Everything you need to know about the limitations of Cost Accounting: -1. It is Expensive 2. The system is more complex 3. Not suitable for small organisations 4. Lack of social accounting 5. Not an exact science 6. Not applicable in all types of industries 7. Results are not dependable 8. Results are not trustworthy 9. Merely a system of estimates and probabilities 10. Lacks a Uniform Procedure 11. Does not Control Cost and Improve Efficiency and More…
Limitations of Cost Accounting
Top 5 Limitations of Cost Accounting
Despite several benefits offered by cost accounting, there are certain limitations also:
1. It is expensive:
The system of cost accounting involves additional expenditure to be incurred in installing it and maintaining it.
2. The system is more complex:
As the cost accounting system involves a number of steps in ascertaining cost, it is considered to be a complicated system of accounting.
All businesses cannot make use of a single method and technique of costing. It all depends upon the nature of business and type of product manufactured by it.
4. Not suitable for small organisations:
A cost accounting system is applicable only to a large organisation but not suitable for small organisation.
5. Lack of social accounting:
Cost account fails to take into account the social obligation of the business. In other words, social accounting is outside the purview of cost account.
10 Major Limitations of Cost Accounting
(a) Not an exact science: Cost Accounting is not an exact science. In the absence of it, various decisions are subject to certain judgements.
(b) Biased: Many judgements are biased and depend on the individual Discretion.
(c) Assumptions: It is based on various assumptions leading to wrong conclusions in some cases.
(d) No solution to problem: It only provides a basis for taking right decisions but does not give solution to the problems.
(e) Expensive: It is expensive and can be adopted only in big companies and not suitable for small concerns.
(f) No uniformity: Lacks uniformity in application.
(g) Arbitrary: Cost apportionment may be arbitrary.
(h) No standards: Determination of standards such as labour hours, materials, cost etc. are subject to fluctuations leading to suspicion.
(i) Different types of costs: Different types of costs are required for different purposes.
(j) Different formats: Different formats are used for the same product indifferent industrial units.
Top 6 Limitations of Cost Accounting
Cost Accounting has the following limitations:
1. It is not an exact science and involves an inherent element of judgement.
2. Cost varies with purposes. Therefore, cost collected for one purpose will not be suitable for another purpose.
3. Cost accounting presents the base for taking the best decisions. It does not give the outright solution to the problem.
4. It is too expensive to be adopted by small concerns.
5. There is no uniform system of cost accounting which is applicable to all types of business.
6. The system cannot be applied to all types of industries.
What are the main Limitations of Cost Accounting?
In spite of the various advantages claimed by cost accounting, the discipline suffers from the following limitations:
1. Cost Accounting is costly to operate:
It involves heavy expenditure to operate. The benefits derived by operating the system are more than the cost.
2. Cost Accounting involves many forms and statements:
It involves usage of many forms and statements which leads to increase of paperwork.
3. Costing may not be applicable in all types of industries:
Existing methods of cost accounting may not be applicable in all types of industries. Cost accounting methods can be devised for all types of industries and services.
4. It is based on estimation:
Costing system relies on predetermined data and therefore it is not reliable. Costing system estimates costs scientifically based on past and present situations and with suitable modifications for the future.
This leads to accurate cost figures based on which management can initiate decisions. But for the predetermined costs, cost accounting also becomes another ‘Historical Accounting’.
5. It is not an exact science:
Like any other accounting system, it is not an exact science but an art that has developed through theories and practices.
6. Bias judgements:
Many judgements are biased and depend on individual discretion.
7. Difference in opinion:
Different views are held by different cost accounts about the items to be included in cost.
Limitations of Cost Accounting
Despite a number of benefits, cost accounting suffers from the certain limitations.
1. Cost accounting cannot be applicable to all types of industries.
2. It cannot be adopted by small business concerns.
3. It is expensive.
4. Immediate benefits cannot be expected and it is unnecessary for many.
5. It requires routine and mechanical activity on the part of a person.
6. Results are not dependable.
Limitations of Cost Accounting: Unnecessary, Expensive, Inapplicable and A Failure
The main limitations of cost accounting are as follows:
Maintaining cost records is unnecessary as its opponents argue on account of its involvement in duplication of work. In the support of their statement they put the principle that a good number of concerns are functioning prosperously without any system of costing.
The above statement may be true, but in the present world of competition, to conduct a business with utmost efficiency, the management needs detailed cost information for correct decision-making. Only a cost accounting system can serve this need of the management and thus render help in the efficient conduct of a business.
Installation of a costing system is quite expensive therefore, only large firms can afford it. It is also argued that installation of the system will involve additional expenditure which will lead to a decrease in profits.
In the reply to the above criticism and argument in its support it may be said that a costing system should be treated as an investment and the benefits derived from the system must exceed the amount spent on it. It should not prove a burden on the finances of the company. For an economical operation of the system, the maintenance of the records should be kept to the minimum taking into account the need and use of each record.
It is argued that modern methods of costing are not applicable to many types of industry.
In reply to this criticism it can be argued that it is hardly tenable, in view of the complexities of operating any enterprise today. The fault lies in an attempt to introduce a readymade costing system in an industry. A costing system must be specially designed to meet the needs of a business.
Only then will the system work successfully and achieve the objectives for which it was introduced. In fact, applications of costing are too wide. All types of activities like manufacturing and non-manufacturing, should consider the use of cost accounting.
4. A Failure:
Cost accounting is a failure as it is introduced in various undertakings as quoted by some people. This argument is too misleading one. If a system does not produce the desired results, it is wrong to jump to the conclusion that the system is at fault. Instead of finding fault with the system the reasons for its failure should be searched.
Often it is discovered that employees were opposed to the introduction of a costing system because they might have looked with suspicion/doubt at the introduction of any method with which they are not acquainted.
5 Major Limitations of Cost Accounting
1. It is Expensive:
The system of cost accounting involves additional expenditure to be incurred in installing and maintaining it. However, before installing it, care must be taken to ensure that the benefits derived are more than the investment made on this system of accounting.
2. The System is More Complex:
As the cost accounting system involves a number of steps in ascertaining cost such as collection and classification of expenses, allocation and apportionment of expenses, it is considered to be a complicated system of accounts. Moreover the system makes use of several documents and forms in preparing the reports. This will tend to delay in the preparation of accounts.
3. Inapplicability of Same Costing Method and Technique:
All business enterprises cannot make use of a single method and technique of costing. It all depends upon the nature of business and type of product manufactured by it. If a wrong technique and method is used, it misleads the results of business.
4. Not Suitable for Small Scale Units:
A cost accounting system is applicable only to a large-sized business but not to a small-sized one. Hence, there is limitation to its application to all types of business.
5. It Lacks Social Accounting:
Cost accounting fails to take into account the social obligation of the business. In other words, social accounting is outside the purview of cost accounts.
Limitations of Cost Accounting – Top 5 Objections against Cost Accounting
From various quarters, a number of objections are raised against cost accounting and its introduction as an accounting system in the organisations.
A few of these limitations are:
(i) Cost System is Highly Expensive
When an organisation introduces a costing system various proformas – stationery, forms, reports are to be prepared which involve heavy expenses. Again a very heavy expenditure is also to be incurred on the establishment of the costing department and its operations which ultimately increases the cost of production.
(ii) Cost System is Unnecessary
As the world over every type of business or industry is not maintaining cost accounts. Rather without cost accounts they are running smoothly. So where is the need to burden the organisation with one more department and extra accounting work.
(iii) The Results of Cost System are not Trustworthy
The argument is that as the cost depends upon predetermined rates or the standards are used with so many assumptions which may not take place in reality. Hence, cost accounts are not true and trustworthy.
(iv) An Accounting System of so many Forms and Proformas
To record the purchase, storing and issue of material, to record the arrival, departure and working during the day, for each job, section, division, cost centre and products, various proformas, forms, documents and reports are to be prepared and presented for cost control and cost calculations. Hence it is said to be the subject of forms and proformas.
(v) Inapplicability of Costing System in so Many Cases
The argument is that the system of cost accounting cannot be applied effectively in so many types of businesses and specially in small business and trading business.But all these limitations cannot be sustained because of the benefits of the cost accounts to the business, industry, management, society and the nation as a whole.
Overall, consumer is benefitted the most as the best quality product are produced at the minimum possible cost and in this age of competition, openness, globalisation and liberalisation, Cost accounting has more significant role to play in industrial and service sector.
Limitations of Cost Accounting – Expensive, Unnecessary, Not Applicable, Failure and More…
Though the costing system is very useful in the modern business world, there are certain limitations against the system.
The following are some of the limitations of cost accounting:
The expenditure incurred on the installation of a costing system is quite heavy and the operational part is also expensive. Apart from financial accounting, costing records are to be maintained, which requires extra staff and also the help of technical staff. It increases the total cost of the organization.
It is argued that there are many organizations running successfully without the costing system. The financial accounting is sufficient to run the business successfully. Therefore, the costing system is unnecessary.
3. Not applicable:
One of the objections against cost accounting is that methods of cost accounting cannot be applied to all types of industries. It is suitable especially for production industries. There are certain industries and trading concerns in which the costing system cannot be more useful as compared to the manufacturing. In many cases costing methods can be devised specially to suit a particular industry.
There are instances where the costing system has failed to give desired results. Therefore, the costing system is defective.
5. Routine forms and statements:
It is argued that after sometimes of the introduction, the system becomes the matter of routine forms and statements. It does not need the skill in handling.
6. Results are not trustworthy:
The cost accounting results are sometimes based on estimations. The results arrived by using the estimated figures may give wrong results. The actual results may not tally with the results disclosed by costing system. The variance in the result is bound to occur. Therefore, the results disclosed by costing system are not accurate and trustworthy.
Though there are many objections to the costing system, it has gained its importance in almost all industries. The objections against the system can be corrected with care and attention. It requires the strong commitment of the management.
Limitations of Cost Accounting Raised by Critics
Despite several benefits offered by cost accounts, critics have leveled the following limitations:
1. Cost accounting is merely a system of estimates and probabilities:
Though the main purpose of cost accounting is to ascertain the cost of production with a reasonable degree of accuracy, yet absolute accuracy is not possible owing to the two reasons.
(a) Indirect expenditures are absorbed on the basis of predetermined rates instead of actual rates, and
(b) The material cost and labour cost is inflated so as to cover the normal loss and wastage of materials and normal idle time of workers.
2. Cost accounting is unnecessary in such business enterprises which make large profit:
It is argued that industries which earn large amount of profit need not have a system of cost accounting. This statement is absolutely wrong. Earning of more profit by industry does not necessarily mean that its cost of production is lowest and there is no scope for further reduction in the cost.
Profit represents the difference between the selling price and the cost of a product. Profit earned by a business may be high because of increased price prevailing in the market. Two or more than two products manufactured by business may earn profit for one line of product and loss by other.
The profit earned by one product may outweigh the loss suffered by other product thus resulting in overall profit. So it is wrong to judge the efficiency of the business on the basis of overall profitability of the business.
If necessary steps are taken to reduce or eliminate losses suffered by a second line product, the industry would earn more amount of profit. It is in this context that a system of costing is felt.
3. It is unnecessary:
This criticism is leveled owing to lack of understanding of the objectives and advantages of costing. In the present-day competitive world, every manufacturer must know the cost of production for each article so that he can fix selling price on a reliable and reasonable basis.
Further he can also compare his selling price thus fixed with the price prevailing in the market.
Cost ascertainment involves application of certain principles and techniques. Having ascertained the cost, control techniques are used to keep the costs under check and thereby increase the profit. Thus it can be said that cost accounting is necessary in most of the concerns.
4. It is expensive:
This criticism is true as long as the benefits derived from this system are not commensurate with the investment made on it. But by carefully designing the system so as to suit the business, the criticism can be nullified.
5. Competition governs price and hence there is no need for costing system:
Some critics contend that in these days of competition prices are determined by the forces of demand and supply as against fixation of selling price by adding a desired margin of profit on the cost price. This argument is incorrect. Even in this situation cost accounts disclose the margin of profit that is earned by comparing the market price and cost of production.
It impresses upon management the need to reduce cost by increasing the volume of production or by elimination of losses and wastages if any. If the cost price tends to be higher than the market price, it is desirable to abandon such a product line and pay attention to profitable line of products.
6. There is no need for costing where production efficiency is high:
The statement is misleading as without a yardstick to measure the efficiency it is not possible to appraise the efficiency of a business. Cost accounting system offers a number of techniques such as standard costing, budgetary control, inter-firm comparison and so on.
The cost of production can also be compared between two periods of time to know whether business is currently running efficiently when compared to previous year. In case of inefficient operation remedial measures can be taken to improve the business.
7. Other objections:
Some other objections that are raised against the installation of cost accounting system are as follows:
(a) It is a Mere Matter of Forms and Rulings:
Often it is argued that the cost accounting system degenerates into a matter of mere forms and rulings. This is not the defect of cost accounting system but the way in which the system is maintained. No doubt different forms are necessary under the costing system but they must be simplified and altered to meet the changing condition.
(b) Failure in Many Cases:
The system of cost accounting is often condemned as defective in as much as it has failed to produce the desired result. The defect does not lie in the costing system but for some other reasons such as indifferent attitude of the management, lack of adequate facilities, non-co operations or opposition from employees. These defects can be overcome by reversing the above trend.
(c) For Want of Necessity:
It is contended by some that costing is of recent origin and that its application was not felt in the past. Though it was not used earlier, still many industries prospered. So it is felt by some critics that the installation of costing involves unnecessary expenditure.
However it is to be remembered that today’s business functions in a competitive conditions and every manufacturer must know the actual cost of production in order to reduce the selling price. Many industrial failures in the past may be attributed to the lack of knowledge on the part of management relating to the actual cost of production thereby selling product below cost.
Notes on the Limitations of Cost Accounting
The main limitations of cost accounting are as follows:
1. It is Highly Expensive:
The cost accounting system involves additional expenditure to be incurred in installing and maintaining it. However, before installing it, care must be taken to ensure that the benefits derived are more than the investment made on this system of accounting.
2. It is a More Complex System:
As the cost accounting system involve, number of steps in ascertaining cost such as collection and classification of expenses, allocation and apportionment of expenses, it is considered to be a complicated system of accounts.
Moreover, the system makes use of several documents and forms in preparing the reports. This will tend to delay in the preparation of accounts.
3. Lack of Accuracy:
The accuracy of cost accounts get distorted owing to the use of notional cost such as estimated cost, standard cost, etc.
4. Not Suitable for Small Scale Units:
A cost accounting system is applicable only to large scale business but not to small scale. Hence, there is limitation to its application to all types of businesses.
5. Inapplicability of same Costing method and Technique:
All business enterprises cannot make use of a single method and technique of cost accounting. It all depends upon the nature of business and type of product manufactured by it. If a wrong technique and method is used, it misleads the results of business.
6. Cost Accounting Lacks a Uniform Procedure:
It is possible that two equally competent cost accountants may arrive at different results from the same information. Keeping in view this limitation, all cost accounting results can be taken as more estimates.
Top 9 Limitations of Cost Accounting
Cost accounting is of immense help not only to the management, but also to the employees, creditors, government and the society.
In spite of these advantages, a number of limitations are raised against the introduction of cost accounting, which are as follows:
Limitation # 1. Cost Accounting is Inapplicable to Certain Industries:
One of the objections against cost accounting is that the modern system of cost accounting cannot be applied to all types of industries. Certain type of industries and trading concerns are not amenable to the introduction of cost accounting.
It is true that cost accounting cannot be applied to certain types of industries and trading concerns with as much advantages as it bestows on manufacturing concerns. It is also true that there is no stereotyped readymade cost accounting system applicable to all types of industries regardless of the nature of the articles produced or services rendered by them.
But in every industry or business activity, some method of costing can always be applied to suit the requirements of the industry or business. That means, cost accounting can be applied to every type of industry or activity. So, the argument that cost accounting is inapplicable to certain industries or trading concerns is not quite convincing.
Limitation # 2. Cost Accounting Can not be Adopted by Small Businesses:
Another objection against cost accounting is that small concerns cannot afford to install cost accounting because of the heavy expenses involved in the installation and maintenance of cost accounting.
It is true that an elaborate costing system may involve heavy expenses, and a small concern cannot afford it. But a small concern does not require an elaborate costing system. It requires just a simple costing system which may not involve huge expenses. Further the expenses of the simple costing system can be minimised, if it is run efficiently and economically.
That means, if a simple costing system is adopted, and is run efficiently and economically, costing will be well within the reach of even small concerns. So, the arguments that small concerns cannot afford to install any costing system is not quite correct.
Limitation # 3. Cost Accounting is Highly Expensive:
It is alleged that the installation and maintenance of cost accounting involves a considerable amount of expenditure, and so, cost accounting is highly expensive. As regards this objection, it may be pointed out that, no doubt the introduction of costing system involves initial and recurring expenditure.
But if the cost accounting system adopted is simple, suitable to the requirements of the particular industry and capable of adapting itself to changing conditions, the expenditure on the installation and maintenance of cost accounting will not be much. Further, if care is taken to see that cost accounting system becomes an investment, cost accounting cannot be expensive.
Limitation # 4. Cost Accounting is Unnecessary:
It is argued by some people that a number of industries have been functioning prosperously and making good profits from time immemorial without any cost accounting system. So, there is no need for cost accounting system at present.
As regards this argument, it may be stated that some industries might have made profits in the past without any costing system. But the conditions under which an industry is working today are quite different from what they were some 40 to 50 years ago.
In the present world of competition, every management must know not only the exact cost per unit of its product, but also how the cost has been made up so that it can take steps to trace the wastage, effect economy, reduce the cost of its product and offer its product in the market at the most competitive price and survive in the world competition.
That means, in the modern competitive world, cost accounting is absolutely necessary so the argument that cost accounting is unnecessary does not hold good today.
Limitation # 5. Cost Accounting is a Failure Today:
It is argued by some people that cost accounting is a failure, it has failed to give good results in many cases. As regards these arguments it may be pointed out that cost accounting might have failed in some cases. But there are, at the same time, a number of instances where cost accounting has proved to be very successful.
Further it may be pointed out that cost accounting system is bound to be a failure, if it has been introduced just for fashion regardless of the requirements of the particular industry. But if proper method of cost accounting is introduced taking into account the requirements of the concerned industry, and is run efficiently, cost accounting is bound to become a success.
Limitation # 6. Cost Accounting does not Control Cost and Improve Efficiency:
It is argued that cost accounting does not control cost or improve efficiency. On the contrary, it adds to the cost by necessitating additional forms and records and causes considerable delay in production by necessitating the recording the data on those forms.As regards these arguments it may be stated that cost accounting does not control cost or improve efficiency.
Cost accounting can only provide the necessary cost data to the management to enable it to take appropriate action to correct the cost or to improve the efficiency and it is up to the management to take appropriate action for controlling the cost or improving the efficiency. Thus, if management plays an important role, the use of costing will reduce the necessary recording work, expedite the production and reduce the cost.
Limitation # 7. Results of Cost Accounting are not Dependable:
It is alleged by some people that the results of cost accounting system, i.e., the cost data are not dependable, as they are based upon estimates.
As regards this allegation, it may be pointed out that under the system of historical costing, the costs are ascertained after they have been actually incurred and audited by qualified accountants and as such, the cost ascertained are actual or true costs and not estimated costs.
Under the system of continuous costing, it is true that some costs are actual and some are estimated. But, even here, the estimates are quite scientific and not mere guess work. So, the allegation that costs are based upon, and so, the results are not dependable, is not convincing.
Limitation # 8. Cost involved in Installing Cost Accounting is Out of Proportion to the Benefits Derived Therefrom:
It is argued that the cost of installing and working a cost accounting system is out of proportion to the benefits derived therefrom.
This argument is not convincing. If a proper method of cost accounting is adopted, and if it is efficiently and economically organised, cost accounting will not become unprofitable. Definitely, the benefits derived from cost accounting will be under more than the cost involved in the introduction and maintenance of cost accounting.
Limitation # 9. Cost Accounting a Matter of Routine Forms and Statements:
It is argued that cost accounting is a matter of routine forms and statements, and so, becomes stereotyped and mechanical.
As regards this objection, it may be pointed out that it is not the fault of the cost accounting system. It is the fault of the way in which the cost accounting system is operated. It is true that cost accounting requires a number of forms and statements, and the forms and statements become routine and stereotyped, if they are not revised and made up-to-date according to changing conditions of the business.
But the mere increase in the number of forms and statements should not be taken to mean that the cost accounting system becomes mechanical. In fact, more forms mean simplification of work.
The above discussion clearly shows that most of the allegations against cost accounting are not really convincing. The objections against cost accounting are mainly due to lack of proper knowledge of the subject of cost accounting and its practical applications.
It has been proved that cost accounting has been successfully installed and efficiently operated and immense benefits have been derived from cost accounting in all types of organisations, manufacturing as well as non-manufacturing organisations like banking companies, insurance companies, transport undertakings, mining companies, hospitals, hotels, educational institutions, cinema houses, agricultural firms, etc.
Limitations of Cost Accounting – Lack of Uniformity, Second Hand Data, Conventions, Uncertainty, Costly and Applicability
1. Lack of Uniformity:
There is no uniform system of costing applicable to all industries. Even for the same firm, two different cost accountants may arrive at two different cost figures.
2. Second Hand Data:
Costing depends on financial accounts for a lot of information, which is second hand. Any errors or shortcomings in that data creep into cost accounts also.
Several conventions are routinely applied or used in costing which may not be appropriate in all situations. For example, classifying overheads into variable and fixed, recovery of overheads on machine hour or labour hour basis etc.
Estimates are used in different contexts like Tenders & Quotations, Contracts etc. Different methods of pricing of materials are available. Several methods of absorption and apportionment of overheads can be used. All these factors lead to uncertainty and fluidity in costing. It becomes difficult to derive correct costs. Actual costs may differ from estimated costs, rendering quotations etc., erroneous.
The need to observe several formalities to derive benefits of costing makes it costly for small and medium enterprises.
Costing is applicable primarily in manufacturing and service firms. It is not useful for trading firms.
Limitations Raised against Cost Accounting
Cost accounting has become an indispensable tool to management for exercising effective decisions.
However, the following are the usual limitations raised against cost accounting:
(a) Cost Accounting is Costly to Operate:
One of the objections against cost accounting is that it involves heavy expenditure to operate. No doubt, expenses are involved in the introduction and operation of cost accounting system.
This is the case with any accounting system; the benefits derived by operating the system are more than the cost. Therefore an organisation need not hesitate to install and operate the system.
(b) Cost Accounting is Unnecessary:
It is felt by a few that cost accounting is of recent origin and an enterprise can survive without cost accounting.
No doubt financial accounting may be helpful to draw P&L Account and Balance Sheet but an enterprise can work efficiently with the help of cost accounting and it is necessary to increase efficiency and profitability in the long run.
(c) Cost Accounting Involves Many Forms and Statements:
It is pointed against cost accounting that it involves usage of many forms and statements which leads to monotony in filling up of forms and increase of paperwork.
It is true that cost accounting is operated by introducing many forms and preparation of statements. This will become routine and as time passes the utility of forms is realised and the forms can be reviewed, revised, simplified and minimised.
(d) Costing may not be Applicable in All Types of Industries:
Existing methods of cost accounting may not be applicable in all types of industries.Cost accounting methods can be devised for all types of industries, and services.
(e) It is based on Estimations:
Some people claim that the costing system relies on predetermined data and therefore it is not reliable.
Costing system estimates costs scientifically based on past and present situations and with suitable modifications for the future. This leads to accurate cost figures based on which management can initiate decisions. But for the predetermined costs, cost accounting also becomes another ‘Historical Accounting’.
Limitations of Cost Accounting
1. Absence of uniformity in procedures
There is no uniformity in the procedures followed in Cost Accounting. As a result of which the same information will show different results when different procedures are applied.
2. Excessive dependence on conventions, estimates and flexible factors
Such dependence makes it impossible to get exact results.
3. In-affordability of small firms
The installation and operation of a Cost Accounting system is a little expensive and procedural. Therefore small firms cannot afford it.
4. Difficulty in futuristic applications
It’s difficult to apply cost accounting for certain futuristic aspects.