It’s a fact that firms get benefited after using a cost accounting system. Nowadays, almost all firms depend on cost accounting methods. But despite having so many advantages, there are also limitations of cost accounting. Many small firms consider the cost accounting system more complex, compared to others. In this article we will focus on the limitations of cost accounting. But before that let’s have a small look at cost accounting and its advantages.
What is Cost Accounting?
It is an accounting method which measures a firm’s total cost of production, by deriving the cost of each production step. Cost accounting records every expense of a firm, such as: lease expense, production expense, service and product expense. Cost accounting has no such fixed time period. A firm’s management team uses a cost accounting method to record its expenses and make better decisions.
Cost accounting system was introduced during the time of globalisation. Due to the new global supply system, firms had to monitor their manufacturing costs. Cost accounting is similar to financial accounting in many ways. Both accounting systems use the same information, but their results are different. Financial accounting focuses on a firm’s whole profit and loss, whereas cost accounting measures a firm’s production cost. It can also measure the cost of producing a certain product.
Types of Cost Accounting
- Standard costing
- Activity-based costing
- Lean accounting
- Marginal costing
Advantages of Cost Accounting
Cost accounting is a helpful tool in examining a firm’s expenses. It helps a firm in improving it’s internal cost control. During the time of globalisation, cost accounting helped businesses in enhancing their production efficiency. Cost accounting can be adapted and applied according to the changing needs of a firm.
Cost accounting helps companies to survive in the market, by managing their production cost. Majorly, it benefits the manufacturing firms. However, the benefits of cost accounting differ from company to company. Some of the common advantages of cost accounting is mentioned below:
- Measures and improves efficiency: Cost accounting analyses the observed differences, and then maintains it. It measures the efficiency of a firm with the help of data and improves it.The efficiency could be in any respect, such as: cost efficiency, production efficiency and time efficiency. Sometimes production cost increases due to material wastages or any such inefficiency. Cost accounting always aiims to sort out such inefficiency, so that production efficiency could be increased.
- Identifies unprofitable activities: Cost accounting categories every process of a firm as profitable and unprofitable activities. It identifies the unprofitable activity quickly and eliminates it. Material wastages, resources wastages and wrong production step is considered as the biggest factor of unprofitable activities. These factors can affect the overall profit of a firm.
- Helps in price fixing: Cost accounting fixes a product price based on its production cost. It also helps in making a contract quotation, by estimating the project cost. Often the quoted price of a product is too high or too low, if it is fixed without the help of cost accounting. Only cost accounting can determine the profitable price of a product.
- Handles tough situation: During a tough financial disaster, a firm needs to reduce it’s product cost. Sometimes firms need to reduce the cost of a product, below its production cost. Cost accounting guides the firm in such crucial conditions. It handles such situations and helps the firm to survive in the market.
- Helps in making better decisions: Cost accounting believes in re-calculations and estimations before making a decision. It is an effective tool in making decisions. Cost accounting provides suitable cost data and other information. The management team utilises such data and makes better decisions for the firm.
- Controls expenses and production cost: Cost accounting compares product cost firm-to-firm to reduce the production cost. This accounting method utilizes time and maximizes production efficiency, resulting in controlling the production cost. Cost accounting can determine the reason for loss and sorts out extra expenses. It minimises the wastages and wrong production steps to control the production cost.
Limitations of cost accounting
In this modern era, cost accounting has become an integral part of the accounting system. If the firms apply a cost accounting system with proper caution and care, it surely benefits them. It helps the management team in making better decisions.
Principles of cost accounting are not constant, they change with the need of time. Due to its complexity and its different results, small businesses consider it unnecessary for them. Time-to-time small firms raise concerns about this accounting method. They consider it the disadvantages of cost accounting. However, it has no such disadvantages, but there are few limitations of cost accounting.
Following are the highlighted limitations of cost accounting:
- Inaccuracy: It is one of the major limitations of cost accounting methods. Sometimes this method creates two different reports, using the same piece of data and information. It happens because cost accounting uses standard cost in place of the actual cost. Many firms avoid using this method. They state that it can often create confusion about non-cost things. They consider its result as an estimated result, not the actual result. However, cost accounting results are not always inaccurate. Because this method estimates on the basis of data and information, not on imagination.
- It is expensive: Installation and maintenance cost of cost accounting is high. Cost accounting maintains a set of two account books. Cost accounting requires experts accountants and auditors. Firms need to pay more to these employees, making cost accounting more expensive.It is a modern costing method, so it may cost more during the time of installation. But it always benefits the company. It changes the way of accounting. But a firm needs to keep in mind that cost accounting should always be profitable. A firm should always earn more than its expenses on the accounting system.
- It is more complex: Cost accounting process contains many steps while deriving the cost. It records all the expenses from the record book, classifies it in different categories and maintains two account books.Like its report, its steps also need a lot of forms and documents, making cost accounting more complex. Some of its steps and processes are quite different from traditional accounting methods. Firms require training their employees to decode its complexity. Due to its paperwork, sometimes it delays in report preparation.
- Can’t apply to all firms: All kinds of firms and businesses can not depend on a single system of costing. Management team uses the cost accounting method, if it fulfills the firm’s requirement. Due to different business nature, firms need to use different costing methods. Usage of cost accounting depends on the nature of business.Sometimes this method does not suit all kinds of businesses, its methods can prove wrong if applied forcefully. And a wrong method can affect the result of a firm’s business. That is why different businesses use different costing methods. Manufacturing firms should always use cost accounting methods, it surely benefits them.
- Not suitable for small firms: Cost accounting system not only requires some extra investment, it needs revision also. This method contains a lot of forms and statements. Firms require to update its forms and standard cost time-to-time. Cost accounting system contains some additional work with it. Small firms have a limited number of employees and resources.
- It becomes difficult for them to adopt this method. It becomes really hard for small firms to train their employees about such a complex system. Due to its complex and expensive nature, it becomes unsuitable for small firms. It is more suitable for bigger firms, as it meets the requirements of their businesses. Small firms consider its benefits, but due to such issues they can not apply this method in their business.
- Sometimes it is biased : While ascertaining the cost of a product, different people give different opinions. Many people state, sometimes this accounting method makes the final judgement on the basis of an individual’s direction. People claim this a biased judgement and consider it the limitations of cost accounting.
Cost accounting is an effective tool for measuring the production cost of a firm. Introduction of this method in a firm is a good step towards increasing the firm’s performance. But firms should understand this method properly, before applying it to their business. If the firms apply with proper caution and care, cost accounting increases the firm’s growth.
Many times it does not give immediate growth, it acts like a long-term return. There is no such disadvantage that can harm a firm, but there are some limitations of cost accounting. It does not meet the requirements of all types of firms, so many firms avoid this accounting method. Many firms consider it unnecessary.
Firms need to understand that cost accounting not only helps in the account, it helps in making better decisions also. Firms also raise concerns about its predetermined costing. But in this competitive market firms should know their product cost. Cost accounting makes it easier for firms to examine and maintain their records without having a formal system. As each and every cost is estimated.