Cost Accounting

Assignment’s topic: Historical development of cost accounting

Submitted to prof: Ahmed Farghaly

Submitted by: Martina Nabil Saad

Introduction

Over the years, Cost accounting techniques have been employed in the
determination of the prices of products as well as in assisting and facilitating
the process of decision making. Although cost accounting has evolved as a
result of advancements in production technology, some of its early practices
may be stated to be somewhat similar to those that are being used today
(Adum, Ovunda, 2015, p1845)1.

History of cost accounting

Cost accounting, dated back to the ancient times, is one of the oldest
managerial tools used to determine the amount of taxes that were taken by
kings or used to determine the prices of the products that trading people of
antiquity were selling. The trading people of ancient times such as the
Chinese, Egyptians and Arabs had accountants in the service of the royal
courts, some of whom were experts in the determination of costs (Perren,
1944, p1060)2.

Cost Accounting in the Seventeenth and Eighteenth Centuries

The most interesting examples of seventeenth century cost calculations belong

to the members of the Worshipful Company of Bakers in 1620. This company
prepared a cost statement to show that the selling price of baked bread in 1620
was not adequate to cover the cost of baking (Garner, 1947, p390)3.
According to (Edwards and Newell ,1991, p44)4 about a copper production
mine that was located near Keswick in 1615.

Hechstetter, owner of the copper mine, evaluated the relative cost of

producing rough copper in detail. This indicates that comprehensive accounts
of all aspects of production were kept. Weekly cost of labor, various materials,
carriage, horses, etc. are listed and multiplied by 52 (i.e., the number of weeks
in a year). The cost of copper ore, charcoal and other smelting materials, as
well as miscellaneous items such as rent and interest are added to this amount
which gives an annual total cost of production. Hechstetter was using these
calculations for cost related decision making, from the late 16th century. For
example, he calculated the effect on profit of selling copper in a different
geographical area and also the effects on cost of changing the level of
production.

Cost Accounting in the Nineteenth Century

Most accounting professionals, researchers, authors, and scholars see the

nineteenth century as the formal beginning of cost and management
accounting because this century was characterized by the emergence of large
business enterprises. this was the period of the industrial revolution, during
which England and the US witnessed the upshot of large cotton textile
factories that used cost accounts to ascertain the direct labor and overhead
costs of converting raw materials into finished yarn and fabric.

Capital-intensive manufacturing operations conducted by the late 1800s in

iron and steel, foodstuffs, petroleum, chemicals, machinery-making, and so
forth, were vastly more complex and larger than were operations within the
early nineteenth-century New England textile industry. Nevertheless, at the
end of the century most of these large manufacturing organizations still
conducted, as had the early textile firms, only one basic activity: namely, the
conversion of raw materials into finished goods (Johnson, H. T. 1981, p.p511-
514)5.
Also, in the nineteenth century, Between the 1820s and 1830s, British mining
and smelting industries were using some elements of costs like material, labor
and overhead costs which were similar to the cost elements used at about the
last decade of the twentieth century. (Richard & Thomas, 1993, p510)6.

Cost Accounting in the Twentieth Century

Until the last thirty years of the 20th century, the overhead expenses of a
business that are not directly related with production, or costs auxiliary
activities, were added to a product or service cost by direct costs’ distribution
means subject to production volumes (Karcıoğlu, 2000, p156)7.

This process was reliable as long as overhead costs were in direct proportion
to production volumes. But in cases where overhead costs are not in direct
proportion to production volumes, reliability cannot be achieved (Gündüz,
1997, p 87)8.

In the late nineteenth century up till the early part of the twentieth century,
managers such as F. Taylor and Emerson devised new cost accounting
procedures primarily to assess and control financial and physical efficiency of
processes. Because of the financial and physical efficiency mentioned, one
may be tempted into concluding that it was meant to evaluate the overall
profitability of the company. No. The whole idea was aimed at assessing the
efficiency of processes. The cost systems which existed in 1910 provided
information that was relevant to a wide range of decisions concerning
efficiency and product differentiation. The systems were designed by
engineers working in factories to assign costs to products and product lines.
After 1910, these practices faced out probably because the collection of cost
information was very difficult and expensive for a widening range of products
thereby making it nearly impossible to justify their benefits. (Díaz et al., 2009,
p.p140-143)9.

Cost Accounting Techniques

Nowadays companies face strong competition at a global level, so there is a

lot of pressure to increase productivity and lower production costs. The
modern costing techniques used frequently within last decades include; Just
in Time principle, Activity Based Costing and Life Cycle Costing. The usage
of the techniques depends on the situation on the ground, that is, the level of
technological advancement, the size of the company, organizational culture
and stage of the product.

1. Just-in-Time (JIT):

Usually, JIT process being implemented in the organisation that reached the
highest application of JIT. This is because organisation and the supplier
should have a good relationship and believe because when there is demand
from factory, the suppliers can supply them on time. The first way to
implement JIT is build a good relationship with the suppliers, customers and
also sub-contractor to reduce inventory “buffer” to few hours. According to
(Canel, et al., 2000, p51)10. JIT aims is to reduce time waiting during
production process. Therefore, the cost of inventories not only can be
minimized but also the time for the production also shortens. JIT concept is
not saying about the standardization or the way of managing but it really
focusing on the zero inventories

The application of JIT would give a lot of benefits such as to the producer to
increase the quality to fulfil the customer demands and reduce the inventories
and built a good relationship with the supplier (Salaheldin, 2005, p355)11.
Positive of JIT application can successfully give benefit to three communities,
which is supplier only, purchased only or both. The benefits are, reducing in
inventories and time waiting for the inventories, increase the quality and
technical support, increase productivity, reduce waste and machine
maintenance (Wafa, et al., 1996, p20)12. JIT actually help to reduce machine
maintenance and at the same time, to make sure the suppliers can produce the
inventories on time. According to (Yasin, et al., 2001, p1198)13 the big
problem of JIT application is employer issues and the suppliers. Employer
issue is about the objection of JIT concept, less supportive of JIT and less of
employees.

2. Activity-Based Costing (ABC):

Activity-Based Costing Approach: The activity-based costing approach was

developed by Harvard Business School lecturers Robert Kaplan and Robin
Cooper in 1986 and was suggested as a different approach for calculating
product costs (Cooper and Kaplan, 1988, p 96)14.

Activity-based costing was first adopted by production establishments in the

USA. and as a service industry has begun to progress rapidly worldwide, it
was asserted that it should be adapted to the service industry as well

In the most general sense, activity-based costing can be defined as

distribution of indirect costs to activities in the first place, then distributing
this cost added activities to products, services and customers (Cooper and
Kaplan, 1991, p 130)15.
As can be seized from the definition above, the main objective of this
approach is to prevent mistakes caused by production volume related
distribution means, used to distribute costs on goods on services in cost
accounting (Cooper and Kaplan, 1992, p11)16.

In the early 21st century, calculation of activities, establishing and running

costing methods became time consuming and at such a price in dynamic
environments of production and service sectors, that many establishments
gave up using the above-mentioned costing methods and started to search for
a new costing approach. Consequently, time-driven activity-based costing,
which is based on activity-based costing but making up for its deficiencies,
was developed as an alternative to the former SCM approaches by S.R.
Anderson and Acorn Systems team. The time-driven activity-based costing
approach was developed to make-up for the deficiencies of SCM approaches,
and in comparison, with other approaches it is simpler and at lower cost.
Furthermore, it offers more drastic solutions

In the most general sense this approach can be defined as follows: a new SCM
approach, which is effective in obtaining accurate cost information and from
which they can benefit for determining priorities to develop processes, pricing
customer orders, profiling product and service volumes and managing
customer relations according to mutual benefit basis and it provides
businesses with the possibilities to develop a cost management system
(Kaplan and Anderson, 2007, p7)17.
3. Life Cycle Costing:

Product life cycle costing can be defined as inspecting all costs caused by
activities performed during a product’s life cycle and it is a relative notion
which has been considered and adopted by businesses during recent years.
This is an approach which aims to foresee all possible costs which may occur
at all phases of a product’s life cycle even before it is produced, in other words,
it aims to make apparent all factors that might affect the performance of a
product’s total life cycle. It is said that most businesses can make use of this
approach as it may help administrators understand and manage costs that may
tack to a product during its life cycle by providing them with useful
information. (Asiedu,1998, p884) 18.

Life Cycle Costing, sometimes called ‘’whole life costing’’ or ‘’Whole Life
Cycle Costing’’ attempts to identify the total cost associated with the
ownership of an asset so that the decisions made at the initial acquisition have
the effect of locking in certain costs in the future. Life-cycle costing or LCC
is a tool widely used by companies and/or governments which evaluates the
costs of an asset throughout its life-cycle (European Commission). The
benefits of Life cycle costing include; improved evaluation of options,
improved management awareness about the consequences of decision,
improved forecasting and improved understanding of the tradeoff between
performance of an asset and its cost while non availability of data and the fact
that it is difficult and time consuming are parts of its problems.
Life Cycle Costing is applicable where initial capital outflows or the purchase
of physical assets is large; the decision to serve and retain customers can also
be a capital budgeting decision.

A credit card company or an insurance company for example, incur initial

costs due to paperwork, checking credit worthiness, opening policies for new
customers and it takes some times before these initial costs are recouped.
(Waghmod,2014, p245)19.
References

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