Cost Accounting System

1. Introduction
2. Non-integrated accounting system
3. Integrated (or integral) accounting system
4. Reconciliation of cost and financial accounts
5. Accounting for management information and cost control
   
   

To operate business operations efficiently and successfully, it is necessary to make use of an appropriate accounting system. Such a system should state in clear terms whether cost and financial transactions should be integrated or kept separately (Non- integrated). Where cost and financial accounting records are integrated, the system so evolved is known as integrated or integral accounting system. In case cost and financial transactions are kept separately, the system is called Non- Integrated Accounting system or Cost Control System. While non-integrated system of accounting necessitates reconciliation between financial and cost accounts but no reconciliation is required under integrated accounting system.

It is a system of accounting under which separate ledgers are maintained for both cost and financial accounts. This system is also known as cost ledger accounting system. Under this system the cost accounts restrict itself to recording only those transactions which relate to the product or service being supplied. Items of expenses which are related to sales, production or other matters of factory management are the ones dealt with in such accounts. This leads to the exclusion of certain expenses like interest, bad debts and revenue/income from ‘other than the sale of product or service’.

 

Non-Integrated Accounting Systems contain fewer accounts as compared to financial accounting system due to the exclusion of purchases, expenses and also Balance Sheet items like fixed assets, debtors and creditors. Items of accounts which are excluded are represented by an account known as Cost ledger control account.

The important ledgers to be maintained under non-integrated accounting system in the Cost Accounting are the followings:

1. Cost Ledger - This is the principle ledger of the cost department in which impersonal accounts are recorded. This ledger is made self-balancing by maintaining therein a Control Account for each subsidiary ledger.
2. Stores Ledger - It contains an account for each item of stores. The entries in each account maintained in this ledger are made from the invoice, goods received note, material requisitions, material received note etc. Accounts in respect of each item of stores show receipt, issue and balance in physical as well as in monetary terms.
3. Work-in-Process Ledger - This ledger is also known as job ledger, it contains accounts of unfinished jobs and processes. All material costs, wages and overheads for each job in process are posted to the respective job accounts in this ledger. The balance in a job account represents total balance of job/work-in-process, as shown by the job account.
4. Finished Goods Ledger - It contains an account for each item of finished product manufactured or the completed job. If the finished product is transferred to stock, a credit entry is made in the work-in-process ledger and a corresponding debit entry is made in this ledger.

The main accounts which are usually prepared when a separate Cost Ledger is maintained are as follows:

1. Cost Ledger Control Account - This account is also known as General Ledger Adjustment Account. This account is made to complete double entry. All items of expenditure are credited to this account. Sales are debited to this account and net profit/loss from Costing Profit & Loss Account is transferred to this account. The balance in this account at the end of the particular period represents the net total of all the balances of the impersonal accounts.
2. Stores Ledger Control Account – This account is debited for the purchase of material and credited for issue of materials from the stores. The balance in this account indicates the total balance of all the individual stores accounts. Abnormal losses or gains if any in this account are transferred to Costing Profit & Loss Account. Entries are made on the basis of goods received notes and stores requisitions etc.
3. Wages Control Account - This account is debited with total wages paid (direct and indirect). Direct wages are further transferred to Work-in- Process Control Account and indirect wages to Production Overhead; Administration Overhead or Selling & Distribution Overhead Control Accounts, as the case may be. Wages paid for abnormal idle time are transferred to Costing Profit & Loss Account either directly or through Abnormal Loss Account.
4. Manufacturing/Production/Works/ Factory Overhead Control Account - This account is debited with indirect costs of production such as indirect material, indirect employee, indirect expenses (carriage inward etc.). Overhead recovered (absorbed) is credited to this Account. The difference between overhead incurred and overhead recovered (i.e. Under Absorption or Over Absorption of Overheads) is transferred to Overheads Adjustment Account.
5. Work-in-Process Control Account - This account is debited with the total cost of production, which includes—direct materials, direct employee, direct expenses, production overhead recovered, and is credited with the amount of finished goods completed and transferred. The balance in this account represents total balances of jobs/works-in-process, as shown by several job accounts.
6. Administrative Overhead Control Account - This account is debited with overheads incurred and credited with overhead recovered. The overhead recovered are debited to Finished Goods Control Account, if administrative overhead is related with production activities otherwise to Cost of Sales A/c. The difference between administrative overheads incurred and recovered is transferred to Overhead Adjustment Account.
7. Finished Goods Control Accounts - This account is debited with the value of goods transferred from Work-in-process Control Account and administration costs recovered (if relates to production activities). This account is credited with Cost of Sales Account. The balance of this account represents the value of goods unsold at the end of the period.
8. Selling and Distribution Overhead Control Account - This account is debited with selling and distribution overheads incurred and credited with the selling and distribution overheads recovered. The difference between overheads incurred and recovered is transferred usually to Overhead Adjustment Account.
9. Cost of Sales Account - This account is debited with the cost of finished goods transferred from Finished Goods Control Account for sale, General Administrative overhead recovered, Selling and distribution overhead recovered. The balance of this account is ultimately transferred to Sales Account or Costing Profit & Loss Account.
10. Costing Profit & Loss Account – This account is debited with cost of sales, under-absorbed overheads and abnormal losses and is credited with sales value, over-absorbed overhead and abnormal gains. The net profit or loss in this account is transferred to Cost Ledger Control Account.
11. Overhead Adjustment Account - This account is to be debited for under- recovery of overhead and credited with over-recovery of overhead amount. The net balance in this account is transferred to Costing Profit & Loss Account.

Note: Sometimes, Overhead Adjustment Account is dispensed with and under/over absorbed overheads is directly transferred to Costing Profit & Loss Account from the respective overhead accounts.

The manner in which the Cost Ledger, when maintained on a double entry basis, would operate is illustrated by the following statements of various journal entries as would appear in the cost books.

(a) Purchase- 5,000 (credit or cash)

	Particulars	Dr	Cr
1	Materail Control A/c                                                               Dr	5000
	To Cost Ledger Control A/c		5000
2	Strores Ledger Control A/c                                                     Dr	5000
	To Material Control A/c		5000

(b) Purchase worth 500 for special job

Particulars	Dr	Cr
Work in Process ledger control A/c                                                    Dr	500
To Cost Ledger Control A/c		500

(c) Material returned to vendor-500

Particulars	Dr	Cr
Cost Ledger Control A/c                                                                   Dr	500
To Store Ledger Control A/c		500

(d) (i) Material (Direct) issued to production- 1000

Particulars	Dr	Cr
Work in process Control A/c                                                              Dr	1000
To Cost Ledger Control A/c		1000

(ii) Material (Indirect) issued to rpoduction - 200

Partculars	Dr	Cr
Production Overhead Control A/c                                                      Dr	200
To Store Ledger Control A/c		200

(e) (i) Material worth 200 returned from shop to stores

Partculars	Dr	Cr
Store Ledger Control A/c                                                                  Dr	200
To Work in process Control A/c		200

(ii) Material worth 100 is transferred from Job 1 to Job 2

Particulars	Dr	Cr
Production Overheads Control A/c                                                     Dr	100
To Store Ledger Control A/c		100

(f) Material worth 100 is issued from stores to repairs

Particulars	Dr	Cr
Production Overhead Control A/c                                                     Dr	100
To Store Ledger Control A/c		100

Labour:

(g) Direct wages paid to workers - 1000

Particulars	Dr	Cr
Wages Control A/c                                                                         Dr	1000
To Cost Ledger Control A/c		1000

(h) Indirect wages paid to workers in the production - 700

	Particulars	Dr	Cr
i	Wages Control A/c                                                                  Dr	700
	To Cost Ledger Control A/c		700
ii	Production Overhead Control A/c                                             Dr	700
	To Wages Control A/c		700

(i) Indirect wages paid to workers in administration - 500

	Particulars	Dr	Cr
i	Wages Control A/c                                                                 Dr	500
	To Cost Ledger Control A/c		500
ii	Administration Overhead A/c                                                  Dr	500
	To Wages Control A/c		500

(j) Indirect Wages apid to workers in Selling & dist. department - 300

	Particulars	Dr	Cr
i	Wages Control A/c                                                                  Dr	300
	To Cost Ledger Control A/c		300
ii	Selling & dist. Overhead A/c                                                     Dr	300
	To Wages Control A/c		300

Direct Expenses:

(k) Direct expenses incurred 500 for Job no. 12

Particulars	Dr	Cr
Job no. 12 A/c (WIP Control A/c)                                                   Dr	500
To Cost Ledger Control A/c		500

Overheads:

(l) Overhead expenses incurred 500 (Production 150; administrative 150; Selling and distribution 200)

Particulars	Dr	Cr
Production Overhead Control A/c                                                    Dr	150
Administrative Overhead Control A/c                                              Dr	150
Selling & Dist. Overhead Control A/c                                              Dr	200
To Cost Ledger Control A/c		500

(m) Carriage Inward (Director to factory) - 100

Particulars	Dr	Cr
Production Overhead Control A/c                                                  Dr	100
To Cost Ledger Control A/c		100

(n) Production Overhead recovered - 1000

Particulars	Dr	Cr
Work in Process Ledger Control A/c                                              Dr	1000
To Production Overhead Control A/c		1000

(o) Administrative Overhead recovered 500 from finsihed goods

Particulars	Dr	Cr
Finished Goods Ledger Control A/c                                                Dr	500
To Administrative Overhead Control A/c		500

(p) Selling and Distribution Overhead 100 recovered from sales

Particulars	Dr	Cr
Cost of Sales A/c                                                                         Dr	100
To Selling & Dist. Overhead Control A/c		100

(q) Under recovery of overheads

Particulars	Dr	Cr
Costing Profit & Loss A/c                                                              Dr	xxx
To Administrative Overhead Control A/c		xxx

(r) Over recovery of overheads

Particulars	Dr	Cr
Production Overheads Control A/c                                                  Dr	xxx
To Costing Profit & Loss A/c		xxx

Sales:

(s)

Particulars	Dr	Cr
Cost Ledger Control A/c                                                                Dr	xxx
To Costing Profit & Loss A/c		xxx

Profit/Loss

(t) In case of Profit

Particulars	Dr	Cr
Costing Profit & Loss A/c                                                               Dr	xxx
To Cost Ledger Control A/c		xxx

(u) In case of Loss

Particulars	Dr	Cr
Cost Ledger Control A/c                                                                 Dr	xxx
To Costing Profit & Loss A/c		xxx

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3. INTEGRATED (OR INTEGRAL) ACCOUNTING SYSTEM

Integrated Accounts is the name given to a system of accounting, whereby cost and financial accounts are kept in the same set of books. Obviously, then there will be no separate sets of books for Costing and Financial records. Integrated accounts provide or meet out fully the information requirement for Costing as well as for Financial Accounts. For Costing it provides information useful for ascertaining the cost of each product, job, process and operation of any other identifiable activity and for carrying necessary analysis. Integrated accounts provide relevant information which is necessary for preparing profit and loss account and the balance sheet as per the requirement of law and also helps in exercising effective control over the liabilities and assets of its business.

The main advantages of Integrated Accounts are as follows:

1. No need for Reconciliation- The question of reconciling costing profit and financial profit does not arise, as there is only one figure of profit.
2. Less efforts- Due to use of one set of books, there is a significant saving in efforts made.
3. Less time consuming- No delay is caused in obtaining information as it is provided from books of original entry.
4. Economical process- It is economical also as it is based on the concept of “Centralisation of Accounting function”.

The essential pre-requisites for integrated accounts include the following steps:

1. The management’s decision about the extent of integration of the two sets of books. Some concerns find it useful to integrate up to the stage of prime cost or factory cost while other prefers full integration of the entire accounting records.
2. A suitable coding system must be made available so as to serve the accounting purposes of financial and cost accounts.
3. An agreed routine, with regard to the treatment of provision for accruals, prepaid expenses, other adjustment necessary for preparation of interim accounts.
4. Perfect coordination should exist between the staff responsible for the financial and cost aspects of the accounts and an efficient processing of accounting documents should be ensured.

Under this system there is no need for a separate cost ledger. Of course, there will be a number of subsidiary ledgers; in addition to the useful Customers’ Ledger and the Purchase Ledger, there will be: (a) Stores Ledger; (b) Stock Ledger and (c) Job Ledger.

Features of Integrated Accounting System: Following are the main points of integrated accounting:

1. Complete analysis of cost and sales are kept.
2. Complete details of all payments in cash are kept
3. Complete details of all assets and liabilities are kept and this system does not use a notional account to represent all impersonal accounts

In non-integrated system, a cost ledger control account or general ledger adjustment account is used in cost ledger. But in the integrated accounting system, general ledger adjustment account is eliminated and detailed accounts for assets and liabilities are maintained. In other words, following accounts are used for “General Ledger Adjustment Account/ Cost Ledger Control Account” of non- integrated system:

1. Bank account
2. Receivables (Debtors) account
3. Payables (Creditors) account
4. Provision for depreciation account etc.

In integrated system, all accounts necessary for showing classification of cost will be used but the cost ledger control account of non-integrated accounting is replaced by use of following accounts:

1. Bank account
2. Receivables (Debtors) account
3. Payables (Creditors) account
4. Provision for depreciation account
5. Fixed assets account
6. Share capital account

When the cost and financial accounts are kept separately, it is imperative that these should be reconciled to make the cost accounts reliable. It is necessary for reconciliation of the two sets of accounts that sufficient details are available to locate the differences and the reasons for the same. It is, therefore, important that in the financial accounts, the expenses should be analysed in the same way as in the cost accounts.

The General Ledger Adjustment Account in the Cost Ledger may be studied to know the items which are included here and how differently these are presented in the financial accounts. The reconciliation of the balances of two sets of accounts is possible by preparing a Memorandum Reconciliation Account. In this account, the items charged in one set of accounts but not in the other or those charged in excess as compared to the other are identified and collected. These items of differences are either added or subtracted from the profit as shown by one of the accounts. Finally the profits from two sets of accounts are reconciled. The procedure is similar to those which are followed for reconciling bank balance as per bank ledger with the balance as shown in bank statement.

It is important, however, to know the causes which, generally, give rise to differences in the Cost and Financial Accounts. These are briefly summarised below:

(a) Purely Financial Expenses:

1. Interest on loans or bank mortgages.
2. Expenses and discounts on issue of shares, debentures etc.
3. Other capital losses i.e., loss by fire not covered by insurance etc.
4. Losses on the sales of fixed assets and investments
5. Goodwill written off
6. Preliminary expenses written off
7. Income tax, donations, subscriptions
8. Expenses of the company’s share transfer office, if any.

(b) Purely Financial Income

1. Interest received on bank deposits, loans and investments
2. Dividends received
3. Profits on the sale of fixed assets and investments
4. Transfer fee received.
5. Rent receivables

1. Charges in lieu of rent where premises are owned
2. Interest on capital at notional figure though not incurred
3. Salary for the proprietor at notional figure though not incurred
4. Notional Depreciation on the assets fully depreciated for which book value is nil.

3. Items whose treatment is different in the two sets of accounts: The objective of cost accounting is to provide information to management for decision making and control purposes while financial accounting conforms to external reporting requirements. Hence there are chances that certain items are treated differently in the two sets of accounts. For example, LIFO method is not allowed for inventory valuation in India as per the Accounting Standard 2 issued by the Council of the ICAI. However, this method may be adopted for cost accounts as it is more suitable for arriving at costs which may be used as a base for deciding selling prices. Similarly cost accounting may use a different method of depreciation than what is allowed under financial accounting.

4. Varying basis of valuation: It is another factor which sometimes is responsible for the difference. It is well known that in financial accounts stock are valued either at cost or market price, whichever is lower. But in Cost Accounts, stocks are only valued at cost.

1. Ascertainment of profit as per financial accounts
2. Ascertainment of profit as per cost accounts
3. Reconciliation of both the profits (similar to the bank reconciliation statement)

Circumstances where reconciliation statement can be avoided: When the Cost and Financial Accounts are integrated - there is no need to have a separate reconciliation statement between the two sets of accounts. Integration means that the same set of accounts fulfil the requirement of both i.e., Cost and Financial Accounts.

With a view to control costs, standard cost for each element of cost is set. The standard costs so set are used to measure and compare the actual costs. This enables the management to trace cost variances from the standard cost. The variances so obtained are analysed and necessary actions are taken. This ensures that standard costs are adhered.

For cost control purpose, the management needs specific accounting system which fulfils the management objective of controlling costs. On the basis of timing of variance analysis, two main types of management accounting systems are followed:

Under this system of management accounting, the variances in costs from the set standards are reported at its happenings without waiting for books closing. Timely analysis is done so that much time is not lost in taking corrective action wherever needed.

The single plan system envisages the posting of all items in the debit side of the work-in-process account at the standard cost leaving the credit side to represent the standard cost of finished production and work-in-progress.

This system enables the ascertainment of variances as and when the transaction is posted to work-in-process account. In other words, the analysis of variances is done from the original documents like invoices, labour sheets, etc., and this method of analysis is known as analysis at source.

 

Since, the single plan system contemplates the analysis of variances at source, the installation of this system requires more planning so that effective documentation at each stage is introduced for proper recording and analysis of variance.

Thus for example, the issue of bill of materials to the stores enables the storekeeper to calculate the standard value of materials. If any material is requisitioned beyond the standard, he can mark the same for material usage variance account. In the production department, as and when the finished output is recorded, the standard waste and actual waste can be compared and necessary entries can be made by the shop supervisors for posting the excessive usage to appropriate variance accounts.

Scheme of entries: So far as materials are concerned, material price variances are recorded at the time of receipt of the material and the material quantity variances are recorded as far as possible when excess materials are used. The entries will be as illustrated below:

1. Material Control A/c Dr.

    Material Price Variance A/c Dr.

    (Actual Cost > Standard Cost)

                    To Creditors/ Cost Ledger Control A/c.

                    To Material Price Variance A/c

    (Actual Cost < Standard Cost)

This entry enables the firm to debit the material control account with the actual purchases at standard cost and credit the creditor’s account at the actual cost of actual prices thereby transferring the variances to price variance account.

2. Work-in-process Control A/c Dr.

    Material Usage Variances A/c Dr.

    (Actual usage > Standard usage)

                     To Material Control A/c

                     To Material Usage Variances A/c

    (Actual usage < Standard usage)

This entry charges the work-in-progress control account with the standard cost of standard quantity and credit the material control account at the standard cost of actual issue, the variance being transferred to usage variance account.

 

3. Wages Control A/c Dr.

    Labour Rate Variances A/c Dr.

    (Actual wage rate > Standard wage rate)

                       To Cash (or Bank) / Cost Ledger Control A/c
                       To Labour Rate Variances A/c

    (Actual wage rate < Standard wage rate)

This entry is passed to record the wages at standard rate thereby transferring rate variances to the appropriate account.

4. Work-in-process Control A/c Dr.

    Overhead Expense Variances A/c Dr.

    (Actual OH > Standard OH)

                      To Overhead Expense Control A/c.

                      To Overhead Expense Variances A/c

    (Actual OH < Standard OH)

In the partial plan, variances are analysed at the end of period. Under this method the work-in-process account is charged at the actual cost of production for the period and is credited with the standard cost of the period’s production of finished product.

The closing balance of work-in-process is also shown at standard cost. The balance after making the credit entries represents the variance from standard for the period. The analysis of the variances is done after the end of the period. This method is simple in operation because variances are analysed after the end of period but may present difficulties if the firm makes a variety of products.

(1) Current standards are used in both the systems.

(2) Under the partial plan, material stocks are carried at actual cost whereas the same are carried out at standard cost under the single plan.

(3) The work-in-process and finished goods are valued at standard cost under both the methods.

(4) Computation of variances :