Introduction

A business enterprise must keep a systematic record of what happens from day-to-day events so
that it can know its position clearly. Most of the business enterprises are run by the corporate
sector. These business houses are required by law to prepare periodical statements in proper form
showing the state of financial affairs. The systematic record of the daily events of a business
leading to presentation of a complete financial picture is known as accounting. Thus, Accounting
is the language of business. A business enterprise speaks through accounting. It reveals the
position, especially the financial position through the language called accounting
Meaning of Accounting
Accounting is the process of recording, classifying, summarizing, analyzing and interpreting the
financial transactions of the business for the benefit of management and those parties who are
interested in business such as shareholders, creditors, bankers, customers, employees and
government. Thus, it is concerned with financial reporting and decision making aspects of the
business.
The American Institute of Certified Public Accountants Committee on Terminology proposed in
1941 that accounting may be defined as, The art of recording, classifying and summarizing in a
significant manner and in terms of money, transactions and events which are, in part at least, of a
financial character and interpreting the results thereof .
Branches of Accounting
Accounting can be classified into three categories:
1. Financial Accounting
2. Cost Accounting, and
3. Management Accounting

Financial Accounting
The term Accounting unless otherwise specifically stated always refers to Financial
Accounting. Financial Accounting is commonly carried on in the general offices of a business.
It is concerned with revenues, expenses, assets and liabilities of a business house. Financial
Accounting has two-fold objective, viz.

1. To ascertain the result of the business, and
2. To know the financial position of the concern.
Nature and Scope of Financial Accounting
Financial accounting is a useful tool for management as well as for external users such as
shareholders, potential owners, creditors, customers, employees and government as it provides
information regarding the results of its operations and the financial status of the business. The
following are the functional aspects of financial accounting:-



1. Dealing with Financial Transactions
Accounting as a process deals only with those transactions which are measurable in terms
of money. Anything which cannot be expressed in monetary terms does not form part of
financial accounting however significant it may be.

2. Recording of information
Accounting is an art of recording financial transactions of a business concern. As there is
a limitation for human memory, it is not possible to remember all transactions of the business.
Therefore, the information is recorded in a set of books called Journal and other subsidiary books
and it is useful for management in its decision making process.

3. Classification of Data
The recorded data are arranged in a manner so as to group the transactions of similar nature at
one place so that full information of these items may be collected under different heads. This is
done in the book called Ledger. For example, we may have accounts called Salaries, Rent,
Interest, Advertisement, etc. To verify the arithmetical accuracy of such accounts, trial balance
is prepared.
4. Summarizing Group of Information
The classified information of the trial balance is used to prepare profit and loss account and
balance sheet in a manner useful to the users of accounting information. The final accounts are
prepared to find out operational efficiency and financial strength of the business.

5. Analyzing
It is the process of establishing the relationship between the items of the profit and loss
account and the balance sheet. The purpose is to identify the financial strength and weakness of
the business. It also provides a basis for interpretation.

6. Interpreting the Financial Information
It is concerned with explaining the meaning and significance of the relationship
established by the analysis. It is useful to the users, as it enables them to take correct decisions.

7. Communicating the Results
The profitability and financial position of the business as interpreted above are
communicated to the interested parties at regular intervals so as to assist them to make their own
conclusions.

Limitations of Financial Accounting
Financial accounting is concerned with the preparation of final accounts. The present day
business has become so complex that mere final accounts are not sufficient in meeting financial
needs. Financial accounting is like a post-mortem report. At the most it can reveal what has
happened so far, but it does not have any control over the past happenings. The limitations of
financial accounting are as follows:-

1. It records only quantitative information.
2. It records only the historical cost. The impact of future uncertainties has no place in financial
accounting.
3. It does not take into account price level changes.
4. It provides information about the whole concern. Product-wise, process-wise, department-
wise or information of any other line of activity cannot be obtained separately from the
financial accounting.
5. Cost figures are not known in advance. Therefore, it is not possible to fix the price in
advance. It does not provide information to increase or reduce the selling price.
6. As there is no technique for comparing the actual performance with that of the budgeted
targets, it is not possible to evaluate performance of the business.
7. It does not tell about the optimum or otherwise of the quantum of profit made and does not
provide the ways and means to increase the profits.
8. In case of loss, whether loss can be reduced or converted into profit by means of cost control
and cost reduction? Financial accounting does not answer such question.
9. It does not reveal which departments are performing well? Which ones are incurring losses
and how much is the loss in each case?
10. It does not provide the cost of products manufactured
11. There is no means provided by financial accounting to reduce the wastage.
12. Can the expenses be reduced which results in the reduction of product cost and if so, to what
extent and how? There is no answer to these questions in financial accounting.
13. It is not helpful to the management in taking strategic decisions like replacement of assets,
introduction of new products, discontinuation of an existing line, expansion of capacity, etc.
14. It provides ample scope for manipulation like overvaluation or undervaluation. This
possibility of manipulation reduces the reliability.
15.It is technical in nature. A person not conversant with accounting has little utility of the
financial accounts.


Cost Accounting
An accounting system is to make available necessary and accurate information for all those who
are interested in the welfare of the organization. The requirements of majority of them are
satisfied by means of financial accounting.
However, the management requires far more detailed information than what the conventional
financial accounting can offer. The focus of the management lies not in the past but on the
future.
For a businessman who manufactures goods or renders services, cost accounting is a useful tool.
It was developed on account of limitations of financial accounting and is the extension of
financial accounting. The advent of factory system gave an impetus to the development of cost
accounting.
It is a method of accounting for cost. The process of recording and accounting for all the
elements of cost is called cost accounting.
The Institute of Cost and Works Accountants, London defines costing as, the process of
accounting for cost from the point at which expenditure is incurred or committed to the
establishment of its ultimate relationship with cost centres and cost units. In its wider usage it
embraces the preparation of statistical data, the application of cost control methods and the
ascertainment of the profitability of activities carried out or planned.
The Institute of Cost and Works Accountants, India defines cost accounting as, the technique
and process of ascertainment of costs. Cost accounting is the process of accounting for costs,
which begins with recording of expenses or the bases on which they are calculated and ends with
preparation of statistical data.
To put it simply, when the accounting process is applied for the elements of costs (i.e., Materials,
Labour and Other expenses), it becomes Cost Accounting
Objectives of Cost Accounting:
Cost accounting was born to fulfill the needs of manufacturing companies. It is a mechanism of
accounting through which costs of goods or services are ascertained and controlled for different
purposes. It helps to ascertain the true cost of every operation, through a close watch, say, cost
analysis and allocation.
The main objectives of cost accounting are as follows:-

Cost Ascertainment
2. Cost Control
3. Cost Reduction
4. Fixation of Selling Price
5. Providing information for framing business policy.
Cost Ascertainment
The main objective of cost accounting is to find out the cost of product, process, job, contract,
service or any unit of production. It is done through various methods and techniques.
2. Cost Control
The very basic function of cost accounting is to control costs. Comparison of actual cost with
standards reveals the discrepancies (Variances). The variances indicate whether cost is within
control or not. Remedial actions are suggested to control the costs which are within control.
3. Cost Reduction
Cost reduction refers to the real and permanent reduction in the unit cost of goods manufactured
or services rendered without affecting the use intended. It can be done with the help of
techniques called budgetary control, standard costing, material control, labour control and
overheads control.
4. Fixation of Selling Price
The price of any product consists of total cost and the margin required. Cost data are useful in
the determination of selling price or quotations. It provides detailed information regarding
various components of cost. It also provides information in terms of fixed cost and variable
costs, so that the extent of price reduction can be decided.
5. Framing Business Policy
Cost accounting helps management in formulating business policy and decision making. Break
even analysis, cost volume profit relationships, differential costing, etc are helpful in taking
decisions regarding key areas of the business like-
a. Continuation or discontinuation of production
b. Utilization of capacity
c. The most profitable sales mix
d. Key factor
e. Export decision
f. Make or buy
g. Activity planning, etc.

Nature and Scope of Cost Accounting
Cost accounting is concerned with ascertainment and control of costs. The information provided
by cost accounting to the management is helpful for cost control and cost reduction through
functions of planning, decision making and control. Initially, cost accounting confined itself to
cost ascertainment and presentation of the same, mainly to find out product cost. With the
introduction of large scale production, the scope of cost accounting got widened and providing
information for cost control and cost reduction assumed equal significance along with finding
out cost of production. To start with cost accounting was applied in manufacturing activities but
now it is applied also in service organizations, government organizations, local authorities,
agricultural farms, extractive industries and so on.
Cost accounting guides for ascertainment of cost of production. Cost accounting discloses
profitable and unprofitable activities. It helps management to eliminate the unprofitable
activities. It provides information for estimate and tenders. It discloses the losses occurring in the
form of idle time spoilage or scrap etc. It also provides a perpetual inventory system. It helps to
make effective control over inventory and for preparation of interim financial statements. It helps
in controlling the cost of production with the help of budgetary control and standard costing.
Cost accounting provides data for future production policies. It discloses the relative efficiencies
of different workers and for fixation of wages to workers.
Limitations of Cost Accounting
It is based on estimation: as cost accounting relies heavily on predetermined data, it is not
reliable.
No uniform procedure in cost accounting: as there is no uniform procedure, with the same
information different results may be arrived by different cost accountants.
Large number of conventions and estimates: There are number of conventions and estimates
in preparing cost records such as materials are issued on an average (or) standard price,
overheads are charged on percentage basis, Therefore, the profits arrived from the cost records
are not true.
Formalities are more: Many formalities are to be observed to obtain the benefit of cost
accounting. Therefore, it is not applicable to small and medium firms.
Expensive: Cost accounting is expensive and requires reconciliation with financial records.
It is unnecessary: Cost accounting is an additional tool not essential tool and an enterprise can
survive even without cost accounting.
Secondary data: Cost accounting depends on financial statements for a lot of information. The
errors or short comings in that information creep into cost accounts also.
Management Accounting
Management accounting is not a specific system of accounting. It could be any form of
accounting which enables a business to be conducted more effectively and efficiently. It is
largely concerned with providing economic information to mangers for achieving organizational
goals. It is an extension of the horizon of cost accounting towards newer areas of management.
Though much of the management accounting information are financial in nature but are
organized in a manner relating directly to the decision on hand.
Management Accounting is comprised of two words Management and Accounting. It means
the study of managerial aspect of accounting. The emphasis of management accounting is to
redesign accounting in such a way that it is helpful to the management in formation of policy,
control of execution and appreciation of effectiveness.
Management accounting is of recent origin. This was first used in 1950 by a team of accountants
visiting U. S. A under the auspices of Anglo-American Council on Productivity
Definition
Anglo-American Council on Productivity defines Management Accounting as, the presentation
of accounting information in such a way as to assist management to the creation of policy and
the day to day operation of an undertaking
The American Accounting Association defines Management Accounting as the methods and
concepts necessary for effective planning for choosing among alternative business actions and
for control through the evaluation and interpretation of performances.
The Institute of Chartered Accountants of India defines Management Accounting as follows:
Such of its techniques and procedures by which accounting mainly seeks to aid the management
collectively has come to be known as management accounting
From these definitions, it is very clear that financial data are recorded, analyzed and presented to
the management in such a way that it becomes useful and helpful in planning and running
business operations more systematically.
Objectives of Management Accounting
The fundamental objective of management accounting is to enable the management to maximize
profits or minimize losses. The evolution of management accounting has given a new approach
to the function of accounting. The main objectives of management accounting are as follows:
1. Planning and Policy Formulation
Planning involves forecasting on the basis of available information, setting goals; framing
polices determining the alternative courses of action and deciding on the programme of
activities. Management accounting can help greatly in this direction. It facilitates the preparation
of statements in the light of past results and gives estimation for the future.
2. Interpretation process
Management accounting is to present financial information to the management. Financial
information is technical in nature.
Therefore, it must be presented in such a way that it is easily understood. It presents accounting
information with the help of statistical devices like charts, diagrams, graphs, etc.
3. Assists in Decision-Making Process
With the help of various modern techniques management accounting makes decision-making
process more scientific. Data relating to cost, price, profit and savings for each of the available
alternatives are collected and analyzed and thus it provides a base for taking sound decisions.
4. Controlling
Management accounting is a useful tool for managerial control. Management accounting tools
like standard costing and budgetary control are helpful in controlling performance.
Cost control is affected through the use of standard costing and departmental control is made
possible through the use of budgets. Performance of each and every individual operation is
controlled with the help of management accounting.

5. Reporting
Management accounting keeps the management fully informed about the latest position of the
concern through reporting. It helps management to take proper and quick decisions. The
performances of various departments are regularly reported to the top management.
6. Facilitates Organizing
Since management accounting stresses more on Responsibility Centers with a view to control
costs and responsibilities, it also facilitates decentralization to a greater extent.
Thus, it is helpful in setting up effective and efficient organization framework.
7. Facilitates Coordination of Operations
Management accounting provides tools for overall control and coordination of business
operations. Budgets are important means of coordination.
Nature and Scope of Management Accounting
Management accounting involves furnishing of accounting data to the management for basing its
decisions. It helps in improving efficiency and achieving the organizational goals. The following
paragraphs discuss about the nature of management accounting.
Provides accounting information
Management accounting is based on accounting information. Management accounting is a
service function and it provides necessary information to different levels of management.
Management accounting involves the presentation of information in a way it suits managerial
needs. The accounting data collected by accounting department is used for reviewing various
policy decisions.
2. Cause and Effect Analysis
The role of financial accounting is limited to find out the ultimate result, i.e., profit and loss,
where as management accounting goes a step further. Management accounting discusses the
cause and effect relationship. The reasons for the loss are probed and the factors directly
influencing the profitability are also analyzed. Profits are compared to sales, different
expenditures, current assets, interest payables, share capital, etc. to give meaningful
interpretation.
3. Use of Special Techniques and Concepts
Management accounting uses special techniques and concepts according to necessity, to make
accounting data more useful. The techniques usually used include financial planning and
analyses, standard costing, budgetary control, marginal costing, project appraisal etc.
4. Taking Important Decisions
It supplies necessary information to the management which may be useful for its decisions. The
historical data is studied to see its possible impact on future decisions. The implications of
various decisions are also taken into account.
5. Achieving of Objectives
Management accounting uses the accounting information in such a way that it helps in
formatting plans and setting up objectives. Comparing actual performance with targeted figures
will give an idea to the management about the performance of various departments. When there
are deviations, corrective measures can be taken at once with the help of budgetary control and
standard costing.
6. No Fixed Norms
No specific rules are followed in management accounting as that of financial accounting. Though
the tools are the same, their use differs from concern to concern. The deriving of conclusions
also depends upon the intelligence of the management accountant. The presentation will be in the
way which suits the concern most.
7. Increase in Efficiency
The purpose of using accounting information is to increase efficiency of the concern. The
performance appraisal will enable the management to pin-point efficient and inefficient spots.
Effort is made to take corrective measures so that efficiency is improved. The constant review
will make the staff cost conscious.
8. Supplies Information and not Decision
Management accountant is only to guide to take decisions. The data is to be used by the
management for taking various decisions. How is the data to be utilized will depend upon the
caliber and efficiency of the management.
9. Concerned with Forecasting
The management accounting is concerned with the future. It helps the management in planning
and forecasting. The historical information is used to plan future course of action. The
information is supplied with the object to guide management for taking future decisions.
Limitations of Management Accounting
Management Accounting is in the process of development. Hence, it suffers from all the
limitations of a new discipline. Some of these limitations are:
Limitations of Accounting Records
Management accounting derives its information from financial accounting, cost accounting and
other records. It is concerned with the rearrangement or modification of data.
The correctness or otherwise of the management accounting depends upon the correctness of
these basic records. The limitations of these records are also the limitations of management
accounting.
2. It is only a Tool
Management accounting is not an alternate or substitute for management. It is a mere tool for
management. Ultimate decisions are being taken by management and not by management
accounting.
3. Heavy Cost of Installation
The installation of management accounting system needs a very elaborate organization. This
results in heavy investment which can be afforded only by big concerns.
4. Personal Bias
The interpretation of financial information depends upon the capacity of interpreter as one has to
make a personal judgment. Personal prejudices and bias affect the objectivity of decisions.
5. Psychological Resistance
The installation of management accounting involves basic change in organization set up. New
rules and regulations are also required to be framed which affect a number of personnel and
hence there is a possibility of resistance form some or the other.
6. Evolutionary Stage
Management accounting is only in a developmental stage. Its concepts and conventions are not
as exact and established as that of other branches of accounting
Therefore, its results depend to a very great extent upon the intelligent interpretation of the data
of managerial use.
7. Provides only Data
Management accounting provides data and not decisions. It only informs, not prescribes. This
limitation should also be kept in mind while using the techniques of management accounting.
8. Broad-based Scope
The scope of management accounting is wide and this creates many difficulties in the
implementations process. Management requires information from both accounting as well as
non-accounting sources. It leads to inexactness and subjectivity in the conclusion obtained
HOW DOES MANAGEMENT ACCOUNTING DIFFER FROM THE OTHER BRANCHES
OF ACCOUNTING
Management Accounting differs significantly from the other branches of accounting such as
Financial Accounting and Cost Accounting. Factors that distinguish Management Accounting
from Financial Accounting and Cost Accounting are separately discussed as follows:
Management Accounting and Financial Accounting
Financial Accounting records all monetary transactions in the books of accounts and ascertains
the results of the financial activities of the concern for an accounting period by preparation of
financial statements at the end of every accounting period. On the other hand, Management
Accounting collects the basic data mainly from the Financial Accounting System and provides
necessary information to the management after analyzing and interpreting those data. Points of
difference between the Management Accounting and Financial Accounting are enumerated as
follows:
Management Accounting Financial Accounting
1. Management Accounting is primarily
based on the data as obtained from
Financial Accounting.
1. Financial Accounting is based on the
monetary transactions of the enterprise.
2. Its main function is to assist the
management in the process of its planning,
controlling, performance evaluation and
decision-making by proving necessary
information to the management.
2. Its main functions are recording and
classifying monetary transactions in the
books of accounts and preparation of
financial statements at the end of every
accounting period.
3. Reports as prepared in Management
Accounting may contain both objective as
well as subjective figures.
3. Reports as prepared in Financial
Accounting should always be supported
by relevant figures. It lays emphasis on
the objectivity of the data.
4. Reports as prepared in Management
Accounting are exclusively meant for the
management of the concern.
4. Reports as prepared in Financial
Accounting are meant for the
management as well as for shareholders
and creditors of the concern.
5. Reports are prepared as per the
requirement of the management.
5. Reports are prepared at the end of
every accounting period.
6. Reports as prepared in Management
Accounting are not subject to statutory
audit.
6. Reports as prepared in Financial
Accounting are always subject to
statutory audit.
7. It evaluates the sectional as well as the
entire performance of the business.
7. It ascertains the results and exhibits
the financial strength of the business as
a whole.
8. Its success depends on the existence of a
sound Financial Accounting System.
8. Its success does not depend, in any
way, on the existence of a sound
Management Accounting System.
Management Accounting and Cost Accounting
Management Accounting collects the basic data from the Financial Accounting and Cost
Accounting systems and provides necessary information to the management after analysing and
interpreting those data. On the other hand, Cost Accounting records all cost data in the cost book
as obtained from the Financial Accounting, ascertains costs and reveals all cost-related
information of the concern at the end of every accounting period. Points of difference between
Management Accounting and Cost Accounting are stated as follows:
Management Accounting Cost Accounting
1. The main objective of Management
Accounting is to assist the management in the
process of its planning, controlling,
performance evaluation and decision-making
by providing necessary information on time.
1. The main objective of Cost Accounting
is to ascertain, allocate and do accounting
for costs and to assist the management in
the process of its cost control and cost-
related decision-making.
2. It uses both quantitative as well as
qualitative data, measurable and even not
measurable in monetary terms.
2. It uses only quantitative cost data
measurable in monetary terms.
3. Primary emphasis given in Management
Accounting is on effective and efficient
performance of the business.
3. Primary emphasis given in Cost
Accounting is on cost determination and
cost control of the business.
4. Its success depends on the existence of a
sound Cost Accounting System.
4. Its success does not depend, in any way,
on the existence of a Management
Accounting System.
5. It is based on the data as obtained from
Financial Accounting and Cost Accounting.
5. It is based on the cost-related data as
obtained from Financial Accounting.
6. Management Accounting provides historical
as well as predictive information for future
decision-making.
6. Cost Accounting provides historical cost
information for future cost-related
decision-making.
7. Reports as prepared in Management
Accounting are exclusively meant for the
management of the concern.
7. Reports as prepared in Cost Accounting
are mainly meant for the management, but
also useful to the shareholders and
creditors of the concern.
8. It uses the principles and practices of
financial as well as Cost Accounting.
8. It uses the principles and practices of
Cost Accounting alone.
9. Reports as prepared in Management
Accounting are not subject to statutory audit.
9. Reports as prepared in Cost Accounting
are subject to statutory audit (i.e., cost
audit) in many countries.
10. It deals with cost- as well as finance-related
data of an enterprise.
10. It deals only with cost-related data of
an enterprise.

Types of cost:
CLASSIFICATION OF COSTS
Costs may be classified on different bases. They can be classified as follows:
1. By time (historical, predetermined)
2. By nature of elements (material, labour, overhead)
3. By association (product or period)
4. By traceability (direct, indirect)
5. By changes in activities or volume (fixed, variable, semi-variable)
6. By function (manufacturing, administration, selling, research and development)
7. Controllability (controllable, non-controllable)
8. Analytical and decision-making (marginal, uniform, opportunity, sunk,
differential etc.)
9. By nature of expense (capital, revenue)
10. Miscellaneous (conversion, traceable, normal, total)
Classification on the Basis of Time
Costs can be classified into historical costs and predetermined costs.
1.Historical costs: Historical costs are determined after they are incurred actually. When
production is completed, i.e., products reached their final stage of finished status, costs are
available and on that basis costs are ascertained. Only on the basis of actual operations, costs
are accumulated. Hence they are objective in nature.
Predetermined costs: Costs are calculated before they are incurred, i.e., before the production
process is completed.
These predetermined costs may further be classified into estimated costs and standard costs
1.Estimated costs: Costs are estimated before goods are produced. As these are purely
estimates, they lack accuracy.
2.Standard costs: These costs are also predetermined. But certain factors are analysed with
care before setting up costs. Standard cost is not only a concept of cost but a technique or
method of costing also.
Classification by Nature or Elements
Elements of costs may be broadly divided into material, labour and expenses.
Direct costs: In general, production is carried on in different cost centres. Costs which can be
directly identifiable with cost centres, processes or production units are known as direct costs.
Indirect costs: If costs cannot be identifiable with cost centres or cost units, they are termed as
indirect costs. Such costs that cannot be easily identifiable with cost centres have to be
apportioned on some equitable basis. These terms should be understood properly, as the same
will be applied in case of materials, labour and wages.
Material Costs
Commodities or substances from which products are produced are called materials. They may be
further divided into direct and indirect. The term direct means that which can be identified
with and allocated to cost centres and cost units. The term indirect means that which cannot be
allocated but can be apportioned to, or absorbed by, cost centres and cost units.
Direct materials: Direct materials are those materials which enter into and form part of the
product, e.g., wood in furniture, chemicals in drugs, leather in shoes. Direct materials include:
1. All materials specially purchased or requisitioned for a particular process or job
or order
2. All componentspurchased or produced
3. All materials passing from one process to another
4. All primary packing materials
Indirect materials: Materials which cannot be traced as part of the product are known as
indirect materials. Indirect materials include:
1. Fuel, lubricating oil, grease etc. (for maintenance of plant and machinery)
2. Tools of small value for general use
3. Consumable stores
4. Printing and stationery materials
5. Stores of small value used
Labour Costs
Labour costs can also be classified into direct labour and indirect labour.
Direct labour: Where employees are employed directly in making the product and their work
can be easily identified in the process of conversion of raw materials into finished goods, such
labour is called direct labour. The cost incurred on direct labour is called direct wages. Example:
Wages paid to the driver of a bus in a transport service.
Indirect labour: Labour employed in the works on factory which is ancillary to production is
known as indirect labour. The cost incurred on indirect labour is called indirect wages. These
costs may not be traced to specific units of output. Wages which cannot be directly identified
with a job or process are treated as indirect wages. Example: wages of store keepers, time
keepers, supervisors etc.
Expenses Costs
Expenses also can be direct and indirect.
Direct expenses: Direct expenses do not include direct material cost and direct labour cost.
These expenses are incurred in respect of a specific product. Example: cost of special pattern,
drawing or layout; secret formula, hire charges of machinery to execute an order, consultancy
fees to a specific job. The latest trend in cost accounting is that these expenses are not taken into
account. The terminology of CIMA is also of this view. Generally, direct expenses form a small
part of total cost.
Indirect expenses: Expenses which cannot be charged to production directly and which are
neither indirect material cost nor indirect wages cost are treated as indirect expenses. Examples:
Rent, rates, taxes, power, insurance, depreciation.
Overheads
Overheads include the cost of indirect material, indirect labour and indirect expenses. Overheads
may be classified into (i) production or manufacturing overheads, (ii) administrative overheads),
(iii) selling overheads and (iv) distribution overheads.
1. Production or factory overhead: It is the aggregate of indirect material cost,
indirect wages and indirect expenses incurred in respect of manufacturing activity. It
commences with the supply of raw materials and ends with the primary packing of
finished goods.
2. Administration overhead: It is the aggregate of indirect material cost, indirect
wages and indirect expenses incurred for policy formulation, control and
administration. Example: Directors remuneration.
3. Selling overhead: It is the cost of creating sales and retaining customers. It is
the aggregate of all indirect material costs, indirect wages and indirect expenses
incurred in creating and stimulating demand for a firms products and securing orders.
Example: advertisement, publicity expenses.
4. Distribution overhead: It is the aggregate of indirect material cost, indirect
wages and indirect expenses incurred in preparing the packed products for despatch
and making them available to customers. Example: rates and taxes for finished goods,
godown expenses.
Accounting Period-Wise Classification of Costs
1. Capital expenditure: It may be defined as expenditure which results in the
acquisition of or increase in an asset, or pertains to the extension or enhancement of
earning capacity at a smaller cost. A capital expenditure is intended to benefit future
periods. It is classified as a fixed asset. Example: Costs of acquiring land, building and
machinery.
2. Revenue expenditure: This expenditure occurs for the maintenance of assets
in working condition and not intended for increasing the revenue-earning capacity. A
revenue expenditure benefits the current accounting period. It is treated as an expense.
For matching of costs and revenues, the distinction between capital expenditure and revenue
expenditure is inevitable.
Behaviour-Wise Classification of Costs
Variable Cost
The terminology of CIMA defines variable cost as a cost which tends to follow (in the short-
term) the level of activity. Variable costs are also known as marginal costs. Variable costs vary
directly and proportionally with the output. Variable cost per unit is constant but the total costs
change corresponding to the levels of output. Variable cost is expressed in terms of units only.
Variable costs are synonymous with engineered costs. Example: Materials used to manufacture a
product, wages of workers in a manufacturing process. To illustrate, let direct material cost to
produce one unit of a product be Rs. 25. The existing volume of production is 10,000 units per
annum, then the existing direct material cost is 10,000 units Rs. 25 = Rs. 2,50,000. In case, if
the production increases to 20,000 units, the direct material cost would be Rs. 25 20,000 units
= Rs. 5,00,000. This shows that the direct material cost per unit remains constant but total
material cost rises with an increase in activity level.Figure.depicts the behaviour of variable
costs.

Figure 1.2A Total variable cost



Figure 1.2B Variable cost per unit


Note:
1. Figures are not drawn to scale.
2. Figures are not based on any figures. (They are only a rough sketch to show the
behaviour of variable cost.)
1.6.6.2 Fixed Cost
The terminology of CIMA defines fixed cost as the cost which accrues in relation to the passage
of time and which, within certain limits, tends to be unaffected by fluctuations in the level of
activity.
A going business should have physical facilities and an organization for use. These things
provide the capacity to manufacture and sell. The continuing costs of having capacity incurred in
anticipation of future activity are termed as capacity costs. In case capacity is utilized,
additional costs are incurred. Such additional costs of manufacturing and selling are controllable
with current activity, while capacity costs tend to continue regardless of the current rate of
activity as long as the same capacity is maintained.
Fixed costs are those which are not expected to change in total within the current budget year,
irrespective of variations in the volume of activity. Such costs are fixed for a given period over a
relevant range of output, on the assumption that technology and methods of manufacturing
remain unchanged.
For the purpose of cost analysis, fixed costs may be classified as follows:
1. Committed Costs: These costs cannot be eliminated instantly. These costs are
incurred to maintain basic facilities. Example: Rent, rates, taxes, insurance.
2. Policy and managed costs: Policy costs are incurred in enforcing management
policies. Example: Housing scheme for employees. Managed costs are incurred to
ensure the operating existence of the company. Example: Staff services.
3. Discretionary costs: These are not related to operations. These can be
controlled by the management. These occur at the discretion of the management.
To illustrate, a factory manufacturing CDs incurs a fixed cost of Rs. 1,00,000 per annum (which
includes rent, depreciation of plant and machinery, insurance of all fixed assets, salaries of staff).
The existing volume of production is 10,000 CDs per annum. If the production increases to
20,000 CDs, the total fixed cost remains the same i.e., Rs. 1,00,000 only. But the average fixed
cost per unit will come down from (Rs. 1,00,000 10,000) Rs. 10 to (Rs. 1,00,000 20,000) Rs.
5 per unit. Figure 1.3A and B depict the nature of fixed costs.
1.6.6.3 Semi-Variable Costs
The terminology of CIMA defines semi-variable cost as a cost containing both fixed and
variable elements which is thus partly affected by fluctuations in levels of activity Semi-
variable costs consist of features of both fixed and variable costs. These costs vary in total with
changes in the level of activitynot in direct proportion. Due to the fixed part of the element,
they do not change in direct proportion to output. Due to the variable part of the element, they
tend to change with volume. Semi-variable costs change in the same direction of output but not
in the same proportion. Example: electricity charges, stationery, telephone expenses. To
illustrate, telephone expenses is a semi-variable cost. Annual rental is Rs.1000. For every call
used the charge per call is Re. 1. Here the annual rental is the fixed part of the elementremains
unchangedwhereas the call made forms the variable element. It varies as per usage.Figure
1.4 shows the behaviour of semi-variable costs.

Figure 1.3A Total fixed cost



Figure 1.3B Fixed cost per unit
1.6.6.4 Step Cost
Step costs remain unchanged (constant) for a given level of output and then increase by a fixed
amount at higher level of output, i.e., from one level of output to another higher level. Example:
Salary of supervisors in a factory.


Figure 1.4 Semi-variable cost
Assume that a supervisor can supervise effectively 10 workers, a second supervisor would be
needed if workers exceed 10, and a third supervisor if workers exceed 20 and so on. There would
be a sudden increase in the salary of the supervisors, if the activity level increases from one
range to next.
Depending upon the period up to which an expense can be kept up to a certain level in spite of
increase in activity, the height and width of steps vary. In case, if the steps are small and narrow,
the behaviour of cost is like that of pure variable cost. This is called step variable cost. In
case, if the steps are wider, cost is like that of fixed cost. This is called step fixed
cost. Figure 1.5A and B show the behaviour of step fixed costs and step variable costs.

Figure 1.5A Step fixed costs

Figure 1.5B Step variable costs
1.6.6.5 Relevant Range
A relevant range is said to be a band of activity (volume) in which a specific form of budgeted
sales and cost (expense) relationship will be valid. A fixed cost is regarded as fixed only in
relation to a given relevant range and a given time (budget period). Example: (in the fixed cost
example) A fixed cost level of Rs.1,00,000 may be valid up to a relevant range i.e., production
value of 20,000 CDs per year. Beyond this volume of production, fixed costs would increase as
additional capacity has to be increased.
Figure 1.6 shows the behaviour of all three types of costs, viz., fixed costs, variable cost and
semi-variable costs.

Figure 1.6 Behaviour of costs
1.6.7 Functional Classification of Costs
Production costs: They are the cost of operating a production department in which manual and
machine operations are performed directly upon any part of product manufactured. This includes
the cost of direct materials, direct labour, direct expenses, primary packing expenses and all
overhead expenses pertaining to production.
Administration costs: These expenses include all indirect expenses incurred in formulating the
policy, directing the organization and controlling the operation of a concern. The expenses
relating to selling and distribution, production, development and research functions are not to be
included under this head.
Selling and distribution costs: These expenses include all expenses incurred with selling and
distribution functions.
Research and development costs: These include the cost of discovering new ideas, processes or
products by research and the cost of implementation of such results on a commercial basis.
Preproduction costs: when a new manufacturing unit is started or a new product is launched,
certain expenses are incurred. There would be trial runs. All such costs are called preproduction
costs. They are charged to the cost of future production because they are treated as deferred
revenue expenditure.
1.6.8 Costs for Planning and Control
Controllable cost: The terminology of CIMA defines controllable cost as a cost which can be
influenced by the action of specified member of an undertaking. It refers to those costs which
may be regulated at a specified level of authority (management) within a specified time period.
The term controllable costs means variable costs. Cost-control factor depends on time factor
and level of managerial authority. If the time period is sufficiently long, cost can be well
controlled. Proper delegation of authority with responsibility facilitates the task of control of
costs.
Uncontrollable costs: Uncontrollable cost is defined as the cost which cannot be influenced by
the action of a specified member of an undertaking. This cost is not subject to control at any
level.
The difference between the terms is important for the purpose of cost control, and
responsibility accounting costs which are not subject to the control of a person should not be
charged to that person. For instance, a foreman should not be charged with the plant
superintendent salary. The foreman should be charged only with such items as usage of
materials, direct labour, supplies. Further, it must be noted that the distinction between
controllable and uncontrollable cost is not absolute. It is made in relation to a given member of
an organization. A cost which is considered uncontrollable by a manager can be controlled by a
higher official. Examples of uncontrollable cost: rent, salary of staff, depreciation.
Budget: A budget is a plan for a future period. It is expressed in monetary terms. The
terminology of CIMA defines a budget as a plan quantified in monetary terms, prepared and
approved prior to a defined period of time usually showing planned income to be generated
and/or expenditure to be incurred during that period and the capital to be employed to attain a
given objective. It is also a tool of control.
Standard costs: Standard costs are closely related to budgets, and both are said to be
complementary to each other. It is a basic accounting tool. A standard cost is a predetermined
calculation of how much costs should be under specific working conditions. It is built up from an
assessment of the value of cost elements and correlates technical specifications and
quantification of material, labour and other costs to the prices and/or wage raves expected to
apply during the period in which standard cost is intended to be used. Its main purposes are to
provide bases for control through variance accounting, for valuation of stock, and work-in-
progress and in some cases, for fixing selling prices.
1.6.9 Costs for Analytical and Decision-Making Purposes
Imputed costs: Imputed costs do not involve actual cash outlay (cash payment). They are not
recorded in the books of accounts. They are not measurable accurately. However, imputed costs
are useful while taking decisions. Imputed costs can be estimated from similar situations.
Imputed costs can be estimated from similar situations outside the organization. Although these
are hypothetical costs, in making comparison, in performance evaluation, in making decision, the
inclusion of imputed costs is inevitable. Examples: Interest on invested capital, rental value of
company-owned building, salaries of owner-directors of sole proprietorship firms.
Sunk costs: Sunk cost is invested cost or recorded cost. A sunk cost is one which has been
incurred already and cannot be avoided by decision taken in future. Sunk cost may be defined as
an expenditure for equipment or productive resources which has no economic relevance to the
present decision-making process. Sunk cost is a past cost which cannot be taken into account in
decision making. Sunk cost may also be defined as the difference between the purchase price of
an asset and its salvage value. Non-incremental costs (i.e., cost which do not increase) are also,
at times, termed as sunk costs (one specific group of non-incremental costs).
Differential costs: Differential costs arise on account of the change in total costs associated with
each alternative. In the language of the AAA committee, it is the increase or decrease in total
costs, or the changes in the specific elements of cost that results from any variation in operation.
Differential cost consists of both variable and fixed costs. The differential cost between any two
levels of production is (i) the difference between two marginal costs (variable cost) at these two
levels and (ii) the increase or decrease in fixed costs. A distinction has to be understood between
differential cost and incremental cost. Incremental cost applies to increase in production and
restricted to cost only, whereas differential cost confines to both increase or decrease in output.
Differential cost is of much use in decision-making process, especially in choosing the best
alternative and in ascertaining profit where additional investments are introduced in the business.
Opportunity costs: Opportunity costs are the economic resources which have been foregone as
the result of choosing one alternative instead of another. The unique feature of an opportunity
cost is that no cash has changed hands. There is no exchange of economic resources. It results
from sacrificing some action. They are never shown in regular cost accounting records.
Example:
Some amountsay, Rs. 5,00,000in the purchase of one modern equipment which is necessary
to run the business. This amount, as present, cannot be invested in equity shares of dividends.
The loss of interest that would have been earned from this type of investment (shares and
debentures) is the opportunity cost. One alternativeinvesting in equipmentis chosen over
another alternative (investing in shares and debentures is sacrificed). The economic resources
interest from debentureshave been foregone, which is termed as opportunity cost. Its role is
important in decision-making process.
Postponable costs: These are costs which may be postponed to the future with little or no effect
on current operations. Actually it means deferring the expenditure to some future date. It does
not mean that the cost is avoided and rejected summarily. Example: Repairs and maintenance.
Avoidable costs: By choosing one alternative, costs may be saved. That means by avoiding one,
and choosing another, costs can be saved. Example: By not manufacturing a new product, the
appropriate direct material, labour and variable costs can be avoided.
Out-of-pocket costs: Out-of-pocket cost means those elements of cost which warrant cash
payment in the period under consideration. This is helpful in deciding whether a particular
venture will at least return the cash expenditure caused by the expected project. Example: Taxes,
insurance premium, salaries of supervisory staff, etc.
Relevant costs: Relevant costs are those expected future costs that differ between alternatives. It
is a cost affected by a decision at hand. Historical costs are irrelevant to a decision. It is
reasonable because it helps to ascertain whether the costs are relevant to a particular decision at
the present condition. In general, variable costs are affected by a decision and so they are
considered relevant.
Uniform costs: Generally they are not distinct costs as such. According to this, common costing
principles and procedures are being adopted by a number of firms. These costs are mainly
intended for inter-firm comparison.
Marginal costs: It is the aggregate of variable costs. It is useful in various ways for the
management.
Common costs: Common costs are those costs which are incurred for more than one produce,
job territory or any other specific costing object. The National Association of Accountants
defines common costs as the cost of services employed in the creation of two or more outputs,
which is not allocable to those outputs on a clearly justified basis.
1.6.10 Other Costs
Normal cost: This cost is incurred at a given level of output in the conditions that level of output
is achieved.
Traceable cost: This cost can be easily identified with a product or job or process.
Total costs: It denotes the sum of all costs in respect of a particular process or unit or job or
department or even the entire organization.

various Elements of Cost
There are broadly three elements of cost - (1) material, (2) labour and (3) expenses.:
The substance from which the product is made is known as material. It may be in a raw state-raw
material, e.g., timber for furniture and leather for shoe, etc. It may j also be in manufactured
state-components, e.g., battery for car, speaker for radio, etc, Materials can be direct and indirect.
Direct Material: All materials which become an integral part of the finished j product, the cost of
which are directly and completely assigned to the specific physical units and charged to the
prime cost, are known as direct material. The following are some of the materials that fall under
this category:
(a) Materials which are specifically purchased; acquired or produced for a particular job, order or
process.
(b) Primary packing material (e.g. carton, wrapping, cardboard, etc.)
(c) Materials passing from one process to another as inputs.
In order to calculate the cost of material, expenses such as import duties, dock charges, transport
cost of materials are added to the invoice price.
Material considered direct at one time may be indirect on other occasion. Nail used in
manufacturing wooden box is treated as direct material, but treated as indirect material when
used to repair the factory building.
Indirect Material: All materials, which cannot be conveniently assigned to specific physical
units, are termed as 'indirect material'. Such commodities do not form part of the finished
products. Consumable stores, lubrication oil, stationery and spare parts for the machinery are
termed as indirect materials.
Labour
Human efforts used for conversion of materials into finished products or doing various jobs in
the business are known as labour. Payment made towards the labour is called labour cost. It can
also be direct and indirect.
Direct Labour: Direct labour is all labour expended and directly involved in altering the
condition, composition or construction of the product. The wages paid to skilled and unskilled
workers for manual work or mechanical work for operating machinery, which can be specifically
allocated to a particular unit of production, is known as direct wages or direct labour cost. Hence,
'direct wage' may be defined as the measure of direct labour in terms of money. It is specifically
and conveniently traceable to the specific products Wages paid to the goldsmith for making gold
ornament is an example of direct labour.
Indirect Labour: Labour employed to perform work incidental to production of goods or those
engaged for office work, selling and distribution activities are known as 'indirect labour'. The
wages paid to such workers are known as 'indirect wages' or indirect labour cost.
Example: Salary paid to the driver of the delivery van used for distribution of the product.
Expenses
All expenditures other than material and labour incurred for manufacturing a product or
rendering service are termed as 'expenses'. Expenses may be direct or indirect.
Direct Expenses: Expenses which are specifically incurred and can be directly and wholly
allocated to a particular product, job or service are termed as 'direct expenses'. Examples of such
expense are: hire charges of special machinery hired for the fob, carriage inward, royalty, cost of
special and specific drawings, etc. These are also known as 'chargeable expenses'.
Indirect Expenses: All expenses excluding indirect material and indirect labour, which cannot be
directly and wholly attributed to a particular product, job or service, are termed as 'indirect
expenses'. Some examples of such expenses are: repairs to machinery, insurance, lighting and
rent of the buildings.
The elements of cost may be shown by means of a chart as follows:

Cost Allocation and Cost Apportionment
Cost allocation and cost apportionment are the two procedures which describe the identification and
allotment of costs to cost centers or cost units. Cost allocation refers to the allotment of all the items of
cost to cost centers or cost units whereas cost apportionment refers to the allotment of proportions of
items of cost to cost centers or cost units Thus, the former involves the process of charging direct
expenditure to cost centers or cost units whereas the latter involves the process of charging indirect
expenditure to cost centers or cost units.
For example, the cost of labor engaged in a service department can be charged wholly and directly but
the canteen expenses of the factory cannot be charged directly and wholly. Its proportionate share will
have to be found out. Charging of costs in the former case will be termed as allocation of costs
whereas in the latter, it will be termed as apportionment of costs.
Cost Sheet Format
Cost sheet is a statement shows the detailed cost of finished goods during a period. It presents detailed
information relating to cost per unit of a product at the different stages of production process. The
preparation of cost sheet is one of the important and primary functions of cost accounting. Cost sheet is
not an account. A cost sheet is a statement of cost prepared for a given period of time in such a manner
that indicates various elements of cost as clearly as possible. Sometimes standard cost data are provided
to compare with the actual cost increased. The format of a cost sheet is as follows:





















Cost Sheet for the Period:
Production:. Units
Particulars

Total cost Cost per Unit
(a) Direct Materials

Opening Inventory **********

Add: Purchase of Raw Materials **********

Less: Purchase Return **********

Less: Purchase Allowance **********

Less: Purchase Discount **********

Add: Freight **********

Direct Materials Available for Consumption **********

Less: Ending Inventory **********

Direct Materials Consumed **********

(b) Direct Labour **********

Direct Expenses **********

Prime Cost

********** **********
(c) Factory Overhead or Manufacturing Overhead

Indirect Materials **********

Indirect Labour **********

Rents and Rates (Factory) **********

Lighting and Heating (Factory) **********

Power and Fuel **********

Repairs and Maintenance **********

Depreciation of Factory Plants **********

Works Stationery **********

Payroll Taxes **********

Work Managers salaries **********

General Factory Overhead **********

Total Factory Overhead Cost **********

Total Manufacturing Cost

********** **********
Add: Work in Process (Opening) **********

Less: Add: Work in Process (Ending) **********

Cost of Goods Manufactured

********** **********
Add: Finished Goods Inventory (Opening) **********

Cost of Goods Available for Sale

********** **********
Less: Finished Goods Inventory (Ending) **********

Cost of Goods Sold

********** **********
Add: Administrative Overhead Cost **********

Add: Selling and Distribution Overhead Cost **********

Total Cost or Cost of Sales

********** **********
Add: Profit (Loss) **********

Sales

********** **********

Methods of Costing
As per the nature and peculiarities of the business, different Industries follow different methods
to find out the cost of their product. There are different principles and procedure for doing the
costing. However the basic principle and procedure of costing remain the same. Some of the
methods are mentioned below:


1. Unit Costing
2. Job Costing
3. Contract Costing
4. Batch Costing
5. Operating Costing
6. Process Costing.
7. Multiple Costing
8. Uniform Costing.
Different Methods of Costing
Unit Costing: This method also called 'Single output Costing'. This method of costing is used
for products which can be expressed in identical quantitative units and is suitable for products
which are manufactured by continuous manufacturing activity. Costs are ascertained for
convenient units of output. Examples: Brick making, mining, cement manufacturing, dairy, flour
mills etc.

Job Costing: Under this method costs are ascertained for each work order separately as each job
has its own specifications and scope. Examples: Painting, Car repair, Decoration, Repair of
building etc.

Contract Costing: Under this method costing is done for big jobs which involves heavy
expenditure and stretches over a long period and often it is undertaken at different sites. Each
contract is treated as a separate unit for costing. This is also known as Terminal Costing.
Construction of bridges, roads, buildings, etc. comes under contract costing.

Batch Costing: This methods of costing is used where the units produced in a batch are uniform
in nature and design. For the purpose of costing each batch is treated as a job or separate unit.
Industries like Bakery, Pharmaceuticals etc. usually use batch costing method.

Operating Costing or Service Costing: Where the cost of operating a service such as nursing
home, Bus, railway or chartered bus etc. this method of costing is used to ascertain the cost of
such particular service. Each particular service is treated as separate units in operating costing. In
the case of a Nursing Home, a unit is treated as the cost of a bed per day and for buses operating
cost for a kilometer is treated as a unit.

Process Costing: This kind of costing is used for the products which go through different
processes. For example, manufacturing cloths goes through different process. Fist process is
spinning. The out put of spinning is yarn. It is a finished product which can be sold in the market
to the weavers as well as use as a raw material for weaving in the same manufacturing unit. For
the purpose of finding out the cost of yarn, the cost of spinning process is to be ascertained. The
second step is the weaving process. The out put of weaving process is cloth which also can be
sold as a finished product in the market. In such case, the cost of cloth needs to be evaluated. The
third process is converting cloth in to finished product such as shirt or trouser etc. Each process
is to be evaluated separately as the out put of each process can be treated as a finished good as
well as consumed as a raw material for the next process. In such industries process costing is
used to ascertaining the cost at each stage of production.

Multiple Costing: When the output comprises many assembled parts or components such as in
television, motor Car or electronics gadgets, costs have to be ascertained or each component as
well as the finished product. Such costing may involve different methods of costing for different
components. Therefore this type of costing is known as composite costing or multiple costing.

Uniform Costing: This is not a separate method of costing. This is a system of using the same
method of costing by a number of firms in the same industry. It is treated as a common system of
using agreed principles and standard accounting practices in the identical firms or industry. This
helps in fixation of price of the product and inter-firm comparisons.
Reconciliation of Cost and Financial Accounts
Cost accounts act as a check on financial accounts. To achieve this, we have to compare the
profit/loss ascertained under the cost accounts with the profit/loss arrived under financial
accounts. By preparing a reconciliation statement, we can find out the causes of difference in
cost accounting and financial accounts.

Double entry system of account is being used by large manufacturing firms and they adopt one
of the following two methods:

1. Integral or integrated Accounting: When cost and financial transactions are unified, it is
called the integral/integrated accounting. In integral or integrated accounting Cost and financial
transactions are not kept separate, they are together recorded in one set of books of account.

2. Non-integral or Independent Accounting. When the cost and financial transactions are kept
separate, the method followed is called "non-integral or Independent Accounting". A separate set
of books are maintained under this system.

Need of reconciliation of cost and financial accounts arises only when non-integral accounting
method is followed.

Integral Accounting: means the maintenance of cost and financial accounts in a single set of
books. In other words the merger of financial and cost accounting by using a single set of books
of accounts. This serve the purpose of both financial account and cost account. A cost ledger and
three subsidiary ledgers i.e. Stores Ledger, Work-in-progress Ledger and Finished Stock Ledger
are also maintained in addition to the General Ledger, Sales Bought Ledger and Sales Ledger.
Cost Ledger: It contains all the nominal accounts and known as principal ledger in cost
accounting. Please note when the non-integral account is followed, cost ledger contains control
account for each subsidiary ledger. Example: Work-in-progress Ledger Control Account, Finished
Stock Ledger Control Account, Stores Ledger Control Account etc. It is also be noted that when
the integral account method is followed these control accounts are maintained in the General
Ledger.
Work-in-progress ledger: It is a subsidiary ledger which contains an account for each process,
job or operation which is pending on the shop floor. The cost of materials, overheads and labour
is debited and the cost of goods transferred to Finished Stock Ledger is credited to the account
as and when they are completed.
Finished Stock Ledger: It is a subsidiary ledger which contains an account for each item of job
completed or finished product manufactured. Each such completed job or product account is
debited with the cost of production and credited with the cost of goods transferred to Cost of
Sales Account.
Stores Ledger: It is a subsidiary ledger where in all the items of stores and its movements are
recorded. Purchase of materials debited to this account and issue of materials to jobs credited
to this account.
Under this method, no costing profit and loss account is prepared since only one set of
account is maintained. Therefore, There is no need for reconciliation of costing and
financial profit or loss.



Non-integral Accounting


The subsidiary ledgers and the cost ledger are inter-locked through control accounts maintained
in each ledger when independent cost accounts are maintained. This is practice (maintaining
Control Accounts) is followed for the purpose of cross checking the accuracy of ledgers and also
make each ledger self balance so that a separate trial balance may be prepared for each ledger
without reference to the other ledgers. A general ledger Adjustment Account is opened in the
cost ledger for all items of income and expenditure besides the control accounts. It is also known
as "Cost Ledger Control Account". The cost ledger also contains control accounts such as
Production Overheads Control Account, Wages Control Account, Administrative Overheads
Control Account, Selling and Distribution Overheads Control Account etc. The double entry is
completed through control accounts in the Non-integral accounting system. Therefore, it is also
known as "Control Accounts System".
Costing Profit and Loss Account: A separate Costing Profit and Loss Account is prepared for determining
the profit or loss of a particular period when cost accounts are maintained independent of financial
accounts. This account is debited with the cost of sales and credited with the sales value. It is also
debited with items like abnormal losses, under-absorption of overheads, loss or sale of special jobs etc.,
and credited with items like abnormal gains, over-absorption of overheads, profit on sale of special jobs,
etc. The balance of this account will indicate the profit or loss as per cost records which should be
reconciled with the profit or loss as per financial records.

Need for reconciliation of Cost and Financial Accounts.

When financial and cost accounts are maintained independently many a times the profit or loss
disclosed by the two sets of books may differ from each other. This difference in profit/loss
necessitates the preparation of a reconciliation statement. This statement will show the reason for
the difference in figures in the two accounts i.e. cost account and financial account. It not only
helps in checking the arithmetical accuracy of operating results shown by the financial accounts
but also establish the accuracy of cost accounts.