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Introduction to Cost Accounting, Financial Accounting and Management Accounting


Cost Accounting
This can be defined as the application of accounting and costing principles, methods and techniques in the ascertainment of cost and the analysis of saving and/or excess as compared with previous experience or with standard.

The aim of cost accounting is achieved by establishing budgets, standard costs and actual costs of operations, processes, activities or products and the analysis of variances, profitability or the social use of funds.

Financial Accounting
This concerns itself with the recording of transactions between a business and its stakeholders such as customers, suppliers, employees, owners, etc and the preparation of income statement, statement of financial position and statement of cash flow, at least, once every year for the stakeholders.

Financial Accounting, therefore, ensures that the assets and liabilities of a business are properly accounted for, and provides information about profit and so on to stakeholders.

Management Accounting
This is an integral part of management concerned with identifying, presenting and interpreting cost and financial accounting information used for planning ,decision making and controlling as well as the optimum use of resources. The source of information is the financial and cost accounts.

                                     Differences between Financial, Cost and Management Accounting
Financial Accounting
Cost Accounting
Management Accounting
1.      It shows the financial performance and position of a business.
1.      It is used to establish the cost of a product, an activity or a department.
1.      It aids management to plan, control and make decisions for a business.

2.      It is required by law especially for limited companies.

2.      There is no legal requirement to prepare cost accounts.

2.      There is no legal requirement to prepare management accounts.

3.      Format for presentation of information is determined by law or accounting standards.
3.      Format of cost accounts is at management discretion.
3.      Format of management accounts is at management discretion.
4.      It covers the business as a whole.

4.      May focus on specific areas of a business.
4.      May focus on specific areas of a business.
5.      It is for external use.

5.       It is for internal use.
5.      It is for internal use.
6.      It prepares statements in summaries or aggregates.

6.      Statements prepared may be aggregate or detail.

6.      Statements prepared may be aggregated or detailed.
7.      It is of monetary in nature.

7.      Information is both monetary and non monetary.
7.      Information is both monetary and non monetary.
8.      It is historical.

8.      It is both historical and forward-looking.
8.      It is both historical and forward-looking.

9.      Statements are normally prepared annually.
9.      Statements prepared cover shorter periods i.e. daily etc.
9.      Statements prepared covers shorter periods such as monthly management accounts, etc.

The accountant’s work involves the collection of data and processing it into information to be used by various stakeholders.

Data refers to the raw material for data processing. That is, the raw facts, events or transactions that are processed into information.

Information refers to data that has been processed in such a way as to be meaningful to the person using it. Information may be classified as financial or non financial. It can also be classified as quantitative or qualitative.

Exercise 1
Explain with examples what is meant by
  1. financial information;
  2. non-financial information that is
    1. quantitative,
    2.  qualitative.

Qualities of Good Information
Good management information must have the following qualities so as to make it useful:
1.      Relevance: Information that is relevant meets the needs and aspirations of management. Irrelevant information does not serve management needs.

2.      Accuracy: Good information should be free of material errors. However there is no need to go into unnecessary detail for pointless accuracy.

3.      Clarity (Understandability): Information must be clear to understand by the user.

4.      Completeness: Information users should have all the facts needed to make a particular decision.

5.      Confidence: Good information must inspire confidence so as to be trusted by users. Where there is uncertainty, the assumptions underlying the information should be stated.

6.      Volume: Good information must be brief and concise. Where possible, the exception principle must be used.

7.      Timeliness (Speed): Information must be prompt for any decision. That is, information which is too late is as bad as too early.

8.      Communication: Information is classified as good when communicated to the right person.

9.      Cost (Economy): The benefit derived from any good information should be greater than the cost of acquiring it.

10.  Channel of communication: Good information must be communicated using the right channel or medium. For example using memos, professional magazines, journals, electronic mail, word-of-mouth, etc.

The three main functions of management are planning, decision making and control.
A.    Planning refers to the establishment of business objectives and devising strategies or means to achieve those objectives. The three levels of planning are
                 i.            Strategic  planning (long term planning)
               ii.            Tactical planning (management control)
             iii.            Operational planning (operational control or  short term planning)    

B.     Decision making refers to making a choice between alternative courses of action. The three levels of  decision making are
i.     Strategic decision
ii.                  Tactical decision (management decision)
iii.                Operational decision

C.     Control refers to the setting of standards, measurement of actual results and comparison with the standard set so as to take corrective action where there are deviations or variances.

 It must be noted that the three management activities above are interdependent. That is, all three are inseparable in practice. For example, there cannot be effective control without planning and planning without control is practically impossible.

Cost Classification and Analysis
Costs can be classified using various criteria or characteristics. Classification is necessary for the following reasons;
  1. Stock valuation
  2. Decision making
  3. Product pricing
  4. Cost control
  5. Performance measurement or evaluation
  6. Planning or budgeting
  7. Preparation of financial statements

Cost Classification by Elements
The elements of cost are
        i. material cost,
      ii. labour cost and
    iii. expenses.

  1. Material cost refers to the cost of the basic inputs, ingredients or component that undergo significant changes in a production process.
Give examples of material cost in various industries.

  1. Labour cost refers to the amount paid to employees for the services the render.

  1. Expenses refer to all other cost of a business apart from material and labour costs. They are the costs of the services enjoyed by a business and the costs of using the business own assets.

Discuss various cost components that can be classified under each of the elements of costs discussed above.

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