Cost of Capital is the rate that must be earned in order to satisfy the required rate of return of the firm’s investors. Keep Reading What is the Cost of Capital? Meaning and Definition. It can also define as the rate of return on investmentsat which the price of a firm’s equity share will remain unchanged.
Cost of Capital – Meaning and Definition, define each one, Read this article to learn about the Cost of Capital.
Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds.COC is the required rate of return on its investments which belongs to equity, debt and retained earnings. If a firm fails to earn the return at the expected rate, the market value of the shares will fall and it will result in the reduction of the overall wealth of the shareholders.
Meaning of Cost of Capital:
An investor provides long-term funds (i.e., Equity shares, Preference Shares, Retained earnings, Debentures etc.) to a company and quite naturally he expects a good return on his investment. In order to satisfy the investor’s expectations, the company should be able to earn enough revenue. Thus, to the company, the COC is the minimum rate of return that the company must earn on its investments to fulfill the expectations of the investors.
If a company can raise long-term funds from the market at 10%, then 10% can use as the cut-off rate as the management gains only when the project gives return higher than 10%. Hence 10% is the discount rate or cut-off rate. In other words, it is the minimum rate of return required on the investment project to keep the market value per share unchanged.
In order to maximize the shareholders’ wealth through increase price of shares, a company has to earn more than the COC. The firm’s cost of capital can determine by working out the weighted average of the different costs of raising different sources of capital.
Definition of Cost of Capital:
We have seen that the cost of capital is the average rate of return required by the investors.
Various authors defined the term cost of capital in different ways some of which are stated below. Some definitions of financial experts are given below for the clear conception of the COC:
Ezra Solomon defines:
“Cost of capital is the minimum required rate of earnings or cutoff rate of capital expenditure”.
According to Mittal and Agarwal:
“The cost of capital is the minimum rate of return which a company is expected to earn from a proposed project so as to make no reduction in the earning per share to equity shareholders and its market price”.
According to Khan and Jain, cost of capital means:
“The minimum rate of return that a firm must earn on its investment for the market value of the firm to remain unchanged”.
According to the definition of John J. Hampton:
“Cost of capital is the rate of return the firm required from investment in order to increase the value of the firm in the marketplace”.
Each type of capital used by the firm (debt, preference shares, and equity) should incorporate into the COC, with the relative importance of a particular source being based on the percentage of the financing provided by each source of capital. Using the cost a single source of capital as the hurdle rate is tempting to management, particularly when an investment is financed entirely by debt. However, doing so is a mistake in logic and can cause problems.
Investment in capital projects needs funds. The Concept of the study Explains – Cost of Capital: Meaning, What is the Cost of Capital? Components of Cost of Capital, Significance of the Cost of Capital, Classification of Cost of Capital, and the Importance of Cost of Capital. These funds are provided by the investors like equity shareholders, preference shareholders, debenture holders, etc in expectation of a minimum return from the firm. The minimum return expected by the investors depends upon the risk perception of the investor as well as on the risk-return characteristics of the firm. Also learn, Cost of Capital: Meaning, Classification, and Importance!
Understand and Learn, Cost of Capital: Meaning, Classification, and Importance!
This minimum return expected by the investors, which in turn, is the cost of procuring funds for the firm, is termed as the cost of capital of the firm. Thus, the cost of capital of a firm is the minimum rate of return that it must earn on its investments in order to satisfy the expectation of the various categories of investors who have invested in the firm.
Meaning By accounting coach: The cost of capital is the weighted-average, after-tax cost of a corporation’s long-term debt, preferred stock, and the stockholders’ equity associated with common stock. The cost of capital is a percentage and it is often used to compute the net present value of the cash flows in a proposed investment. It is also considered to be the minimum after-tax internal rate of return to be earned on new investments.
By Wikipedia: In economics and accounting, the cost of capital is the cost of a company’s funds (both debt and equity), or, from an investor’s point of view “the required rate of return on a portfolio company’s existing securities”. It is used to evaluate new projects of a company. It is the minimum return that investors expect for providing capital to the company, thus setting a benchmark that a new project has to meet.
A firm procures funds from various sources by issuing different securities to finance its projects. Each of these sources of finance entails the cost to the firm. Since the minimum rate of return expected by various investors – equity investor and debt investor – will be different depending upon their risk perception of the firm, the cost of each source of finance will be different. Thus the overall cost of capital of a firm will be the weighted average of the cost of different sources of finance, with the proportion of each source of finance as the weight. Unless the firm earns this minimum rate of return, the investors will be tempted to pull out of the company, let alone, to participate in any further capital issue.
We have seen that the cost of capital of a firm is the minimum required rates of return of various investors – shareholders and debt investors- who supply funds to the firm. How does a firm determine the required rates of return of each investor? The required rates of return are market determined and are reflected in the market price of each security. An investor, before investing in a security, evaluates the risk-return profile of investment and assigns a risk premium to the security. This risk premium and the expected return of an investor is incorporated in the market price of the security. Thus the market price of a security is a function of the return expected by the investors.
There are various sources of finance that are used by the firm for financing its investment activities. The major sources are equity capital and debt. Equity capital represents ownership capital. Equity shares are financial instruments to raise equity capital. A debt may be in the form of secured/unsecured loans, debentures, bonds, etc. The debt carries a fixed rate of interest and the payment of interest is mandatory irrespective of the profit earned or loss incurred by the firm.
Since interest payable on debt is tax deductible, the usage of debt provides a tax shield to the company. Basic three components as follows:
Cost of Equity Share Capital: Theoretically, the cost of equity share capital is the minimum return expected by the equity investors. The minimum return expected by the equity investors depends upon the risk perception of the investor as well as on the risk-return complexion of the firm.
Cost of Preference Share Capital: The cost of preference share capital is the discount rate which equates the net proceeds from the issue of preference shares to the present value of the expected cash outflows in the form of dividend and principal repayment on redemption.
Cost of Debentures or Bonds: The cost of debentures or bonds is defined as the discount rate which equates the net proceeds from the issue of debentures to the present value of the expected cash outflows in the form of interest and principal repayment.
The basic objective of financial management is to maximize the wealth of the shareholders or the value of the firm. The value of a firm is inversely related to the cost of capital of the firm. So in order to maximize the value of a firm, the overall cost of capital of the firm should be minimized.
The cost of capital is of utmost importance in capital structure planning and in capital budgeting decisions.
In capital structure planning a company strives to achieve the optimal capital structure in order to maximize the value of the firm. The optimal capital structure occurs at a point where the overall cost of capital is minimum.
Since the overall cost of capital is the minimum rate of return required by the investors, this rate is used as the discount rate or the cut-off rate for evaluating the capital budgeting proposals.
The cost of capital defines as the minimum rate of return a firm must earn on its investment in order to satisfy investors and to maintain its market value. It is the investors required the rate of return. Cost of capital also refers to the discount rate which is used while determining the present value of estimated future cash flows. The major classification of the cost of capital is:
Historical Cost and future Cost:
Historical Cost represents the cost which has already been incurred in financing a project. It is calculated on the basis of the past data. Future cost refers to the expected cost of funds to be raised for financing a project. Historical costs help in predicting future costs and provide an evaluation of the past performance when compared with standard costs. In financial decisions, future costs are more relevant than historical costs.
Specific Costs and Composite Cost:
Specific costs refer to the cost of a specific source of capital such as equity shares, Preference shares, debentures, retained earnings etc. Composite cost of capital refers to the combined cost of various sources of finance. In other words, it is a weighted average cost of capital. It is also termed as ‘overall costs of capital’. While evaluating a capital expenditure proposal, the composite cost of capital should be as an acceptance/ rejection criterion. When capital from more than one source is employed in the business, it is the composite cost which should be considered for decision-making and not the specific cost. But where capital from only one source is employed in the business, the specific cost of those sources of capital alone must be considered.
Average Cost and Marginal Cost:
The average cost of capital refers to the weighted average cost of capital calculated on the basis of the cost of each source of capital and weights are assigned to the ratio of their share to total capital funds. The marginal cost of capital may be defined as the ‘Cost of obtaining another dollar of new capital.’ When a firm raises additional capital from only one source (not different sources) than marginal cost is the specific or explicit cost. Marginal cost is considered more important in capital budgeting and financing decisions. Marginal cost tends to increase proportionately as the amount of debt increase.
Explicit Cost and Implicit Cost:
Explicit cost refers to the discount rate which equates the present value of cash outflows or value of the investment. Thus, the explicit cost of capital is the internal rate of return which a firm pays for procuring the finances. If a firm takes the interest-free loan, its explicit cost will be zero percent as no cash outflow in the form of interest is involved. On the other hand, the implicit cost represents the rate of return which can be earned by investing the funds in the alternative investments. In other words, the opportunity cost of the funds is the implicit cost.
Implicit cost is the rate of return with the best investment opportunity for the firm and its shareholders that will be forgone if the project presently under consideration by the firm were accepted. Thus implicit cost arises only when funds are invested somewhere, otherwise not. For example, the implicit cost of retained earnings is the rate of return which the shareholder could have earn by investing these funds if the company would have distributed these earning to them as dividends. Therefore, the explicit cost will arise only when funds are raised whereas implicit cost arises when they are used.
The cost of capital is a very important concept in financial decision making. Cost of capital is the measurement of the sacrifice made by investors in order to invest with a view to getting a fair return in future on his investments as a reward for the postponement of his present needs. On the other hand from the point of view of the firm using the capital, cost of capital is the price paid to the investor for the use of capital provided by him. Thus, the cost of capital is the reward for the use of capital. The progressive management always likes to consider the importance cost of capital while taking financial decisions as it’s very relevant in the following spheres:
Designing the capital structure:
The cost of capital is the significant factor in designing a balanced and optimal capital structure of a firm. While designing it, the management has to consider the objective of maximizing the value of the firm and minimizing the cost of capital. Comparing the various specific costs of different sources of capital, the financial manager can select the best and the most economical source of finance and can design a sound and balanced capital structure.
Capital budgeting decisions:
The cost of capital sources as a very useful tool in the process of making capital budgeting decisions. Acceptance or rejection of any investment proposal depends upon the cost of capital. A proposal shall not be accepted till its rate of return is greater than the cost of capital. In various methods of discounted cash flows of capital budgeting, cost of capital measured the financial performance and determines the acceptability of all investment proposals by discounting the cash flows.
Comparative study of sources of financing:
There are various sources of financing a project. Out of these, which source should be used at a particular point in time is to be decided by comparing the costs of different sources of financing. The source which bears the minimum cost of capital would be selected. Although the cost of capital is an important factor in such decisions, equally important are the considerations of retaining control and of avoiding risks.
Evaluations of financial performance:
Cost of capital can be used to evaluate the financial performance of the capital projects. Such as evaluations can be done by comparing the actual profitability of the project undertaken with the actual cost of capital of funds raised to finance the project. If the actual profitability of the project is more than the actual cost of capital, the performance can be evaluated as satisfactory.
Knowledge of firms expected income and inherent risks:
Investors can know the firms expected income and risk inherent therein by the cost of capital. If a firms cost of capital is high, it means the firms present rate of earnings is less, the risk is more and capital structure is imbalanced, in such situations, investors expect the higher rate of return.
Financing and Dividend Decisions:
The concept of capital can be conveniently employed as a tool for making other important financial decisions. On the basis, decisions can be taken regarding dividend policy, capitalization of profits and selections of sources of working capital.
In sum, the importance of cost of capital is that it is used to evaluate the new project of the company and allows the calculations to be easy so that it has a minimum return that investor expectations for providing investment to the company.
Cost Accounting and Financial Accounting Difference: Cost Accounting refers to that branch of accounting that deals with costs incurred in the production of units of an organization. A common question asked around, What is the Difference between Cost Accounting and Financial Accounting? On the other hand, financial accounting refers to the accounting concerned with recording financial data of an organization, to exhibit the exact position of the business. Also, take look at the difference between Cost and Management Accounting.
Learn, Explain the Difference between Cost and Financial Accounting!
Cost accounting generates information to keep a check on operations, to maximize profit and efficiency of the concern. On the other hand, Financial accounting ascertains the financial results, for the accounting period and the position of the assets and liabilities on the last day of the period. There is no comparison between these two because they are equally important for the users. This article presents you with the difference between cost accounting and financial accounting in tabular form.
Definition of Cost Accounting:
Cost Accounting is the field of accounting that uses to record, summarise, and report the cost information on a periodical basis. Its primary function is to ascertain and control costs. It helps the users of cost data to make decisions regarding the determination of selling price, controlling costs, projecting plans and actions, efficiency measurement of the labor, etc. also, Cost Accounting adds to the effectiveness of financial accounting by providing relevant information which ultimately results in the good decision-making process of the organization. It traces the cost incurred at each level of production, i.e. right from the input of the material till the output produced, every cost records.
There are two types of Cost Accounting systems, they are:
Non – Integrated Accounting System: The accounting system in which a separate set of books is maintaining for cost information.
Integrated Accounting System: The accounting system in which cost and financial data are maintaining in a single set of books.
Definition of Financial Accounting:
Financial Accounting is the branch of accounting, which keeps the complete record of all monetary transactions of the entity and reports them at the end of the financial period in proper formats that increases the readability of the financial statements among its users. Also, The users of financial information are many i.e. from internal management to outside parties. Preparation of financial statements is the major objective of financial accounting in a specified manner for a particular accounting period of an entity.
It includes an Income Statement, Balance Sheet, and Cash Flow Statement which helps in, tracing out the performance, profitability, and financial status of an organization during a period. Also, the information provided by financial accounting is useful in making comparisons between different organizations and analyzing the results thereof, on various parameters. In addition to this, the performance and profitability of various financial periods can also be compared easily.
Comparison of Cost and Financial Accounting:
Basis For Comparison
Cost Accounting
Financial Accounting
Meaning:
Cost Accounting is an accounting system, through which an organization keeps the track of various costs incurred in the business in production activities.
Financial Accounting is an accounting system that captures the records of financial information about the business to show the correct financial position of the company on a particular date.
Information type:
Also, Records the information related to material, labor, and overhead, which are used in the production process.
Records the information which are in monetary terms.
Which type of cost is used for recording?
Both historical and pre-determined cost
Only historical cost.
Users:
Information provided by the cost accounting uses only by the internal management of the organization like employees, directors, managers, supervisors, etc.
Also, Users of the information provided by financial accounting are internal and external parties like creditors, shareholders, customers, etc.
Valuation of Stock:
At cost
Cost or Net Realizable Value, whichever is less.
Mandatory:
No, except for manufacturing firms it is mandatory.
Yes for all firms.
Time of Reporting:
Details provided by cost accounting are frequently prepared and reported to the management.
Financial statements are reported at the end of the accounting period, which is normally 1 year.
Profit Analysis:
Generally, the profit is analyzed for a particular product, job, batch, or process.
Income, expenditure, and profit are analyzed together for a particular period of the whole entity.
Purpose:
Reducing and controlling costs.
Also, Keeping a complete record of the financial transactions.
Forecasting:
The forecasting is possible through budgeting techniques.
The forecasting is not at all possible.
The upcoming discussion will update you on the difference between cost and financial accounting.
The Difference in Cost Accounting:
The following difference below are;
Cost Accounting explains the principles, techniques, and methods for ascertaining the cost and to find out the variance in comparison with the standard and enquire reasons for such variation.
The objective of cost accounting is to ascertain the cost and allocates the same in respective places.
It applies to the manufacturing and service industries.
Also, Cost accounting supplies necessary information’s to the management for decision-making purposes.
Stocks are valued as per cost price in cost accounting.
Cost accounting determines the profit or loss of each item of product, process, etc.
There is no particular period for ascertaining the cost of a product.
Also, Cost accounting is based on the concept of costing principles.
They include data based on facts and figures and also on some estimates.
Also, Cost accounting considers the requirements of Sec. 209(1) of the Companies Act.
Cost accounting control, material labor and overhead costs with the help of Standard costing, Budgetary control, etc.
Usually, cost accounting provides services to internal management.
The Difference in Financial Accounting:
The following difference below are;
Financial accounting maintains records for keeping accounts relating to all monetary transactions.
Also, Financial accounting supplies information’s to the management relating to profit or loss and financial positions.
In financial accounting, stocks are valued as per cost price or market price whichever is lower.
Financial accounting shows the profit or loss of a firm as a whole at a particular date.
In Financial Accounting, accounts are prepared periodically, usually at the end of the period.
Also, Financial accounting bases on the concept of GAAP.
Financial accounting takes data based on facts and figures only.
They meet the requirements of the Companies Act 1956, Sales Tax, Income-Tax, etc.
Financial accounting does not have any tool to control the financial transaction of the business.
Also, Financial accounting provides information to the internal as well as external users of accounting information.
The Main point of Differences Between Cost and Financial Accounting:
Difference between Cost and Financial Accounting
The following are the major differences between cost accounting and financial accounting:
Cost Accounting aims at maintaining the cost records of an organization. Also, Financial Accounting aims at maintaining all the financial data of an organization.
Cost Accounting Records both verifiable and pre-decided costs. On the other hand, Financial Accounting records just chronicled costs.
Also, Clients of Cost Accounting are restricted to interior administration of the element; though clients of Financial Accounting are inside just as outside gatherings.
In cost, accounting stock qualities at cost while in financial accounting, the stock qualities at the lower of the two for example cost or net feasible worth.
Cost Accounting is obligatory just for the association which participates in assembling and creative exercises. Then again, Financial Accounting is obligatory for all associations, just as consistent with the arrangements of the Companies Act and Income Tax Act, is additionally an unquestionable requirement.
Also, cost Accounting data reports intermittently at continuous spans; yet financial accounting data reports after the fruition of the financial year for example for the most part one year.
Cost Accounting data decide benefit identified with a specific item, work, or cycle. Instead of Financial Accounting, which decides the benefit for the entire association made during a specific period.
Also, the motivation behind Cost Accounting is to control costs; yet the reason for financial accounting is to keep total records of the financial data, in light of which detailing should be possible toward the finish of the accounting time frame.
Cost and Management Accounting Difference; Cost accounting is a branch of accounting that aims at generating information to control operations to maximize profits and the efficiency of the company, that is why it is also termed control accounting. A common question asked around, What is the difference between the Cost Accounting and Management Accounting? Conversely, management accounting is the type of accounting that assists management in planning and decision-making and is thus known as decision accounting. Also learned, Financial and Management Accounting.
Learn, Explain the Difference between Cost and Management Accounting.
The two accounting system plays a significant role, as the users are the internal management of the organization. While cost has a quantitative approach, i.e. it records data that is related to money, management emphasizes both quantitative and qualitative data. Now, let’s understand the difference between cost accounting and management accounting, with the help of the given article.
Definition of Cost Accounting:
They are a method of collecting, recording, classifying, and analyzing the information related to cost. Also, the information provided by it is helpful in the decision-making process of managers. There are three major elements of cost which are material, labor, and overhead. The main aim of cost accounting is to track the cost of production and fixed costs of the company. Also, this information is useful in reducing and controlling various costs. It is very similar to financial accounting, but it is not reported at the end of the financial year.
Definition of Management Accounting:
Management Accounting refers to the preparation of financial and non-financial information for the use of management of the company. It is also termed managerial accounting. Also, the information provided by it helps make policies and strategies, budget, forecasting plans, making comparisons, and evaluating the performance of the management. The reports produced by management accounting are used by the internal management of the organization, and so they are not reported at the end of the financial year.
Comparison of Cost and Management Accounting:
The Basis of Comparison
Cost Accounting
Management Accounting
Meaning
The recording, classifying, and summarizing of cost data of an organization is known as cost accounting.
Also, the accounting in which both financial and non-financial information is provided to managers knows as Management Accounting.
Information Type
Quantitative.
Quantitative and Qualitative.
Objective
Ascertainment of cost of production.
Providing information to managers to set goals and forecast strategies.
Scope
Concerned with ascertainment, allocation, distribution, and accounting aspects of cost.
Impart and effect aspect of costs.
Specific Procedure
Yes
No
Recording
Records past and present data
It gives more stress on the analysis of future projections.
Planning
Short-range planning
Short-range and long-range planning
Interdependency
Can install without management accounting.
Cannot install without cost accounting.
The upcoming discussion will help you to differentiate between cost and management accounting.
The main difference between Cost and Management Accounting:
The following difference below are;
Objective:
The primary objective of Cost Accounting is to ascertain the cost of production as well as to control the same after careful analysis. On the other hand, the primary objective of Management Accounting is to supply the accounting information to the management for taking the proper decision.
Method:
In Cost, accounts are prepared according to predetermined standards and budgets. But in Management reports are submitted to the management after measuring the variance between the actual performances and the budgets. As a result, past errors and defects may rectify and, thereby, efficiency improves.
Accounting System:
The Double Entry System can apply in Cost Account, if necessary, whereas this is not adopting in the case of Management Account.
Accounting Period:
Normally, in Cost, statements of the current year’s activities are to prepare, i.e., importance is not according to future activities while, in Management, primarily future activities are considering.
Management Accounting relates to the whole affair of the concern, the capacity for making profits or losses, and the expectation for the future. To discharge its duties properly, it has to depend on both Financial Accounting and Cost Accounting. Therefore, Management Accounting may regard as the expansion of these two forms of accounting, viz., Financial Account, and Cost Account.
The main points of the difference between Cost and Management Accounting:
The accounting related to the recording and analyzing of cost data is cost account. Also, the accounting related to producing information which uses by the management of the company is management account.
Also, Cost provides quantitative information only. On the contrary, Management provides both quantitative and qualitative information.
Cost is a part of Management as the information uses by the managers for making decisions.
The primary objective of Cost Accounting is the ascertainment of the cost of producing a product but the main objective of management accounting is to provide information to managers for setting goals and future activity.
There are specific rules and procedure for preparing cost accounting information while there is no specific rules and procedures in case of management accounting information.
The scope of Cost Account limits to cost data however the Management Account has a wider area of operation like the tax, budgeting, planning and forecasting, analysis, etc.
Cost related to the ascertainment, allocation, distribution, and accounts face of cost. On the flip side, management associates with the impact and effect aspect of cost.
They stress short-range planning, but management accounting focuses on long and short-range planning, for which it uses high-level techniques such as probability structure, sensitivity analysis, etc.
While management accounting can’t install in the absence of cost accounting; Also, cost accounting has no such requirement, it can install without management accounting.
Difference between Cost and Management Accounting.
Cost Accounting Information System (CAIS) is an accounting information system that determines the costs of products manufactured or services provided and records these costs in the accounting records. Also, The concept of CAIS studying: Functions of Cost Accounting Information System, Technology of Cost Accounting Information System, and Development of Cost Accounting Information System! It is the key to management’s assessment of the company’s efforts to achieve profit. Since it is so important, the CAIS must be careful to design and properly maintains. Also learn, Financial Accounting, What is the Cost Accounting Information System?
Learn, Explain What is the Cost Accounting Information System? Functions, Technology, and Development!
An accounting information system (AIS) is a system of collecting, storing, and processing financial and accounting data that are used by decision-makers. An accounting information system is generally a computer-based method for tracking accounting activity in conjunction with information technology resources. Also, The resulting financial reports can uses internally by management or externally by other interested parties including investors, creditors, and tax authorities.
Accounting information systems are designed to support all accounting functions and activities including auditing, financial accounting & reporting, managerial/ management accounting, and tax. Also, The most widely adopted accounting information systems are auditing and financial reporting modules.
What is the Accounting Information System? Accounting Information System refers to the computer-based method used by the companies to collect, store and process the accounting and the financial data which is used by the internal users of the company to give a report regarding various information to the stakeholders of the company such as creditors, investors, tax authorities, etc.
The cost accounting information system with its operating accounts must correspond to the organizational division of authority; so that the individual foreman, supervisor, department head, or manager can be held accountable for the costs incurred in his department. Also, The concept of authority and responsibility is closely allied with accountability; which recognizes the need for measuring a manager’s discharge of his responsibilities.
Functions of Cost Accounting Information System:
Generally, the purposes or functions of cost accounting information systems fall into four categories. These include providing information for:
External financial statements,
Planning and controlling activities or processes,
Also, Short-term strategic decisions and
Long-term strategic decisions.
These four functions relate to different audiences, emphasize different types of information, require different reporting intervals, and involve different types of decisions.
The technology of Cost Accounting Information System:
They are below;
Input:
The input devices commonly associated with CAIS include standard personal computers or workstations running applications; scanning devices for standardized data entry; electronic communication devices for electronic data interchange (EDI) and e-commerce. Also, many financial systems come “Web-enabled” to allow devices to connect to the World Wide Web.
Process:
Basic processing achieves through computer systems ranging from individual personal computers to large-scale enterprise servers. However, conceptually, the underlying processing model is still the “double-entry” accounting system initially introduced in the fifteenth century.
Output:
Output devices used include computer displays, impact and non-impact printers, and electronic communication devices for EDI and e-commerce. Also, The output content may encompass almost any type of financial report from budgets and tax reports to multinational financial statements.
Development of Cost Accounting Information System:
The development of a Cost Accounting Information System includes five basic phases: planning, analysis, design, implementation, and support.
The period associated with each of these phases can be as short as a few weeks or as long as several years.
Planning, project management objectives, and techniques:
Also, The first phase of systems development is the planning of the project. This entails the determination of the scope and objectives of the project, the definition of project responsibilities, control requirements, project phases, project budgets, and project deliverables.
Analysis:
The analysis phase is using to both determine and document the cost accounting and business processes used by the organization. Such processes are redesign to take advantage of best practices or the operating characteristics of modern system solutions.
Design:
The design phase takes the conceptual results of the analysis phase and develops detailed, specific designs that can implement in subsequent phases. It involves the detailed design of all inputs, processing, storage, and outputs of the proposed accounting system. Also, Inputs may be define using screen layout tools and application generators.
Processing can show through the use of flowcharts or business process maps that define the system logic, operations, and workflow. Also, Logical data storage designs are identified by modeling the relationships among the organization’s resources, events, and agents through diagrams.
Also, the entity-relationship diagram (ERD) modeling is using to document large-scale database relationships. Output designs are documented through the use of a variety of reporting tools such as report writers, data extraction tools, query tools, and online analytical processing tools. Also, all aspects of the design phase can perform with software toolsets provide by specific software manufacturers.
Implementation:
The implementation phase consists of two primary parts: construction and delivery. Also, Construction includes the selection of hardware, software, and vendors for the implementation; building and testing the network communication systems; building and testing the databases; writing and testing the new program modifications; and installing and testing the total system from a technical standpoint.
Delivery is the process of conducting the final system and user acceptance testing; preparing the conversion plan; installing the production database; Also, training the users, and converting all operations to the new system.
Support:
The support phase has two objectives. The first is to update and maintain the CAIS. Also, This includes fixing problems and updating the system for business and environmental changes. For example, changes in generally accepted accounting principles (GAAP) or tax laws might necessitate changes to conversion or reference tables used for financial reporting.
Also, The second objective of the support is to continue development by continuously improving the business through adjustments to the CAIS caused by business and environmental changes. These changes might result in future problems, new opportunities, or management or governmental directives requiring additional system modifications.
Cost accounting examines the cost structure of a business. It does so by collecting information about the costs incurred by a company’s activities, assigning selected costs to products and services and other cost objects, and evaluating the efficiency of cost usage. Discuss the topic, the Concept of Cost Accounting: Meaning of Cost Accounting, Definition of Cost Accounting, Objectives of Cost Accounting, Nature and Scope of Cost Accounting, and Limitations of Cost Accounting! It is mostly concern with developing an understanding of where a company earns and loses money, and providing input into decisions to generate profits in the future. Also learned, Management Accounting; Objectives, Nature, and Scope.
Learn, Explain Cost Accounting: Objectives, Nature, and Scope.
Cost accounting involves the techniques for as: 1) Determining the costs of products, processes, projects, etc. to report the correct amounts on the financial statements, and 2) Assisting management in making decisions and in the planning and control of an organization.
For example, cost accounts used to compute the unit cost of a manufacturer’s products to report the cost of inventory on its balance sheet and the cost of goods sold on its income statement. This is achieving with techniques such as the allocation of manufacturing overhead costs and through the use of process costing, operations costing, and job-order costing systems.
It assists management by providing analysis of cost behavior, cost-volume-profit relationships, operational and capital budgeting, standard costing, variance analyses for costs and revenues, transfer pricing, activity-based costing, and more. They had their roots in manufacturing businesses, but today it extends to service businesses.
For example, a bank will use cost accounting to determine the cost of processing a customer’s check and/or a deposit. This, in turn, may provide management with guidance in the pricing of these services.
Key activities include:
Defining costs as direct materials, direct labor, fixed overhead, variable overhead, and period costs.
Assisting the engineering and procurement departments in generating standard costs, if a company uses a standard costing system.
Using an allocation methodology to assign all costs except period costs to products and services and other cost objects.
Defining the transfer prices at which components and parts are selling from one subsidiary of a parent company to another subsidiary.
Examining costs incurred about activities conducted, to see if the company is using its resources effectively.
Highlighting any changes in the trend of various costs incurred.
Analyzing costs that will change as the result of a business decision.
Evaluating the need for capital expenditures.
Building a budget model that forecasts changes in costs based on expected activity levels.
Determining whether costs can be reduced.
Providing cost reports to management, so they can better operate the business.
Participating in the calculation of costs that will require to manufacture a new product design, and.
Analyzing the system of production to understand where bottlenecks are position, and how they impact the throughput generate by the entire manufacturing system.
Meaning of 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 the majority of them are satisfied using financial accounting. However, the management requires far more detailed information than what 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 accounts a useful tool. It was developed on account of limitations of financial accounting and is the extension of financial accounting. The advent of the 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 the cost calls cost accounting.
Definition of 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 incur or commit to the establishment of its ultimate relationship with cost centers 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 carry out or plan.”
The Institute of Cost and Works Accountants, India defines cost accounting as,
“The technique and process of ascertainment of costs. Cost accounts the process of accounting for costs, which begins with the recording of expenses or the bases on which they are calculating and ends with the preparation of statistical data.”
To put it simply, when the accounting process is applying to the elements of costs (i.e., Materials, Labor and Other expenses), it becomes Cost Accounting.
Objectives of Cost Accounting:
It was born to fulfill the needs of manufacturing companies. Its a mechanism of accounting through which costs of goods or services are ascertaining and control 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:-
1] Cost Ascertainment:
The main objective of cost accounts to find out the cost of product, process,job, contract, service or any unit of production. It is done through various methodsand techniques.
2] Cost Control:
The very basic function of cost accounts to control costs. A comparison of actualcosts with standards reveals the discrepancies (Variances). The variances reveal whether the cost is within the control or not. Remedial actions are suggesting to control the costs which are not within control.
3] Cost Reduction:
Cost reduction refers to the real and permanent reduction in the unit cost of goodsmanufactured or services rendered without affecting the use intended. It can bedone with the help of techniques called budgetary control, standard costing,material control, labor control, and overheads control.
4] Fixation of Selling Price:
The price of any product consists of total cost and the margin required. Cost dataare useful in the determination of selling price or quotations. It provides detailedinformation 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:
It helps management in formulating business policy and decisionmaking. Break-even analysis, cost volume profit relationships, differential costing,etc help make decisions regarding key areas of the business.
Nature and Scope of Cost Accounting:
Cost accounts 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, they 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 was widened and providing information for cost control and cost reduction has assuming equal significance along with finding out the cost of production. To start with cost-accounting was apply in manufacturing activities but now it applies in service organizations, government organizations, local authorities, agricultural farms, Extractive industries and so on.
The guide for the ascertainment of the cost of production. It discloses as profitable and unprofitable activities. They help management to eliminate unprofitable activities. It provides information for estimates and tenders. They disclose 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 the preparation of interim financial statements. They help in controlling the cost of production with the help of budgetary control and standard costing. They provide data for future production policies. It discloses the relative efficiencies of different workers and for the fixation of wages to workers.
Cost Accounting: Objectives, Nature, and Scope! #Pixabay.
Limitations of Cost Accounting:
The following limitations below are;
It is based on estimation: as cost accounting relies heavily onpredetermined 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 accounts.
A large number of conventions and estimate: There are several conventions and estimates in preparing cost records such as materials are issuing on an average (or) standard price, overheads are charging on the percentage basis, Therefore, the profits arrive 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 does not apply to small and medium firms.
Expensive: Cost accounts expensive and requires reconciliation with financial records.
It is unnecessary: Cost accounts of recent origin and an enterprise can survive even without cost accounting.
Secondary data: It depends on financial statements for a lot of information. Any errors or shortcomings in that information creep into cost accounts also.
