This exercise continues the discussion from pages 396-397 (Cost accounting and cost objects: definitions) of the textbook and provides another example to help you appreciate what cost accounting involves, how it works and how you are dealing with cost accounting data on a daily basis.

If you worked out your expected income and what you expected to spend during your first year at university, you have already undertaken a cost accounting exercise: you established a budget to enable you to determine when you might need additional income to meet your spending plans or you will have reduced your planned expenditure to stay within your expected level of income. Comparing what you have actually spent with what you expected to spend will enable you to modify your income and expenditure plans to enable you to keep within your budget or to find ways in which to earn extra income to meet those plans.

In the same way, businesses use budgeting to model how they expect money to flow into and out of the business, to identify cash shortfalls or surpluses. They can then plan to borrow money from their bank or to invest surplus cash to earn interest for the organisation. At the simplest level of planning, organisations will calculate the expected costs of making or buying a product and the expected income from selling that product to other parties. Comparisons will be made between budgeted and actual outcomes to enable the organisation to plan more effectively in the future and to provide more relevant information to management about how the organisation is performing and how it is expected to perform.

Cost accounting thus presents information to parties internal to the business and aims to provide data that is relevant to making business decisions now and in the future. The starting point of this information is not a summary of all transactions but a detailed analysis of individual cost components of products and services with a view to determining selling prices for those products and services. This detailed information can then be used to plan what the business will do and what decisions it will make to enable it to operate profitably in the future. For planning and control purposes, this detailed information will be summarized into budgets for a particular period of time and these budgets will be used to compare actual performance with budgeted performance as a way of controlling the operations of the business. Costing and its use in making decisions and how costing information is used in budgeting and planning will form the basis of the next five chapters of this book and of the exercises and presentations in the workbook.