Benefit and Limitation of Cost Accounting
What is Cost Accounting?
Cost accounting or management accounting is a part of accounting that the company uses to obtain more information regarding costing, pricing, contribution margin, and the target net income. It is very useful for the managements to prepare proper plan and making the right decision. The cost accounting uses the internal information from all relevant departments such as production, warehouse, purchasing, and selling departments. It helps to prepare budget, access company performance, and provide detail information to management besides the financial statement.
Cost accounting or management accounting is a system which widely used for internal reporting, and it is not under any framework or regulation. There is no requirement of cost accountant to present the report to the external stakeholder. The management report will change depending on the business nature and the size, so it mainly depends on the reasonableness and management requirement.
Objective and Important of Cost Accounting
Calculate Cost of Product or Service
One of the primary objectives of management accounting is to calculate the cost of a product or service. The accountant will separate all costs into a variable cost, fixed cost, and production overhead. Each type of them has different characteristics and behavior, and it will impact to product’s price and company profit in different patterns. For example, variable cost will increase as the production increase, but it stays the same per unit of production. Fixed cost will be the same, even the production quantity change.
The accountant will classify all the costs into each category and provides a proper report to management, which will help them make adequate decisions.
Calculate the Selling Price
When we know the total cost of product, it will be more precise to set the correct selling price. The management needs an internal report that shows the relationship between selling price, cost per unit, profit margin, and net income.
To Manage Cost
One of the main objectives of the business is to obtain a high profit, and there are two options in which we could archive this. One is by increasing the selling price; however, it will impact the selling quantity that eventually will reduce the profit. So the second method is to reducing cost, however, we need to ensure that it will not impact the products’ quality.
Cost accounting plays an essential role in managing these costs, as we already know how they behave, their relationship with production. So their fluctuations must be bound by reasons. If any unusual change, we will be able to identify them. Moreover, cost accountant has a deep understanding of value-added and nonvalue added costs which are very important for business because it helps us to reduce any non-value cost, and it will scarify the product’s value to the customers.
Assist Management Decision
In business operations, management may face some situations such as make or buy decisions, discontinue a product line, discontinue operation, …etc. In order to solve these problems, managements need more information besides the financial statements. It required the management report from cost accountant.
Prepare Business Budget
The company will require to prepare annual budget to set the target for each department. So cost accountant plays an important role in ensuring that all the targets are achievable and there is no budget slack. As we already know, cost accountant understands precisely how the cost and revenue relation, so if the company sets target revenue, we will be able to calculate the variable cost and fixed cost which will respond with the goal. The production department may raise some additional cost to represent the wastage and error, which is subjective to be discussed and find a reasonable acceptant rate.
Access Management performance
As we know, financial statements very subjective, and the result can be easily manipulated by assumption and accounting estimation. So in order to access company performance, we require to have more internal reports such as the comparison between budget and actual sale, budget and actual cost, and so on. Again, cost accountant plays an important role here as they have more information and understand the connection between all relevant data.
Limitation of Cost accounting
The purpose of cost accounting is to analyze the business performance, prepare costing, budget in order to support management decisions. However, we still find many limitations as follows:
Cost accounting requires much detail data in order to prepare the report. For example, if we need to prepare the cost of goods sold, we need to allocate the direct material to the specific product/job. It is not an easy task when the factory produce hundred of products if not thousand. Moreover, it also happens to direct labor too, how much does the worker spend their time on each product. It will be more complicated for the indirect material and overhead cost, where they need to allocate to different product types.
It is very expensive to build the proper management accounting system, and it requires both a complex system and responsible people who have enough skills. Besides the accounting team, we also need to have more staff at the warehouse, purchase department and production. The warehouse staffs need to allocate material to a specific job. The purchase department needs to ensure there enough material for production.
Different from financial accounting which is under strict regulation of IFRS or US GAAP, management accounting does not fall under any standard. So the accountant can prepare a report base on the actual situation which can respond to the managements need. Therefore, it is very hard to compare management report from one company to another. Moreover, it very challenging for the accountant who has less experience; they have initiated the reporting template from scratch without any guidelines.
To support management decision but can’t provide a solution
The cost accounting will show us the actual cost is higher than the budget, the direct material cost has increased from the prior month and many other issues. However, it does not give any suggested solutions to all these issues.
Base on Judgment
Most of the figure used in cost accounting depends on the assumption of management and experience, so the result can be different as the people will not have the same judgment.
Difficult to Compare between Entity
For the financial statement, we will be able to benchmark our company with any others within the same industry in order to find any weakness. However, we can not do benchmarking on management reports as they are not publicly available from other companies and they are using a different format which is best fits their business.
Too Many Options
Management accounting provides us with so many options that lead to various outcomes while we have the same data. For example, in order to calculate the product cost of goods sold, we can use job costing, process costing, absorption costing, activity-based costing and so on. They have both advantages and disadvantages which are hard to select, especially for inexperienced accountants.
Does not control the cost
The cost accounting only tells us the increase or decrease in cost, but it will not be able to control. By the way, it just a tool to inform management and expect the management to take action. If the company does not have competent management team, this report will be useless.
Lack of double entries
There are no double entries in cost accounting, so it is hard to illustrate the impact of the report or do any reconciliation in order to prove the information appear on the statement. It is tough to compare cost accounting to financial accounting as they are base on a different perspective.
Lack of future information
The report will not be able to predict the future, but only analyze the information in the past. In the future, we may have a new issue, so we will not be able to use this report.
The quality relies upon data
Cost accountant works on the data provided by various sources, and sometimes the data is not accurate, so it will impact on the quality of work and report to management.