Introduction to Cost and Management Accounting

1 What is Cost?

Cost is the monetary amount of resources or the consideration for using the resource invested or consumed or used up. In its most simplistic form cost is monetary measurement of resource outflow due to any reason.

As cost is information, user of information may require this information to be generated or processed as per the desire of user of such information. Due to same reason we can classify costs in number of ways. And this is sheer beauty of this concept that it can be defined in entirety from each dimension even taken alone and separately from other concepts.

This includes not only the resources actually expended but also the benefits that could have been earned but has been sacrificed in order to avail benefits from current option.

Costs can be related to activities undertaken but it does not necessarily have to have relation with activities of the business (production cost) or time (period cost) or consumption of asset or resource e.g. fine paid to make up any violation is a cost or interest paid on loan is cost as well.

Students interested in details must pay attention to the difference between cost and expense as it is important.

Summing up the discussion we must understand that cost is monetary value of resources consumed and it is a relevant measurement and will be done keeping the requirements of the user in check.

2 Cost Vs Expense

Most of the time the difference between the terms Cost and Expense is ignored and are used interchangeably. However, the difference is significant from accounting perspective and being an accountant it is good if we keep these two terms separate to cause lesser confusion and clearer communication of financial information.

Cost can be defined as the monetary value of the utility (or benefit) which is yet to be derived from the resources used by the business to earn income.
In simple words it is the benefit that we are expecting to have in future from the asset(s) by using such asset(s) for business purposes or by selling such asset in an arm’s length transaction.

Expense can be defined as the monetary value of the utility that has already expired because of the use of the resources in business activities directed towards generating income.

In simple words it is the monetary amount of the benefit used up in the asset(s). So, basically it is the consideration that we have paid in generating income.

Some students might still be confused about the relationship of cost and expense. Let’s understand it with an example.

A company bought one latest piece of machinery worth 100,000. It is expected that it will be useful for next five years and will be used to process raw material into finished goods.

The value of asset in example is 100,000 which is basically monetary representation of the total utility it has i.e. we have counted the total benefit it can provide us in money form and this is the total amount of benefits which we are expecting to recover over next five years. Now, if we use this asset then each year 20,000 (100,000 / 5) worth of utility will expire and at the end of the first year of its use we will left with only 80,000 of the total utility in the asset.

So, basically Expense is the amount of cost which has expired and Cost is the amount of expense which has not yet expired.

Due to same reason we will report only 80,000 in the Statement of Financial Position (Balance sheet) as this is the benefit in the asset which we are left with for next four years. And 20,000 will be transferred to Income Statement as an expense to be set off against the revenues generated by the organization to calculate actual income earned.

From the above discussion we can understand how important it is to make cost versus expense comparison as costs are reported in SoFP as the value of assets whereas expenses are reported in the Income Statement. And we understood that these terms do have their accounting implications and differences in accounting treatments.

3 What is Cost Accounting?

Cost accounting is a process of monetizing outflow of resources or loss of benefits in relation to certain aspect of the business for which user demands an information which is mostly used in decision making process.

It is in the nature of humans to seek benefit in every activity they pursue. Due to the same reason every type of business especially profit making entities require cost information to determine whether flow of returns is more then the flow of resources spent in anticipation of such returns. Only accurate, complete cost information can help reach good decisions and only correct and timely decisions can help business grow.

Cost accounting’s scope is much larger than the next widely known type of accounting i.e. financial accounting. The depth of information i.e. ‘drill down’ is only possible if information is produced on the principals of cost accounting. It is cost accounting that bridges three tiers of time i.e. past, present and future.

Looking again at the role of cost accounting or costing then it has three roles to play:

  • Measure the outflow of resources i.e. provide basis of measurement of expenditures and quantify them so that they can easily be identified and discussed separately from other outflows
  • Monetize the quantified information as measured by costing techniques. Without expressing the information in financial form it is almost impossible to use this information effectively
  • Producing information in the form that it can be used for decision making purposes. It is cost accounting’s supreme power that it can produce information relating costs and revenues etc as per the desires of user. For example if user likes to know the total cost or cost of particular department or particular product or cost incurred in processing single unit of particular product in a particular department it is all possible only with the help of cost accounting.

It does not only handle the past information well it can also be of great help to plan future with budgeting and different analysis like break-even and CVP analysis, variance calculations and not to forget numerous cost measurement techniques like job-order costing, unit costing, process costing, activity based costing and just some of the well-known gems of cost accounting.

And its scope does not even known its boundaries and now extended even to qualitative information with the help of extension to make up management accounting and helping you analyse your business with performance measurement techniques that uses qualitative indicators i.e. your analysis can be done using information that cannot be expressed in monetary terms i.e. Building block model, Balanced score card techniques have just extended the power of cost accounting in non-financial grounds as well.

However, students must remember that management accounting and cost accounting, although often used to mean same, does have differences and they are not exactly same and they must be treated as two separate types of accounting.

4 Cost Accounting Vs. Management Accounting

Usually the terms, Cost accounting and Management accounting, are used interchangeably and are used in one and the same sense. However, there are differences between these two terms conceptually and in application.

Cost accounting deals with calculation and measurement of resources utilized for different business activities usually production and service provision. It relates to calculation of per unit cost using different costing techniques.

On the other hand Management accounting relates to the use of all such information gathered and processed by cost accounting by management. Management accounting is about getting the information from cost accountants and then uses it for decision making purposes.

Therefore, cost accounting supports management accounting and in turn management accounting pushes cost accounting further according to the needs of the management. Because of this strong bondage between cost accounting and management accounting they are to mean one and the same thing now a days.