Cost accounting is central to any business operation. It provides important information for management decision making that is used in financial control and pricing amongst other important business decisions. Cost accounting is directly linked to matters of a business’s profitability. So we can understand how important cost accounting is to businesses. The advantages of cost accounting are many but there are also limitations of cost accounting to be aware of. Before we go into them let us define cost accounting.
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What Is Cost Accounting?
Cost accounting is primarily focused on collecting and processing cost information. It provides information for decision making on matters of cost which in turn affect pricing, profitability and liquidity. Cost accounting is also very important as margins in some businesses are very small and the room for error is very small. Being slightly off in costing can spell the difference between success and failure financially. Now we can discuss the advantages of cost accounting and the limitations of cost accounting. We will start with the advantages of cost accounting.
Advantages Of Cost Accounting
Cost accounting is critical to a business for a number of reasons. The advantages of cost accounting are best explored by looking at various uses that exist for cost accounting information.
Ascertainment Of Cost
The first and foremost advantage of cost accounting is the ascertainment of cost. Cost accounting provides accurate cost information even in the most complex of business structures. Ascertainment of costs is an important advantage of cost accounting because accurate cost information is important on so many functions of a business. Cost information has an impact on pricing, profitability, control and cash flow.
Measures And Improves Efficiency
Cost accounting, through its constant tracking of business costs and factors affecting them, provides a constant measuring system for costs. This presents the advantage of cost accounting of assisting in improving the efficiency of a business. Efficiency is the economic use of resources available and cost accounting is pivotal to this exercise.
Identifies Unprofitable Activities
A further advantage of cost accounting is that through constant tracking the business can easily identify areas, products or activities that prove to be unprofitable to the business. These reduce efficiency and therefore profitability. Such activities and products should either be improved upon or eliminated to ensure the profitability of the business.
Businesses need to price their products profitably. This simple and obvious exercise would be very difficult for any business to exercise without accurate cost information. Hence assisting in the setting of appropriate pricing is an advantage of cost accounting. Pricing is not just a matter of profitability. The right price is also important in matters of competition, product positioning and product mix decisions.
Inventory control is extremely important in businesses that have sizeable inventory investments. It is not limited to businesses which sell physical goods because service businesses still keep an inventory of consumables. Inventory control is an area of business that presents a great risk of loss. The advantage of cost accounting is that it helps keep detailed records of inventory which are essential in a good inventory control system.
Cost control or financial control is an organisational function that concerns itself with ensuring that costs are kept to within budgeted levels or lower. This function requires a lot of information and in great detail to plan and track variances in expenditure. The advantage of cost accounting to this business function is that it keeps extremely detailed cost information that can be used for financial control purposes.
Identifies Reasons For Losses
Another advantage of cost accounting is that it does more than just observe costs. Cost accounting also does a very good job of identifying the reasons behind losses. This cost accounting advantage comes from cost accounting’s ability to drill down into detailed information records it keeps and identifies the underlying causes of variances. Both positive and negative.
Limitations of cost accounting
While there are many advantages of cost accounting there are also limitations of cost accounting we should be aware of. Let us list the limitations of cost accounting.
Lack of Uniformity
Due to a lack of formal structure cost accounting methods can differ widely from business to business. This limitation of cost accounting means that cost accounting information is not comparable from business to business. Businesses in the same industry may have markedly different treatments of the same cost accounting information. The absence of a uniform standard is the primary limitation of cost accounting.
Maintaining the sort of records that cost accounting requires to be effective is costly. Cost accounting is reliant on the possession of highly detailed information. This limitation of cost accounting is expressed in the high cost of the time required to maintain the sort of information that cost accounting needs. The cost of additional time required to support cost accounting may prove a limitation of cost accounting to many businesses.
Cost accounting information is mainly focused on historical information. For the most part cost accounting is producing information that is looking backwards at what happened and this is a limitation of cost accounting. What management tends to need more of is information that predicts or prepares the business for what is to come. However, cost accounting is limited to historical information.
Uses Secondary Data
Cost accounting is not directly responsible for the collection of cost data but rather uses information collected by other departments and relies upon it. The limitation of cost accounting in this regard is that its accuracy is dependent on the accuracy of the original data. If the original data is recorded erroneously cost accounting can neither pick this error up nor correct it. This cost accounting limitation makes cost accounting only as good as the other functions it relies on are.
Only Bring Out The Cost Of Goods
Cost information is important to business however there is a lot of other information that is just as important. The cost and complexity involved with cost accounting mean that it is a very taxing exercise that produces only cost information. This limitation of cost accounting makes it look unimportant when compared to other branches of accounting such as financial and management accounting.
No system is perfect, just as there are advantages of cost accounting there are also limitations of cost accounting.