EVOLUTION OF COST ACCOUNTING

• Prior to the industrial revolution, businesses were small and characterised by simple market exchanges between individuals and organisations. In those times there was a need of accurate book keeping though not that much of cost accounting.
• In seventeenth century in France, the Royal Wallpaper Manufactory had a Cost Accounting System. Some iron masters and potters
• in eighteenth century in England too began to produce Cost Accounting information before the Industrial Revolution.
• Subsequently, with the advent of the industrial revolution, large sized process industries performing single activities (e.g. textiles , railways etc)came into being. During this period, there was a lack of market for intermediary products because of which cost information gained importance as a tool for measuring efficiency of different processes.
• The period, 1880 AD – 1925 AD saw the development of complex product designs and the emergence of multi activity diversified corporations like Du Pont, General Motors etc. It was during this period that scientific management was developed which led accountants to convert physical standards into cost standards, the latter being used for variance analysis and control.
• During World War I and II the social importance of cost accounting grew with the growth of each country’s defence expenditure. In the absence of competitive markets for most of the material required to fight war, the Governments in several countries placed cost-plus contracts under which the price to be paid was the cost of production plus an agreed rate of profit. The reliance on cost information by the parties to defence contracts continued after World War II as well. Even today, most of the government contracts are decided on a cost plus basis.

COST ACCOUNTING AND INVENTORY VALUATION

The spurt in the industrial growth, as mentioned above, also resulted in the increased importance of financial accounting and audit (1900 AD onwards).One of the fundamental issues to be resolved by the accountants during this period was the measurement of the value of inventory while preparing financial statements. The valuation had a deep impact over the projected profitability of a company, which in turn affected the willingness of various stakeholders to inject large amount of capital in the business. The valuation also directly affected the taxes which the company was obliged to pay to the government since higher profits meant higher taxes and vice versa.

It was in this context that the need of establishing rules for inventory valuation was felt. It was then decided that inventory should be valued at ‘cost’ or ‘market value’ which ever is lower. The term ‘cost’, being restricted to the money expended in manufacturing the product till the time the product was sold. Hence, expenditure incurred in research and development, distribution, marketing or customer support functions was to be excluded while computing ‘costs’ for inventory valuation. The computation of the cost incidence on different types of inventory with different degrees of completion necessitated the need of accounting for ‘costs’ in order to arrive at the correct values.

As you would have understood by now, ‘cost accounting’ was initiated for manufacturing organizations and as a field of practice was limited within the factory premises. However, with the increase in its scope , cost accounting today is equally important to both manufacturing and service organizations and also does not restrict itself to inventory valuation alone. It is used in

(1)various decision making scenarios e.g. whether to produce for captive consumption or buy from outside suppliers,

(2) supply of information to the government (cost audit),

(3)planning and control of expenses(variance analysis)

(4)tracking expenses through a products life cycle (life cycle costing),

(5) fixation of selling prices (cost plus and other approaches) etc. The use of information technology has helped companies keep /maintain different cost systems for different purposes.

Today, Cost Accounting is popularly known as ‘Cost and Management Accounting’. Before you begin your study of Cost Accounting, you must be clear in your mind that you are going to study a subject, which is immensely useful in all economic activities. It is a natural instinct with all of us to measure the pros and cons of everything. A prudent housewife who goes for shopping considers the quality and price of each product before she buys it. In short, each economic activity, if rationally viewed, has two aspects - firstly, the costs involved in it and secondly, the benefits obtained out of it. This analysis is technically known as cost-benefit analysis. It is very important in industrial and commercial activities. Cost Accounting involves a study of those concepts, tools, and techniques, which help us in ascertaining and analysing costs.