Cost accounting is sometimes hard to define because it means different things to different people. So let’s differentiate and define two broad categories based on who specifies the effort.
Externality Specified Cost Accounting Systems
Much accounting is specified by external organizations and interests. These specifiers have the power to demand or require by law. Think of tax authorities who require corporations, sole proprietorship, individuals, trust, and estates to report cost.
Shareholders, represented by the Securities and Exchange Commission, also have the power to require companies to report cost. Regulators of utilities are another external force that establishes cost reporting requirements. Congress, state legislators, and local authorities also demand cost reporting.
Financial aid forms and mortgage applications also demand some cost accounting for their use. Even travel reimbursement forms come with a reporting requirement.
These powerful external specifiers also have the power to define how the reporting is to be done. Generally accepted accounting principles tell corporations how they must report costs to the Securities and Exchange Commission. Internal Revenue Service, Congress, and their state and local equivalents write the reporting requirements for tax forms. Any required reporting tends to specify the reporting requirements though auditable rules, laws, or standards.
The Financial Accounting Standards Board codifies corporate reporting methodology. The Government Accounting Standards Board does so for state and local government and the Financial Accounting Standards Board does so for the federal government.
These external specifiers strictly define the methodology because they have a need for consistency, comparability, or equity. All companies following generally accepted accounting principles can then be compared to each other. All taxpayers report on the same forms so there is equity. Mortgage evaluators are trying to evaluate the comparable risk among their applicants.
Internally Specified Cost Accounting Systems
Internally specified cost accounting has a completely different goal set. It has no need for external comparability, consistency, or equity. Nor is it required. Internally specified cost accounting is optional. It is looking for something different: a benefit that justifies the cost of the effort.
Usefulness is then the major concern of an internally specified effort. The costing must provide information that helps run the organization. This is the case whether at a corporation struggling to make a profit or an individual trying to save for retirement or kids’ college. If there is not usefulness then any cost benefit analysis would fail to justify the accounting effort.
Closely tied to usefulness is credibility. If the cost accounting is not credible, it will not be trusted and therefor unused. This is a different requirement than mere consistency. It requires an understanding of the cost accounting and an acknowledgement that it represents reality.
The third requirement of affordability again derives from the need to satisfy the cost benefit requirement. It is always possible to spend more and more on cost accounting. It can always be done more frequently or in greater detail.
At some point, however, there is a diminishing return to detail and frequency. The effort must cost less than the benefit and these facts place an important boundary on the cost of the cost accounting. Since absolute precision is unaffordable, reasonableness becomes the test.
The effect of these goals inevitably means that internally specified cost accounting tends to be customized and situation specific. We will use the term managerial costing to differentiate internally specified cost accounting from cost accounting specified by external forces.
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