encouraged by organizations such as the National Association of
Accountants, Controllers Institute of America, Institute of cost and works
Accountants, Society of Industrial and cost accountants of Canada and similar
groups.
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 Evolution, Importance and Advantages of Cost Accounting

Case Study
ABC Pvt. Ltd, a new comer in small manufacturing firm of formals and
casuals wears. Product range includes, shirts and T- Shirts (Full & Half
sleeves), trousers and jeans, cargo’s, etc…
As it is a newly introduced firm, the burden is on the Finance Manager
of deciding the Accounting method for maintaining books of Account in a
factory.
By considering all the factors determining cost, such as cost structure,
condition of market, type of consumer, area of distribution, capacity of
supply, product’s demand & supply, etc… Manager has to decided to follow
the Cost Accounting for maintaining factory A/c or Manufacturing A/c. Cost
Accounting does not includes physical stock-taking, but it includes detailed
& relevant cost figure of closing stock, raw material, work-in-progress and
Finished goods. Which helped the manager to find out most suitable and
accurate cost per unit. These also helped him to avoid - material wastages,
use of obsolete machinery, poor planning, etc…
They took control over material, labour and overhead expenses, and
started discussing day-to-day operations of business, so they can take
remedial actions. Moreover, introduction of a cost reduction programme
combined with operational research and value analysis leads to improvement in
economic as well as financial condition of the firm.

Questions for Discussion

(1)How cost Accounting helps the firm in determining the Selling Price?
(2)According to you, by adopting Cost Accounting method, Can a firm
prepare a Financial Statement?
(3)Which kind of operating policy decision can we take by using Cost
Accounting Method?
(4)From the case, what are the benefits/ Advantages enjoyed by a firm, by
adopting Cost Accounting?

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 Evolution, Importance and Advantages of Cost Accounting

Answers
(1) How cost Accounting helps the firm in determining the Selling Price?
Soln: - Cost accounting provides detailed and relevant cost figures for
determining the selling price of products or services. In fixing selling prices.
However, regard must be had to the cost structure, condition of the market,
the type of consumer, the area of distribution, the quantity, which can be
supplied, the demand for the product and supply thereof. A cost accountant
should not only accurately ascertain the total cost but also analyze such total
cost under variable and fixed cost so that management may quote prices even
below total cost but above variable or marginal costs for increasing volume
of sales leading maximization of profit.

(2) According to you, by adopting Cost Accounting method, Can a firm

prepare a Financial Statement?
Soln: - In order to prepare financial statements it is required to determine the
stock-values at the end of the period over which such financial
statements are to be prepared. Physical stock-taking is a lengthy
procedure and the business has to be closed down for stock-taking
purpose. Where cost accounts are kept, the ascertainment of the
value of closing stocks of raw materials, work-in-progress and
finished goods become easy and as such financial statements can be
prepared monthly or even weekly.
(3) Which kind of operating policy decision can we take by using Cost
Accounting Method?
Soln: - These policies may be-

a) Determination cost-volume-profit relationship;

b) Whether to shut down or operate at a loss;
c) Whether to make or buy from outside suppliers; and
d) Whether to continue with the existing plant and machinery or to
replace them by improved and economic ones.

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 Evolution, Importance and Advantages of Cost Accounting

(4) From the case, what are the benefits/ Advantages enjoyed by a firm, by
adopting Cost Accounting?
Soln: - They are as follows ---
a) Establishment of more accurate unit costs, a knowledge of which results
in establishment of fair selling prices and in the elimination of
unprofitable lines of product.
b) Elimination of inefficiencies in plant operation. These inefficiencies are
costly and arc caused by material wastage, use of obsolete machinery,
poor planning, or assignment of men to work for which they are not
qualified.
c) Presentation of more frequent and more accurate financial accounts with
the help of perpetual inventory system of stock control.

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 Evolution, Importance and Advantages of Cost Accounting

Importance of Cost Accounting: -

1) Ascertainment of costs: - Costs arc ascertained using any costing

method e.g. job costing or process costing as well as any one more of
the costing techniques and systems, such as historical costing, standard
costing, marginal costing, direct costing, absorption costing, and mi
form costing.

2) Determining the selling price: - Cost accounting provides detailed

and relevant cost figures for determining the selling price of products
or services. In fixing selling prices. However, regard must be had to the
cost structure, condition of the market, the type of consumer, the area
of distribution, the quantity, which can be supplied, the demand for
the product and supply thereof. A cost accountant should not only
accurately ascertain the total cost but also analyze such total cost under
variable and fixed cost so that management may quote prices even
below total cost but above variable or marginal costs for increasing
volume of sales leading maximization of profit. It is during periods
of industrial stress that costing is put to its greatest test. When orders
and production begin to fall, the manufacturer who has a sound
costing system may start to cut his prices judicially. Where there is no
costing system. The manufacturer is apt to cut costs in such a
haphazard way that it may ruin himself.

3) Determining and controlling efficiency: - A cost accountant

must study the various operations involved in the manufacture of
products. This study will enable him to render me service of measuring
efficiency of the organization as a whole or cost-center wise and in
doing so he will be able to devise means of exercising efficiency.

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 Evolution, Importance and Advantages of Cost Accounting
4) Preparation of financial statement: - It is essential to have frequent
review of production, Sales and operating results. In order to prepare
financial statements it is required to determine the stock-values at the
end of the period over which such financial statements are to be
prepared. Physical stock-taking is a lengthy procedure and the business
has to be closed down for stock-taking purpose. Where cost accounts
are kept, the ascertainment of the value of closing stocks of raw
materials, work-in-progress and finished goods become easy and as
such financial statements can be prepared monthly or even weekly.

5) Providing a basis for operating policy: - Cost accounting plays an

important pan in the management, as it is used as a basis for
formulating operating policies. These policies may be-

a) Determination cost-volume-profit relationship;

b) Whether to shut down or operate at a loss;
c) Whether to make or buy from outside suppliers; and
d) Whether to continue with the existing plant and machinery or
to replace them by improved and economic ones.

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 Evolution, Importance and Advantages of Cost Accounting

Advantages of cost accounting: -

The principal advantages of cost accounting are ---

1) Establishment of more accurate unit costs, a knowledge of which results

in establishment of fair selling prices and in the elimination of
unprofitable lines of product.

2) Development of cost comparisons, enabling the management to note

unfavorable developments and to institute procedures for their
elimination. Such comparison may be made, from period to period, of the
figures in respect of the same unit or of several units in an industry by
employing uniform costing and inter-firm comparison methods.

3) Elimination of inefficiencies in plant operation. These inefficiencies are

costly and arc caused by material wastage, use of obsolete machinery,
poor planning, or assignment of men to work for which they are not
qualified.

4) Presentation of more frequent and more accurate financial accounts with

the help of perpetual inventory system of stock control.

5) Establishment of increased operating efficiency through the use of

standards and subsequent analysis and comparison of actual
performance with established standards.

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 Evolution, Importance and Advantages of Cost Accounting

6) Establishment of control over materials, 1abour and overhead

expenditures. The facts of the day-to-day operations of the business arc
discussed and prompt remedial action can be taken to correct adverse
trends. Moreover, introduction of a cost reduction programme combined
with operational research and value analysis leads to considerable
economy.

7) Assisting in developing cost calculations for new products and designs to

guide management in its efforts to determine the profitableness of
proposed changes in products and design.

8) Establishment of an effective costing system prevents manipulation and

fraud and assist in furnishing correct and reliable cost data to the
management as well as to other interested parties such as the
shareholders, the consumers and the Government.

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