Cost accounting is a very effective tool for businesses in terms of tracking expenses, pricing products, and even making decisions that are financially sagacious.
However, the system it provides comes with its limitations.
Although cost accounting provides for many benefits, its challenges and drawbacks in implementation are also helpful to know.
In this blog, we're going to take on some of the main limitations of cost accounting in easy, simple words.
Limitations of Cost Accounting :
1. Time-Consuming and Labour-Intensive
One big disadvantage of cost accounting is that it can be so time-consuming, especially in large companies with numerous products or services.
Cost accounting is elaborate and tracks every single expense, from raw materials to labor costs - and overhead costs like rent and utilities. This has to be fed into the system continually, watched for trend in expenses, and analyzed in numbers.
This, in turn is a significant burden for small businesses or those with limited resources. All this takes a lot of time and effort to maintain accurate cost records if the process is not automated through accounting software.
Even with automation, there is still a need for regular updates and monitoring which can pull employees away from other important tasks.
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2. Complexity in Implementation
For that matter, cost accounting can also be very complicated, depending on the type of different products or services a business offers.
Some types of cost accounting, like Activity-Based Costing (ABC), require businesses to break down their costs into specific activities, which can be prone to becoming confusingly complex quickly.
Take, for instance, the scenario of a firm that has many departments or stages in production-it becomes very difficult trying to figure out how and where costs should be fairly and precisely allocated.
This complexity can make it difficult to implement among most smaller-sized businesses, or even those without any distinct accounting team.
Thus, it would require hiring specialized staff or consultants, which is expensive and time-consuming.
3. Requires Accurate Data
Obviously, of course, if cost accounting is to be of any value, the data collected must be correct and current. If a business inputs incorrect or incomplete information, the results will not reflect the true cost of production.
This can lead one into a series of poor decisions with regard to pricing, or it might incorrectly focus on products that aren't as profitable as they initially appear.
For example, if a firm estimates the costs of materials or labor lower than they are, then an underestimation may lead to overestimation of the amount of profit they are making.
Conversely, overestimating the cost could mean losing competitive pricing in time.
Maintaining accurate data will require constant vigil and high alertness to details, which can prove to be taxing for businesses whose production lines move very fast or whose costs change very often.
4. Doesn't Reflect External Market Influences
Cost accounting is based on internal costs of the business, thus disregarding changes in external market influences, which often have an impact on the prices and profitability.
For example, forces acting in the market such as competition, changes in demand, or changes in the markets are not reflected by the cost accounting report.
As an example, if a business was charging based on cost accounting for a product solely on production costs, it would face difficulty in selling its products although the price covers all its costs because its competitors were selling similar products at lower prices, and the demand of customers might have changed.
In that event, the complete picture of cost accounting would not have been used as it only considers cost from the point of view of the business and not the market.
5. Limited Scope for Long Term Planning
Cost accounting is very good at tracking current costs and assisting with short-term decisions but not in long-term planning.
Cost accounting is more historical data and current expenses, so often it doesn't add much insight to needed future projections or long-term strategy.
For example, a business may require expansion of its operations or introduction of new products in its range. Cost accounting may identify the cost of producing current products; however, no increase in material prices or change in labor market can be identified for the future period.
Thus, a business requires combining cost accounting with other financial planning tools to adequately prepare for long-term challenges.
6. Ignores Qualitative Factors
Cost accounting is strongly oriented to figures and tends to overlook various non-financial factors, which determine the success of a firm.
It fails to recognize the satisfaction of employees, reputation of brand, loyalty of customers, and quality of products and services.
Suppose a company is undertaking cost-cutting in order to enhance profits.
Cost accounting will show that this is a step in the right direction from the financial perspective, but it will not account for how much employee morale or customer satisfaction could be detractions due to employees likely receiving lower wages or use of more inferior materials.
These are qualitative variables important to firm health and don't show up on the cost accounting worksheets.
7. Overemphasis on Cost Reduction
Since cost accounting is keenly interested in tracking and reducing costs, it could lead business operations to be overly concerned with expense cuts at the expense of the big picture.
Cost reduction indeed is vital, but it need not always be done at the expense of product quality or customer satisfaction.
For instance, it may adopt lowest-cost materials for lower manufacturing costs that might appear pretty well in the cost accounting statements.
However, quality of the product suffers there by and customer complaints, return products or loss sales occur where business is actually damaged much more than benefited by such a step.
Cost accounting is not usually balanced with both cost-cutting and also quality preservation.
8. Not Suitable for All Businesses
This form of accounting is not practical for every type of business. It is most advantageous for companies that manufacture because the cost is directly related to the production process, and it's easier to track and measure.
Companies dealing with services have a rather complicated cost structure, and it is more difficult to apply traditional forms of cost accounting.
For instance, in a consulting firm, the "product" is expertise and time, not tangible objects and hence much harder to quantify.
This makes the value of cost accounting less observable within these industries or forces the need to alter it to suit the business model.
Conclusion
Cost accounting is one of the essential business tools because it allows firms to follow expenses, set prices for their merchandise, and take decisions.
Like all tools, it has weaknesses. It can be very time-consuming, complex, and dependent on the inputs being entered accurately. To top it off, it still fails to consider external market factors and qualitative considerations.
Additionally, one cannot be certain that it can be the best tool for long-term planning.
Understanding such limitations makes business concerns aware of when and how they can effectively use cost accounting.
Although it is an actual treasure trove of information, combining cost accounting with other financial tools and business strategies would help get the complete picture about a company's health.
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