Cost Accounting – Types, Example, Advantages, and More

What is Cost Accounting?

Cost Accounting is referred to as a branch of managerial accounting, which mainly aims to encapsulate all costs within a company, by assessing variable costs along with each step of production. It is considered to be a metric that helps companies to make informed decisions that are backed by reliable quantitative measures.

Cost Accounting is different from financial accounting in the sense that financial accounting is used in order to communicate the performance of the company to external stakeholders.

On the contrary, cost accounting mainly considered as an internal metric that helps the company to make important decisions. Therefore, cost accounting is primarily an internal metric that is used to evaluate cost centers, and how they can be managed in order to help the company aim for better efficiency within the organization.

In order to do that, cost accounting inculcates all inputs that are associated with production. This implies that it used both, variable costs as well as fixed costs in order to determine the best strategy for the company. Within the realm of cost accounting, there are several different measures that are utilized by businesses. Various types of Cost Accounting include standard costing, activity-based costing, lean accounting, as well as marginal costing.

Types of Cost Accounting

As mentioned earlier, cost accounting in itself has a number of types. The description for all these types of cost accounting is given below:

1) Standard Costing

Standard Costing involves companies having benchmarks or standards that they believe are going to result in a higher efficiency rate. Therefore, as opposed to actual costs, standard costs are used as the basis of the cost of goods sold and inventory.

Regardless of the fact that the actual costs are still incurred, which have to be borne by the company, yet standard costing helps the company to analyze the reason behind variances. These variances can subsequently be traced down in order to get a better idea regarding what needs to be done in order to minimize the impact of standard costing.

2) Activity-Based Costing

Activity Based Costing is used to identify overhead costs from all the relevant departments within the production setup. In this regard, it is imperative to consider the fact that these activities are used because they are considered to be predominant cost centers for the company.

Therefore, associating relevant costs to these variables considerably helps companies to make decisions regarding the application of these overhead costs. Overhead costs are mostly assigned on generic measures, like machine hours, or labor hours. Based on this, the company is able to make decisions regarding adjustments that need to be made in the cost centers in order to catapult better optimization across their operations.

3) Lean Accounting

Lean Accounting mainly lies in the realms of ensuring that financial management practices are considerably improved within an organization. It is considered to be an extension of lean manufacturing and production.

It mainly requires companies to identify cost centers and value centers, so that they can make decisions based on the actual activities of the business that generate the most profits.

4) Marginal Costing

Also referred to as Cost-Volume-Profit Analysis, marginal costing aims to capture the impact on the overall costing if production is increased by a single unit. It helps management in the identification of varying levels of costs and volumes on the overall operating profit of the company.

Therefore, the company can then make informed decisions based on new product additions, as well as changes in prices and the subsequent impact on the overall volume.

Example of Cost Accounting

Cost Accounting is widely used across almost all organizations today. Here is a few examples of the most commonly used metrics of cost accounting:

Advantages of Cost Accounting

Cost Accounting tends to be highly popular across all organization types, regardless of the industry they are operating in. The main reason as to why cost accounting is highly preferred amongst managerial accounting is summarized in the points mentioned below:

  • Improvement of Efficiency: The greatest advantage of cost accounting is the fact that it helps the company to understand their internal cost structure, and how it can be managed in order to make the system more efficient. For example, Activity Based Costing helps to identify major cost centers, as well as major activities funded by these costs.
  • Distinction between profitable and unprofitable activities: Cost accounting helps in determining which activities are considered profitable. This implies that using cost accounting a company to distinguish the profitable activities from the non-profitable ones. This can help them discontinue operations in cases where they think it is not profitable.
  • Price and Volume Related Decisions: Setting prices arbitrarily is not always a best course of action. In this regard, it is important to note the fact that cost accounting helps companies to set their pricing, with a proper understanding regarding their profitability, and impact on the price change on their overall profits.
  • Control over Materials: Variance Analysis tends to be one of the most important integral insights for the company. Cost accounting helps the company to draw budgets, to make sure that they are able to get have a better material (and labor) utilization rate. This can help them to formulate internal controls. Budgeting and monitoring is going to help them to figure out what exactly were the reasons behind the variation, and how can they avoid this from happening in the future.
  • Cost Accounting helps companies to apply budgeting and forecasting. This helps them to prepare for the future, and hence, get a competitive edge over other players in the market.

Limitations of Cost Accounting

Given the fact that cost accounting is considered to be one of the most integral decision making tool-kit for organizations, yet it can be seen that there are several other factors that need to be considered as considerations towards limitations of cost accounting. These limitations are given below:

  • Firstly, it can be seen that cost accounting is quite expensive. This means that companies might not always have the resources to hire an accountant to execute management accounting in a proper manner. Therefore, for smaller companies with limited budgets, implementing a cost accounting system might not be entirely feasible.
  • Cost Accounting is not required for compliance, therefore, it is often redundant. Since cost accounting is not entirely compulsory by law, it is important to note the fact that it might only lead to increased costs for the company. This is because the reality might often be different from the outcomes put forth by cost accounting. Therefore, cost accounting is normally an addition, which might not always add value to the company.
  • Cost accounting is often complex and is not always applicable. Cost Accounting is often considered to be highly complex, because of which it cannot always be applied. For example, standard costing might change from year to year hence, standardized rates might not always hold. In the case of any variance, it might lead to excessive pressure on the workforce which might eventually lead to demotivated workers.
  • The fact that cost accounting mostly relies on past data tends to be problematic from the perspective of the company. This tends to be problematic because it cannot be used by companies that do not have a past data record, or for companies that are newly established. Also, a lot of companies tend to see significant volatility when it comes to pricing and costing. Therefore, cost accounting might not be well suited across all industry types.
  • Cost Accounting does not consider external factors. The main focus of cost accounting is to derive internal efficiency using internal company metrics. It does not incorporate any external factors that impact the profitability of the business. Therefore, this cannot be solely relied upon by businesses.

What are Accounting Conventions? What Are the 4 Accounting Conventions?

Definition:

Accounting conventions are a set of industry best practices adapted by company requirements to serve as guidelines to record financial transactions of the company.

The accounting conventions play a crucial role in the transition to record financial transactions as per accounting standards in the company’s accounting system.

Accounting conventions do not have any legal obligation although the whole of the accounting industry is based around the generally practiced accounting conventions.

Accounting conventions have developed over time and changes depending on changing financial conditions. The conventions promote consistency and comparability of financial statements across several domains and further the cause of accounting and bookkeeping professionals and also the users of financial statements in order to understand and draw conclusions from the financial statements. Accounting conventions are also called accounting doctrines.

The most important accounting conventions are consistency, conservatism, materiality and full disclosures. These are discussed below:

Accounting convention
Accounting convention

1) Convention of consistency

The convention of consistency provides that the business shall follow the same accounting principles and methods for upcoming accounting periods.

Consistency helps the users of accounting to make conclusions and draw comparisons between financial statements of different accounting periods.

The financial statements between two or more accounting periods can be only compared when the accounting convention of consistency is followed.

If the business makes unnecessary changes in accounting policies each year, it would render the comparison useless and futile.

Convention of consistency does not imply that the company shall be rigid, rather it should only adapt to accounting principles only when necessary.

The proper explanations shall be provided under disclosures to the financial statements for changes in accounting principles and methods.

The convention of consistency helps to make financial statements more accurate and helps the management as well as users of accounting to make effective decisions.

2) Convention of conservatism

The convention of conservatism provides that company shall provide for all the probable losses and anticipate no profit unless realized.

This convention is based on being prudent. The business shall record all the expenses and liabilities when it sees uncertainty of incurring loss or liability.

The business shall take into consideration the worst possible scenarios and provide for those scenarios in the financial statements. If the business is certain of realizing the revenue, only then it shall record as such in the books of accounts.

The convention of the conservatism of accounting advises to provide for all the losses and liabilities and understate the profits and assets.

Take for example, while valuing inventory, the businesses mostly following the accounting convention of recording the inventory at lower acquisition cost or market value.

Another example would be to provide for bad debts as much as possible owing to the probability of being realized.

3) Convention of materiality

The convention of materiality states that business shall include all the relevant and material facts separately in the financial statements.

Material information refers to facts, if those are being left out or interpreted in any other way other than what it is in the financial statements, it could lead to influencing the decisions of users of financial statements.

Hence, exclusion or misreporting of any material information would change and impact the decisions of users of accounting or financial statements.

If any information does not influence the decisions of users of accounting, then that information is not considered material in nature. Take, for example, the materiality of the threshold.

The accounting decides that if any expenses cross $ 500 in a particular accounting period, it shall be recorded separately and if the expenses fall below $ 500 it shall be recorded under miscellaneous expenses.

This provides that based on the professional competence of an accountant, expenses above $500 for a particular accounting period shall be considered material in nature.

4) Convention of full disclosure

The Convention of full disclosure provides that all the relevant and material information shall be properly disclosed in the preparation and presentation of financial statements.

Financial statements are analyzed by various stakeholders as management, employees, debtors, creditors, governments, banks, etc.

Hence, management needs to be concerned about the performance of the business and plan the accounting policies accordingly.

Banks and creditors are concerned about the well-being of the business and important ratios as liquidity ratios and interest coverage ratios.

The management and employees are concerned that the business shall be on the right trajectory to achieve its medium- and long-term objectives related to growth.

The business shall also appropriately disclose all the information that takes place between the date of the balance sheet and the date of publication of the balance sheet.

Key Roles and Responsibilities of an Accountant

Introduction

Over the course of time, it can be seen that the role of accountants has magnified to an utmost extent. This is primarily fueled by the increasing need of the hour to facilitate awareness on the part of stakeholders, to ensure that there are no stones unturned in this aspect.

With cases like Enron and other financial frauds leading to massive public losses, organizations across the globe have vowed to change this for the better, by redefining the role of accountants and establishing clarity regarding the ground they need to cover in order to ensure that they are able to add value to organizations, and stakeholders, at large.

Key Roles and Responsibilities of Accountants

In this aspect, it can be seen that key roles and responsibilities of accountants can broadly be categorized into two broad categories: internal and external.

As far as internal responsibilities are concerned, they refer to the role of accountants that ‘internally’ impacts the organization whereas the ‘external’ aspect mainly focuses on the responsibility of accountants towards external stakeholders.

Internal Responsibilities

Internal Responsibilities of Accountants mainly include the following:

  • Ensuring that there are no inconsistencies in the record keeping within the organization. All records are supposed to be kept and maintained in an orderly fashion, in order to ensure that the respective receipts can be presented when required.  
  • Preparation of books, and relevant journal entries in order to systematically present the records that have been kept. This might also include using software like SAP, or other ERP related issues.
  • Preparation of Financial Statements: This tends to be one of the most important role of the accountant. At every year-end, they are supposed to prepare financial statements in order to be presented to the stakeholders. This is perhaps the fundamental parameter related to accountants.
  • Faithful representation of accounting records: This is something that goes beyond the scope of the preparation part of the financial statements. As a matter of fact, it can be seen that accountants are supposed to ensure that they do not understate or overstate any part of the financial statements. They are supposed to ensure that all the relevant information is included in the financial statements.
  • Preparation and Filing Tax Returns: Taxation tends to be another important aspect within the organization. Accountants are supposed to ensure that they are able to prepare all the tax returns in order to facilitate proper management of resources. Therefore, they are supposed to have an understanding of taxation, so that they can file returns accurately.
  • Acting as an Aid in decision making: Managerial Accounting is also a crucially important aspect of accountant. They are supposed to help the management take decisions, based on calculations, and other respective criteria in this aspect.
  • Helping auditors in the Annual Audit: Annual Audit is perhaps the most important highlight of the organization. Accountants in this aspect should ensure that auditors have all the resources in terms of facilitating the audit process. This includes providing all the resources that are necessary for the auditors to reach a concrete decision in terms of audit process, so that they can conclusively decide based on the supporting evidence.  

External Responsibilities

Speaking of external responsibilities of accountants, it is imperative that they are supposed to report any uncertain activity to the relevant parties. In case of management pressurizing in unfaithful representation of the financial statements, they are supposed to disclose that, keeping in mind the larger stakeholder interest in this regard.

Therefore, accountants are supposed to work for the larger organizational context, to be able to decide on a strategy that can help them make decisions in a proper manner.  They prepare financial statements for the external parties involved, and hence, should include anything that acts as an aid for the external parties.

Conclusion

They key roles and responsibilities of accountants are important to understand the expectation existing with general businesses, and their ability to create a proper strategy regarding the overall state of affairs. It is imperative that there is proper clarity regarding the functions they have to perform within the organizations they are a part of, in order for them to be able to ensure proper clarity regarding the roles and objectives they need to fulfill.

These responsibilities eventually reflect the performance of the company to the external stakeholders, because of which it is important for organizations to maintain a zero tolerance policy towards accountants being unable to achieve the respective goals and objectives.

How to Organize Invoices for Small Businesses? 7 Importance Tips with Guidance

If you run a business, you must become skilled in saving time and cost and becoming organized. Organized businesses are more productive. Invoices play an important part in the documentation of records for small businesses as they keep track of goods and services rendered to customers.

The catalog and keep the track of movement as well. There are many ways to keep invoices organized. Accuracy, consistency, and organization are three things small businesses shall strive to save revenue and time.

These businesses shall try to avoid manual records and go as much as digital as possible.

 Here are some of the popular techniques to organize invoices for small businesses:

1) Be updated

Accuracy is the most important factor in organizing invoices. The small businesses shall try to keep the process as per an ongoing basis and update and not try to lose information as much and saving cost in the process as well. However, the accuracy of organizing is the most important aspect.

The details such as name, address, and information on the invoice shall be correct. The process of filing and retrieval of information shall be daily. The housekeeping shall have the policy to update the process.

As tough as it may seem, getting into the habit of filing receipts and invoices immediately will make a huge improvement in your overall organization. The owners shall go through daily and organize receipts to make sure everything finds the right place.

2) Record invoices in chronological order

Chronological means in order of date. That would mean the small businesses shall prepare separate folders for each month and year.

Sometimes, small businesses do prefer physical storage. However, in current times, every invoice shall be digitized as much as possible.

The invoices recorded in chronological order also become useful in the audit procedure to be conducted by both internal and external auditors.

3) Take the help of Excel

Excel spreadsheets become useful in getting invoices organized. It offers varieties of options like arrangement of monthly invoices in one spreadsheet and sorting by file name, order, and labeling of invoices. The owners should therefore learn to use basic excel.

This would help them in easy organizing tasks along with other works related to office management. Spreadsheets have become a very popular application in today’s era to organize every date of the businesses.

4) Maintain invoice book

Invoice books contain various details like invoice number, name, date, and other information related to invoicing. The small businesses shall take help of preparing an electronic invoice book. Apart from manual records, the invoices shall be digitized and stored on computers.

It helps to preserve the records in computers for years. Invoice books, therefore, have become the primary part of the foundation of recording and organizing invoices. This helps in keeping track of the movement of invoices and the terms and conditions mentioned in it.  

5) Take Assist of software Applications

Software applications are readily available in the market to help small businesses to be updated on the aspects related to invoices.

Popular software applications like Xero and QuickBooks help in organizing invoices in the standard format and even as per customer modification.

The use of invoice software avoids clerical errors and makes the running of the business smooth and efficient. QuickBooks and Xero applications further provide various assistance in backup digitally or in the cloud. Direct message communication can be done through the application as well.

Further, real-time alerts are the mojo of this bookkeeping software. They help in providing the actions to the small businesses as well.

6) Use of invoice scanners

Filing cabinets can be filled easily in a growing business. If the small businesses want to file invoices properly and more in a permanent manner, they should take the help of using invoice scanners. Invoice scanners help in running business issues easier.

The use of invoice scanners needs fewer human resources and if benefits by making faster payments to vendors. This significantly saves revenue when the invoices are digitized.

Further, invoices can be sent to customers instantly taking care of the environment, reducing costs, and making business efficient.

It’s a perfect win-win situation for everyone involved. Hence, invoice scanners shall be invested upon to provide

7) Use of cloud storage

Cloud storage means the application of offsite storage of data. Various companies provide functions related to cloud storage. Small businesses can use cloud-based tools to share and store invoices.

By using files in the cloud, the storage can be accessed on the go and various users can be given access as per their requirement. Cloud storage is the current trend among small businesses.

Audit and Assurance in Auditing: What Are They? And How Does it Work?

What is Audit?

At the end of each financial year, the shareholders hire an auditor to audit the financial statement of the company.

The appointed auditors inspect whether the accounting and financial reporting did by the management is as per applicable financial reporting framework or not.

The completeness, accuracy, and existence of financial records is investigated and verified by the audit team and the entire procedure is known as a financial audit.

Financial Audit is a type of audit that provides reasonable assurance, and not absolute assurance, to the shareholders of the company that the financial statements prepared by the management provide a true and fair view of the financial position of the company.

Generally, all the listed companies are required by law to publish their annual financial statements along with the auditor’s report to the public.

This allows all the stakeholders, including the public, to read and analyze the financial statements before making any stock investments.

Hence, Financial Audit is a process where the external auditors that are hired by the shareholders over the annual general meeting inspect, navigate and evaluate all the financial records of the company for the current year and issue an opinion based on their findings.

A clean auditor’s opinion means the financial statements prepared by the company’s management portray a true and fair view of the company’s financial statements and are as per the International Financial Reporting Standards (IFRS).

On the contrary, in case of a scope limitation or material misstatement due to fraud or error, the auditor issues an unclean opinion in their report.

Other than financial audit also known as statutory audit and external audit, the other type of audit services include:

  • Tax Audit
  • Compliance Audit
  • Information Systems Audit
  • Operational Audit
  • Construction Audit
  • Investigate Audit

What is the assurance?

Assurance is the process of analyzing the processes, controls, and operations of an organization and verifying the accuracy of it.

Assurance services provide a critical assessment of the procedures used in the preparation of accounting and financial records. Auditing is a type of assurance service towards the accuracy of financial statements.

As compared to a statutory audit which is compulsory for specific companies by law, the other companies that aren’t obliged to get an external audit use assurance services for their financial records.

Assurance services can be obtained for any regulation or compliance. It can be for internal controls, IT systems, financial forecasting and other procedures or departments that are intact in the company.

Assurance services are independent services offered to provide confidence to the stakeholders that the organization is following the guidelines, rules, and policies accurately.

A report is provided after a thorough walk-through and analysis which focuses on how the procedures can be improved to ensure accurate financial information is produced by the company.

Conclusion:

Audit and assurance work hand in hand if it is a statutory audit. A statutory audit is a type of assurance service regarding the accuracy of financial statements.

However, audit procedures such as risk assessment and analysis of internal controls of the company come under assurance services.

Modified Cash Basis And Why Use Modified Cash Basis Accounting?

Introduction:

A modified cash basis of accounting, also known as the hybrid basis of accounting is a bookkeeping method that tries to get the best of both worlds i.e. cash basis and accrual basis accounting. 

  • Cash basis accounting: A bookkeeping method in which only cash transactions are recorded by a business during an accounting period. Income is recorded when cash is received, while expense is recorded when cash is disbursed.
  • Accrual basis accounting: A bookkeeping method in which transactions are booked as per the matching concept of accounting. Income is recorded when it is earned and expense is recorded when it is incurred, irrespective of when cash is received or disbursed. 
  • Modified cash basis accounting: A bookkeeping method that is based on a cash basis however, modifications are made to incorporate the accrual basis of accounting as well. It is a hybrid of cash basis and accrual basis of accounting.

Explanation:

The modified cash basis system allows you to modify the pure cash basis accounting system. In fact, there is no definite set of rules for you to follow and it is up to you where and when you want to make the modifications.

The transactions are usually divided into two categories and are recorded in the following manner:

  1. Short-term items: All the short-term items like monthly expenses, which occur throughout the financial year, are booked on a cash basis of accounting. These include utility bills, rent, raw materials, etc. This also implies that there are no accounts receivable and inventory being reported on the balance sheet as they are reported on a cash basis on the income statement.
  2. Long-term items: On the other hand, long-term items that do not change within an accounting period, are booked and reported on the balance sheet as per accrual basis. This includes fixed assets, long-term investments, or long-term debt. Similarly, depreciation and amortization are reported on the income statement as well.

A modified cash basis accounting system is used when the firm wants to represent its financial statements more accurately and precisely than cash basis accounting but does not want to invest the money and time in an accrual basis accounting system. 

It is the middle ground that is used to get a better evaluation of your financial performance by maintaining accounts like inventory and purchases, which is not possible in a cash basis accounting system.

Why use modified cash basis accounting?

For a small or start-up firm, a modified cash basis accounting system has several advantages.

  • It is easy, simple, and inexpensive as compared to the accrual basis of accounting. 
  • It is flexible to use since it allows you to make your own modifications. While using cash basis accounting, if you want to keep a good check on a particular item that is not included in the cash basis accounting, you can make accrual adjustments. For example, if you want, you can maintain an inventory and cost of goods sold account even when using the cash basis of accounting for your business.
  • The modified cash basis of accounting isn’t complex like the accrual basis of accounting; it does not involve management’s judgment for estimating particular items like warranty or provision for bad debts. 
  • As compared to a cash basis accounting system, a modified cash basis accounting is based on a double-entry system. Hence, it is a comprehensive representation of your business except it is in contradiction to the Generally Accepted Accounting Principles (GAAP).

Conclusion:

If you’re a firm that is not obliged to prepare financial statements as per the International Financial Reporting Standards (IFRS) and GAAP by the Financial Accounting Standards Board (FASB), then a modified cash basis accounting system can be one of the best options for you to maintain your business’s books.