May 1, 2019

Role of Costing and Cost Accounting in the Organization

Purposes of Accounting Systems

Accounting is a major means of helping managers of an organization, equity investors of an organization, potential equity investors, creditors and bond holders of an organization, potential creditors and bond holders of an organization, suppliers and customers of an organization and other stake holders to take decisions.

Accounting provides information for three major purposes:

1. External reporting: These reports are used investors, creditors, government authorities, and other outside parties.

2. Routine internal reporting: These reports which are periodically generated are used by managers of the company for their internal decisions.

3. Non-routine internal reporting: This information or reports are generated to support projects and other decisions that come up as the need arises from them.
While the reports are prepared in different formats and basic data is manipulated or summarized in various ways to facilitate decision making, there is one data base maintained by the accounting system that contains data in the form debits and credits to various accounts maintained in the accounting system. Accountants combine these data items in various ways to provide information to internal or external users.

Distinction Between Financial Accounting, Cost Accounting and Management Accounting

Horngren’s distinction between them is interesting.

Management accounting as a discipline focuses on accounting information that facilitates decision making by managers of the organization. If focuses on routine and non-routine accounting reports.

Financial accounting measures and records business transactions and provides financial statements that are based on generally accepted accounting principles (GAAP). Executive compensation is tied to profit figures reported in the financial statements and equity share valuation is also based to a large extent on these financial statements.
Cost accounting provides information to facilitate both management accounting and financial accounting. Its focus is measuring and reporting financial and nonfinancial information that is related to the cost of acquiring or consuming resources by an organization.

Cost Management

Cost management is an activity of managers related to planning and control of costs. Managers have to take decisions regarding use of materials, processes, product designs and have to plan costs or expenses to support the operating plan for their department or section. All these activities come under cost management. Information from accounting systems help managers in cost management activities. But the cost accounting system and the reports it generates is not the cost management system. Accounting system can be interpreted as a part of cost management system of an organization.

Cost management is not cost reduction alone. It is much broader. Organization increase advertising expenditure to increase sales, increase research and development expenditures to promote new products. Here the concerned managers are deliberately incurring additional costs in a period (compared to the previous period) as they expect profits from such decisions or expenditures. Cost management system has to ensure that a cost is incurred with the expectation of profit.

The Role of Management Accounting

The role of management accounting is also described as problem solving, score keeping and attention directing.

Problem solving: The role of accounting in problem solving is to provide information useful in evaluating alternatives.

Scorekeeping: Scorekeeping records the results of various actions of the managers and helps in assessing whether the results expected from the various actions are realized or not.

Attention directing: The scorekeeping function in combination with expected results, and comparative analysis of scores of various companies, divisions and departments, comparative analysis of present period scores or results with previous periods show opportunities of focusing attention of managers to improve things.

Value Chain

Value chain is a visualization of complete business as a sequence of activities in which usefulness is added to the products or services produced and sold by an organization. Management accountants provide decision support for managers in each activity of value chain.

Design of Management Accounting System

The design of management accounting system has to take into consideration the decision needs of the managers. Also it has to take into consideration the new themes and challenges that managers face currently.

Horngren identified four such themes in the tenth edition of his book.

1. Customer focus: The challenge for managers it invest sufficient resources to enhance customer satisfaction. But every action of the organization has to result enhanced profitability or maintained profitability for the organization.

2. Key Success Factors: These are non-financial factors which have an effect on the economic viability of the organization.

Cost, quality, time and innovation are important key success factors. Management accounting systems need to have provisions for tracking the performance of the organization and its divisions as well as competitors on these success factors.

3. Continuous improvement: Continuous improvement or kaizen is a popular theme. Innovation related to this area in costing is kaizen costing .

4. Value Chain and Supply Chain Analysis: Value chain as a strategic framework for analysis of competitive advantage was promoted by Michael Porter. Management accountants have to become familiar with the framework and provide information to implement the framework by strategic planners.

The term supply chain describes the flow of goods, services and information from cradle (the mines sources of raw materials) to grave (where discarded products or dumped), regardless of whether those activities occur in the same organization or many organizations.

Key Guidelines for Management Accounting System Design

Cost Benefit Approach: In the system design resource allocation decisions are to be made. Examples would be software to buy and associates to employ. A cost-benefit approach should be used for all such decisions. Resources should be spent only when there is profit to the organization due to that expenditure. Each incremental addition to the accounting system must be supported by incremental profit to the organization.

Behavioral and Technical Considerations: Management has human dimension and it has to focus on how to help individuals to do their jobs better. Managing people involves discussion of managers with his associates on improving performance. The behavioral responses of people to reports highlighting their underperformance have to be understood. Management accounting should lead to cordial relations and climate.

Different Costs for Different Purposes: It is to be noted that there are several cost concepts and cost measures can be created for each of these concepts. Cost accountants have to careful to provide appropriate cost to the managers. The accounting system has to have some precautions to make sure that the accountant understands the decision situation of a manager and provides appropriate cost measures.

Professional Ethics

Like other professionals, accountants also face ethical dilemmas. They need ethical guidelines. Institute of Management Accountants (IMA), USA published guidance note on ethics to be followed by management accountants.

Competence, confidentiality, integrity and objectivity are important themes of the guidance note.

Role of Cost Information - 2019 Illustration

Cost Information for Zero-Based Productivity Management of Supply Chain - McKinsey Way Supply Chain Industrial Engineering

McKinsey consultants recommend start by breaking costs into four crucial categories—direct labor (including equipment), indirect labor (including equipment), warehouse and logistics, and materials  (including conversion yields)—and building  a bottom-up view on the existing cost base. The category which may have the highest opportunity  varies by industry and type of manufacturing. In more automated settings or continuous manufacturing, equipment category may have higher opportunity. Direct-labor may be more important in  manual assembly to find savings opportunities.

Establishing granular transparency

Companies have to  seek  granularity into costs. This  visibility of lower and lower level costs, gained by aggregating ledger account data from internal sources and benchmarking data from external sources, enables organizations to establish relevant benchmarks across spending categories. Data is collected from existing recorded data  and is augmented by specially made cost studies using  observations and targeted sampling where data is lacking. The  data has to point out  regulatory and customer special requirements, which act as constraints in the problem. 


Horngren, Charles T., George Foster, and Srikant Datar, Cost Accounting: Managerial Emphasis, Tenth Edition, Prentice Hall, Inc., Upper Saddle River, New Jersey, USA, 2000

Cost Accounting - Horngren et al., Book Information and Review

Updated on 2 May 2019, 8 December 2011

Originally posted on Knol


  1. Nice information, thank you for sharing useful content.
    Cost Management and Reduction play an important role in the prosperity of company/business.

  2. Cost management program me leads a key role in any company or business. To run a company it is essential to have knowledge on cost management, Thanks sharing some information on it. Looking forward to your blog.