COST & MANAGEMENT ACCOUNTING

COST & MANAGEMENT ACCOUNTING
Prof. Ranjan Kumar Bal UTKAL UNIVERSITY

COST & MANAGEMENT ACCOUNTING (COMA)
Provides information to managers for planning, controlling & decision making. The controller : The Chief Management Accountant “The Controller is compared to a ship’s navigator, with the President (CEO) being the ship’s captain.”

ROLE OF THE ACCOUNTANT ATTENTION DIRECTING PROBLEM SOLVING
TO MANAGE INFORMATION An Information Technologist SCORE – KEEPING ATTENTION DIRECTING PROBLEM SOLVING

CUSTOMER – DRIVEN FOCUS IN MANAGEMENT ACCOUNTING SYSTEM
VISION STATEMENT OF MANAGEMENT ACCOUNTING GROUP AT JOHNSON & JOHNSON Delight our customers. Develop alternative measurement system. Keep it simple. Utilize 20% of time on Accounting & 80% on analysis. Be the best.

ABILITIES & SKILLS for Management Accountants – A Survey
Communication (oral, written & presentation) skills Ability to work on a team Analytical / problem-solving skills Solid understanding of accounting Understanding of how a business functions. Computer skills

THE MANAGEMENT ACCOUNTANT AND STRATEGIC DECISIONS
The management accountant helps to formulate strategy by answering questions such as : Who are our most important customers ? How sensitive are their purchases to prices, quality, and service ? Who are our most important suppliers ? What substitute products exist in the market place, and how do they differ from our product? Is the industry demand growing or shrinking ? Is there overcapacity ?

IMPORTANCE OF COMA Facilitates decision making.
Helps in achieving the main objective of the organization Identifies unprofitable activities. Improves efficiency/Facilitates cost control. Helps in planning & preparation of budgets. Helps in inventory control. Facilitates decision making.

COMA Vs. FINANCIAL ACCOUNTING Similarities
Both are branches of Accounting. Are concerned with systematic recording and presentation of financial data. Both follow same principles of Dr. and Cr. Both have the same source of recording transactions. Both have the common goal of assisting the organization they serve. Both are complementary to each other.

COMA Vs. FINANCIAL ACCOUNTING : Differences
Purpose Periodicity of reporting Customers served Audit Accounts prepared Tax assessment Actual and standard Profit and Loss Monetary and Non-monetary Relative efficiency Constrained by GAAP

COST AND MANAGEMENT INFORMATION SYSTEM
COST ACCOUNTING INFORMATION SYSTEM OPERATIONAL CONTROL SYSTEM OBJECTIVES OF CMIS: To provide information for costing out services, products and other objects of interest to management. To provide information for decision making. To provide information for planning and control.

COST MANAGEMENT Identifies, collects, measures, classifies, & reports information Useful to managers in costing, planning, controlling, & decision making. Cost Accounting : Evolving into Cost Mgt. It is associated with Mgt. Accounting

THE VALUE CHAIN OF THE BUSINESS FUNCTION
R&D Design Production Marketing Distribution Customer service Accounting helps managers: To administer each of the business functions. To coordinate the functions of value chain.

ENHANCING THE VALUE OF COMA SYSTEM
Customer Focus Value Chain & Supply Chain Analysis Key Success Factors –Cost & efficiency, Quality, Time, Innovation, etc (Distinct or Extinct) Continuous Improvement (Kaizen) & Benchmarking

“We are running harder just to stand still
“We are running harder just to stand still.” “If you’re not going forward, you are going backward.”

QUESTIONS “Management Accounting should not fit the straightjacket of Financial Accounting.” Explain. A leading management observer stated, “The most successful companies are those that have an obsession for their customers.” Is this statement pertinent to management accountants? Explain.

Change is the only constant in today’s world.

MANAGEMENT AND COMA Provides adequate, timely and reliable information. Helps management in managing and controlling costs. Provides cost-benefit approach for resource allocation. Helps in decision making: Pricing Product-mix Profit-volume decisions Helps: Formulation & execution of budgets & standards. Helps in making special studies and investigations. “ Without proper cost and management accounting, decision would be like taking a jump in the dark.”

COST TERMINOLOGY Cost : Resources sacrificed or
Amount of expenditure incurred Costing : Process of cost accumulation & cost assignment Cost Object : Anything for which a measurement of cost is desired. Cost Accumulation : Collection of cost data in some organized way. Cost Assignment : Cost Tracing & Cost Allocation. Cost Tracing : Assigning direct cost. Cost Allocation : Assigning indirect costs. Cost Driver : A variable that causally affects / influences costs over a given time span

COST CLASSIFICATION WHY ? To Achieve a Purpose / Objective
Control, Decision Making To Facilitate Communication / Reporting

COST CLASSIFICATION Behaviour Elements Control Decision Making
Functions Nature

ELEMENTS OF COST MATERIAL : Direct Vs. Indirect
LABOUR : Direct Vs. Indirect EXPENSES : Direct Vs. Indirect Direct cost of a cost object : Traced in an economically feasible (cost effective) way.

OVERHEADS Manufacturing or Factory Office & Administration
Selling & Distribution

OTHER CONCEPTS OF COST Fixed, Variable & Semi-variable
Controllable & Uncontrollable Relevant & Irrelevant Incremental & Decremental Shutdown & Sunk cost Traceable & Untraceable Joint cost & Conversion cost

RELATIONSHIP OF COSTS Direct & Variable Direct & Fixed
Indirect & Variable Indirect & Fixed

METHODS & TECHNIQUES METHODS - Job Costing - Process Costing TECHNIQUES - Marginal Vs. Absorption Costing - Standard Vs. Historical Costing

COST ACCOUNTING OBJECTIVES : To determine product costs
To facilitate planning & control To supply information for decision making “IN GOD WE TRUST, EVERYBODY ELSE BRINGS DATA TO THE TABLE.” INFOSYS

COST ESTIMATION Statement of Cost : For each cost object or cost centre. Different Columns : Total cost / Cost per unit / Previous period costs / Budgeted costs / Variable & Fixed costs …….. Sources of Data : F.A. & C.A. Time Period : A month or week

WHY A COST SHEET ? Fixing selling price Submitting quotations
Planning & control of cost To know relative efficiency of products Decision making

STATEMENT OF COST COST SHEET Prime Costs or Direct Costs
DM + DL + DE = PC Production or Works or Factory Costs PC + P. OH. = FC Office Costs or Cost of Production* FC + O. OH. = COP Total Cost or Cost of Sales COP + S. OH. = TC *Assumption : Office & Admn. Overheads relate to production.

TREATMENT OF STOCK WIP Finished Goods Raw Material
Treatment of the amount realized from the sale of scraps / wastes ?

ITEMS NOT AFFECTING COST SHEET
Income Tax Dividends to Share Holders Interest on Loans Capital Loss Donations Capital Expenditure Discount on Shares & Debentures Underwriting Commission Writing off Goodwill Commission to MD

ESTIMATED COST SHEET Preparation : - Prepare a “Cost Sheet”
Considers all probable changes in cost Preparation : - Prepare a “Cost Sheet” - Establish relationship - Estimate OH costs - Prepare “Estimated Cost Sheet”

CASE The following information are obtained from the records of AB cycles for the month of August: Direct materials : Rs. 19, 80, 000 Direct labour : 18, 00, 000 Factory overheads : 5, 80, 000 Administrative overheads : 3, 90, 000 Outputs for the month : 2,000 cycles. What price the company should quote for an order of 100 cycles? Note: Factory overheads are absorbed on the basis of direct labour and administrative overheads on the basis of works cost.

THE FOLLOWING DATA RELATE TO A COMPANY:
Expected sales : 50,000 units Direct material cost : Rs per unit Direct labour cost : Rs per unit Variable Overhead : Rs.1.50 per unit Fixed cost : Rs per unit Selling price : Rs.10 per unit The firm expects to get a special export order for 10,000 units at a price of Rs per unit. Advise whether the export order should be accepted or not. The company has a capacity to produce 60,000 units.

INFERENCES: An organization has different costs having different nature. Example: Fixed, Variable, Mixed Cost These costs behave differently to changes in the level of business activity. Understanding this relationship helps in planning, control and developing successful business strategies.

Cost of a product / process can be ascertained by :
1. Absorption costing 2. Marginal costing ABSORPTION COSTING Traditional or full cost method : Cost of a product = V. C. + F. C. Variable costs are directly charged to the product. Fixed costs are apportioned on suitable basis. DISADVANTAGES: It assumes that prices are simply a function of costs. It includes past costs which may not be relevant to the pricing decision at hand.

MARGINAL COSTING Meaning : - Direct Costing / Variable Costing
- A Technique of Costing Meaning : Ascertainment of marginal cost by differentiating between F.C. and V.C. and of the effect on profit of changes in volume or type of output. Cost of a product : Only VCs are considered : Product cost FCs : Charged against the revenue of the period FC = Period costs Valuation of inventory at M.C. Contribution = C = S - V = F + P Price = M.C. + Contribution

MARGINAL COST Economists : The cost of producing one additional unit of output is the marginal cost of production. Include an element of FC Accountants : MC is equal to the increase in total VC.

SEGREGATION OF SEMI-VARIABLE COSTS
Levels of output compared to levels of expenditure Method : The variable element in semi- vc = Change in amt. of exp. Change in activity/qnty. High-low method (Range Method) : Similar to the previous method Methods of least squares Y = a + bx, where Y = Semi-VC, a = FC, b = VC, x = Production in units

ABSORPTION COSTING Vs. MARGINAL COSTING
1. Recovery of F.OH. Abs. Costing : Both F. OH. and V. OH. are charged to production Mar. Costing : Only V. OH. is charged to production and F.OH. transferred to P. & L. A/C. 2. Valuation of Closing Stock Abs. Costing : WIP at works cost and F. goods at cost of production. Mar. Costing : WIP and F. Goods -- Only VCs are considered. 3. Profit Vs. Opening and Closing Stock

UTILITY OF MARGINAL COSTING
Helps in determining the volume of production. Helps in selecting production lines. Helps in deciding whether to shutdown or continue.

MARGINAL COSTING Vs. ABSORPTION COSTING
The following information relates to ABC Company for the year : Sales 10,000 units at Rs. 5 each; Production 15,000 units at the following costs: Rs. Direct materials 15,000 Direct labour 30,000 Variable expenses 6,000 Fixed expenses 12,000 Determine net profit.

Income Statement for the year 2011-12
Sales , ,000 Marginal Absorption costing Rs. Costing Rs. Cost of Production: Direct materials , ,000 Direct labour , ,000 Variable overhead , ,000 Fixed overhead _ ,000 51, ,000 Less Closing Stock , ,000

Valuation of closing stock: Marginal costing = (5000/15,000) x 51,000
Cost of goods sold 34, ,000 Contribution (50, ,000) 16,000 4,000 Net profit ,000 Valuation of closing stock: Marginal costing = (5000/15,000) x 51,000 = Rs. 17,000 Absorption costing = (5000/15,000) x 63,000 = Rs. 21,000 Note: Difference in profit is due to the difference in stock valuation. Less Fixed Overhead ,000

comparative income statement for three years under
CASE From the following cost, production and sales data of AB Motors Ltd., prepare comparative income statement for three years under (i) Absorption costing method, and (ii) Marginal costing method. Indicate the unit cost for each year under each method. Also evaluate closing stocks. The company produces a single article for sale. PARTICULARS YEARS Rs Rs Rs. Selling price per unit Variable Mfg. Cost per unit Total fixed manufacturing cost Opening stock Units produced Units sold Closing stock

BEP - Represents a minimum acceptable level of operation
BREAK-EVEN ANALYSIS Narrow Sense : Determination of that level of activity where total cost equals selling price. Broad Sense : The system of analysis which determines the probable profit at any level of activity. Refers to Cost-Volume-Profit Analysis BEP - Represents a minimum acceptable level of operation - Level of activity : Income equals Expenditure - No profit no loss point

Or, Units at BEP x Contribution per unit = F
C = S - V = F + P At BEP, P = 0; Thus, C = F Or, Units at BEP x Contribution per unit = F Or, BEP(units) = F / Contribution per unit BEP (sales) = (F / Cont. per unit) x S.P. per unit = (F/C) x S = F/c/s = F / p/v ratio

Contribution Margin Ratio =
P/V ratio = Contribution / Sales = C / S = Change in Profit / Change in Sales MOS = Total Sales – BEP

BREAKEVEN ANALYSIS FOR MULTIPLE PRODUCTS
A multi products Company has a sales ratio of 2: 3: 5 for models X, Y and Z respectively. Total fixed cost for the year are Rs. 2,00,000. The other information are as follows: Model X Model Y Model Z Sales Price Rs. 50 Rs Rs. 10 Variable Costs Rs. 30 Rs Rs. 8 Contribution Margin Rs Rs Rs. 2 WHAT IS IT’S BEP ?

BREAKEVEN ANALYSIS FOR MULTIPLE PRODUCTS
A market basket approach is used to compute the breakeven point in units. The average market basket is based on the sales ratio and consists of 10 units with a total contribution of Rs. 80 = { (2 x Rs. 20) + (3 x Rs.10) + (5 x Rs.2) } BEP in market baskets = FC / Contribution of one baskets = Rs.200,000 / Rs.80 = 2,500 baskets. To fill 2,500 baskets : The following units for each model. Model X : 5000 units ( 2,500 x 2) Model Y : 7500 units (2,500 x 3) Model Z : units (2,500 x 5)

COST –VOLUME – PROFIT ANALYSIS
Examines the behaviour of total revenues, total costs and operating income : As changes occur in the output level, the selling price, the variable cost per unit, and / or the fixed costs of a product. One of the decision models One aspect of CVP Analysis : BEP Analysis A useful technique for planning profits (budgeting), pricing decisions, sales-mix decisions and production capacity decisions.

CVP Analysis evaluates the effects of:
Price changes on Net Profit (NP) Volume changes on NP Price and volume changes on NP Changes in VC on NP Changes in FC on NP All four factors, viz., price, volume, VC and FC on NP.

Sensitivity Analysis & Uncertainty
A “what-if” technique Analyze the sensitivity of their decisions to changes in underlying assumptions. Managers use this technique to examine - How a result will change : If the original predicted data are not achieved or if an underlying assumption changes.

C-V-P ANALYSIS INCOME TAX I.T. : No effect on BEP S – VC – FC = Op. Income =Target Net Income / (1-T) Desired Sales in Units = ? Desired Sales in Rupees = ?

DO-ALL SOFTWARE SP = Rs.2,000 per unit VC = Rs.1,200 per unit
FC = Rs.20,000 The organisation anticipates selling 40 units. Decision to Advertise Proposed Advertisement = Rs.5,000 Effect : Increase in Sales by 10% DECISION ?

2. Decision to reduce S. P. Proposal : Reduce SP to Rs
2. Decision to reduce S.P. Proposal : Reduce SP to Rs.1,750 Effect : Increase in Sales by 10 units Purchase from Whole-seller at Rs.1,150 per unit. DECISION ?

RELEVANT COSTS & REVENUES
Expected future costs Expected future revenues Differ among the alternative courses of action Insourcing or Outsourcing products or services. Accepting or Rejecting special order. Shutdown or Continue. Qualitative & Quantitative Relevant Information

COST ALLOCATION / APPORTIONMENT
An inescapable problem in every organization. How should the costs of service departments be allocated among production departments ? How should the manufacturing overhead be allocated to individual products in a multi-product company ? The answers are seldom clearly right or clearly wrong.

PURPOSES OF COST ALLOCATION
To provide information for economic decision : Pricing decisions; Make or buy decisions. To motivate managers and employees : To push high margin products or services To justify costs or compute reimbursement : Reimbursement for a consulting firm that is paid a percentage of the cost savings To measure incomes and assets for external reporting : valuation of inventory

SURVEY OF COMPANY PRACTICE Why allocate corporate and other support costs to divisions and departments ? U. S. A. To remind profit-center managers that indirect costs exist and that profit-center earnings must be adequate to cover those costs. To encourage use of central services. To stimulate profit-center managers to control service costs U. K. To acknowledge that divisions would incur such costs if they were not provided centrally. To make division managers aware that central costs exist. To stimulate divisional managers to put pressure on central support managers to control costs. To stimulate divisional managers to economize in usage of central services.

CRITERIA FOR COST ALLOCATION DECISION
CAUSE AND EFFECT: Rent- Floor area occupied BENEFITS RECEIVED: FAIRNESS OR EQUITY: Government contracting ABILITY TO BEAR: Corporate executives salaries on the basis of divisional operating income.

COST POOL POSSIBLE ALLOCATION BASE
Corporate executive Sales; Assets employed; salaries : Operating income Legal Department : Estimated time or usage; Sales; Assets Marketing Department : Sales; No. of sales personnel Payroll Department : No. of employees; Payroll Rupees Personnel Department : No. of employees; Payroll Rupees

ACCOUNTING AND CONTROL OF OH COSTS
Classification Codification Collection Allocation and apportionment to cost centers Absorption in costs of products, services etc.

WHY TO CLASSIFY? Effective cost control : Flexible Budgets Absorption of cost Decision Making : CVP Analysis CODIFICATION Numeral method : Numbers Mnemonic Method : Symbols / Letters Mixed

COLLECTION OF MANUFACTURING OHs
Material Issue Analysis Sheet / Material Abstract Wages Analysis Sheet Cash Book Subsidiary Records Plant Register : Depreciation Asset Register : Depreciation Journal : Outstanding expenses

DISTRIBUTION OF OVERHEAD COSTS
Primary Distribution: Departmentalization of overhead to Production and service departments. Secondary Distribution: Re-distribution of service departments costs among production departments. Re-apportionment Final Distribution: Absorption Overhead costs of production departments are distributed among the units produced.

“CHALLENGE YOUR CURRENT PRACTICES AND ENHANCE YOUR HORIZON” IIMB

ACTIVITY BASED COSTING
REFINING A COSTING SYSTEM: WHY? Intense competition Advances in IT

ABC system Calculates the costs of individual activities:
Assign costs to cost objects such as products and services On the basis of the activities needed to produce each product or service.

A SIMPLE COSTING SYSTEM:
A single indirect cost rate to allocate cost to products Weak cause-and-effect relationship Cost Smoothing : Under-costing & Over-costing Product cost cross-subsidization

ABC : BENEFITS Obtaining true product cost Cost Management
Better decision making

PROCESS : ABC Direct cost tracing Indirect-cost pools
Cost-allocation bases

IMPLEMENTING ABC: Steps
Identify the Products : Cost Objects Identify Direct Cost of the products Select the Cost Allocation Bases : For allocating indirect costs to the products Identify the Indirect Costs : Associated with each cost-allocation base. Compute the Rate per unit of each cost- allocation base : Used to allocate indirect costs to the products Compute the Total Indirect Costs allocated to the products Compute the Total Costs of the products : Adding all direct and indirect costs assigned to the product

PLASTIM CORPORATION Manufactures lenses for the rear lamps (tail lights) of automobiles Contract with G Motors : To supply CL5, a complex lens ($137 per lens) S3, a simple lens ($63 per lens) Operating at full capacity & incurs very low marketing costs. Minimal customer-service costs. Business Environment : Very competitive with respect to S3.

Process : Plastim Corporation
Design products and processes Manufacturing operations Shipping and distribution G. Motor’s purchasing manager : A new competitor offering to supply the S3 lens at a price of $53. Plastim’s management is worried.

Options for Plastim: Give up G. Motor’s business. Reduce cost.
Lower its selling price. Give up G. Motor’s business. Reduce cost.

Existing Costing System
60, ,000 S3 CL5 Total($) Per Unit($) Total($) Per Unit($) Direct Material , , Direct labour , , Total Direct Cost , , Indirect cost Allocated , , Total Cost , , Actual indirect Actual total cost in indirect cost pool cost rate = Actual total quantity of cost allocation base = 2385,000 / 39750(Labour Hours) = $60 per Labour hour S3 : Uses 30,000 labour hours = $1800,000 CL5 : Uses 9,750 labour hours = $585,000

Possible Reasons : Plastims technology and process are inefficient in manufacturing and distributing S3 lens. Ineffective cost management. Is costing system over-costing the S3 lens ?

SEVEN ACTIVITIES OF PLASTIM
Design products and processes : $ 450,000 Set up of molding machines : $ 300,000 Manufacturing operations : $ 637,500 Cleaning and Maintenance : $ 270,000 Shipment set up : $ 81,000 Distribution : $ 391,500 Administration : $ 255,000

Guidelines for refining the costing system :
Direct Cost Tracing To identify some costs or cost pools that can be reclassified as direct costs instead of indirect costs (improves cost accuracy) Example: Cleaning and maintenance activity Indirect Cost Pools To create smaller cost pools linked to the different activities: Plastim : Subdivides- One direct activity cost pool & Six indirect activity cost pool Cost Allocation Bases A measure of activity performed serves as the cost allocation base for each activity-cost pool

Activity – Cost Rates for Indirect–Cost pools
Activity Total Cost-allocation OH allocation Cost Base Rate Design $ 450, parts- $ 500 per part- square feet square foot Setups of $ 300, $ 150 per setup- Molding Setup-hours hour Machines Manufacturing $ 637, ,750 operations Molding $ 50 per molding machine hours machine-hour Shipment $ 81, $ 405 per shipment Setup Distribution $ 391,500 67,500 $ 5.80 per cubic Cubic feet foot shipped Administration $ 255, ,750 $ per Direct manuf Direct manuf. Labour hours labour –hour

Product Cost using ABC Direct Costs : S3(60000) CL5(15,000)
Total($) Per unit($) Total($) Per unit Direct Costs : Direct Materials1125, , Direct Labour , , Direct Mold Cleaning120, , Total Direct Costs1,845, ,020,

Indirect Costs : Design activity costs:
S3, 30 parts-sq.ft.*$4, , CL5, 70 parts-sq.ft.*$4, , Setup activity costs: S3, 500 setup-hours*$ , CL5, 1,500 setuphours*$ , Manufacturing operations Activity costs: S3,9,000 moulding Machine hours*$ , CL5,3,750 moulding Machine hours* $ ,

Shipping setup activity:
S3, 100 shipments*$ , CL5, 100 shipments*$ , Distribution activity: S3,45,000 cubic feet Shipped*$ , CL5, 22,500 cubic feet shipped*$ , Administration activity: S3,30,000 dir. Manuf. Labour-hours*$ , CL5,9,750 Dir. Manu. Labor-hours*$ , Total indirect costs: 1,153, , Total Costs $ 2,998, $ $1,981, $132.07

WHO SAID THESE WORDS ? A manager’s job is to pursue the interests of society. Customer is the only valid reason for the existence of a business. Entrepreneurship and innovation are not inborn characteristics. Management is neither an art nor a science, but a practice.

PETER F. DRUCKER Father of Modern Management.
The most enduring Management Thinker of our Time : Business Week Born in Austria:1909; Died in Los Angeles:2005 Studied Law in Germany at Hamburg University Received Ph.D. from Frankfurt University in International Law. Moved to London & Taught Economics. Married Doris & Moved to America as a Correspondent for several British Newspapers. Professor of Management at New York University.

“Without proper cost and management accounting, decision would be like taking a jump in the dark.”

COST ACCOUNTING SYSTEM
Determines per unit cost. Helps management in planning and controlling costs. Provides information for decision making Used to develop timely information about: Cost of producing specific products. - Cost of performing specific functions / services.

CAS Most widely used in manufacturing companies Also used in services sector: Banks Accounting firms IT sector Govt. agencies US congress has passed legislation requiring hospitals to measure and report the average unit cost of their “product”.

Why to find unit cost? Basis for inventory valuation.
Measurement of cost of goods sold. Useful in fixing selling prices. Deciding : Products to manufacture. Evaluating the efficiency of operations Controlling costs.

DESIGNING COSTING SYSTEM
Cost-benefit Approach Tailored to fit the operations/functions Facilitate decision making Costing System : Only one source of information for Managers – combine non-cost information & non-financial performance measures

BUILDING-BLOCK CONCEPTS
Cost Object Direct Costs of a Cost Object Indirect Costs of a Cost Object Cost Tracing Cost Allocation Cost Pool & Cost Allocation Base

CAS DELL COMPUTER WIPRO Will they have same CAS ?

Two basic types of CA system:
Two extremes of product costing : JOB ORDER COST SYSTEM PROCESS COST SYSTEM

JOB ORDER COST SYSTEM Used by companies:
Producing “one-of-a-kind” products Tailor products to the specifications of individual customers

APPLICATIONS Ship / Aircraft Building, Printing,
Defense Contractors, Hospitals, Motion Picture Studios, Furniture Makers, Accounting Firms, Advertising Industries, Consultancy Firms, Construction Firms.

JOB Represents the goods manufactured at one time to fill a particular order Unique Feature : Cost are accumulated separately for each job. JOB COST SHEET : JOB-COST RECORD Heart of JOCS

JOB COSTING A method of ascertaining cost.
Also known as “Specific Order Costing” . Production : Always against customers orders and not for stock. Each Job : Different characteristics and needs special treatment. Each job undertaken : A cost unit or cost object. A separate job cost sheet : To ascertain profit or loss for each job . No uniformity in the flow of production from one department to another in respect of jobs.

GENERAL APPROACH TO J.C. Identify the Job : Cost Object
Identify the Direct Costs of the Job Select Cost-Allocation Bases Identify the Indirect Costs Compute the Rate per Unit of Base Compute the Indirect Costs allocated Compute Total Cost of the Job

ACTUAL COSTING Vs. NORMAL COSTING
Direct Cost : Actual Rates Actual Rates Indirect Cost : Actual Rates Budgeted Rates Both Methods Use : Actual Quantities of Inputs for Tracing Direct costs Actual Quantities of Allocation Bases for Allocating Indirect Costs Some organizations use budgeted rates to assign both direct costs & indirect costs, to jobs.

JOB COST SHEET Job Number Product Date Started Date Completed Number of units DIRECT MATERIAL Date Requisition Number Quantity Unit Price Cost DIRECT LABOUR Date Time Card Number Hours Rate Cost MANUFACTURING OVERHEAD Date Activity Base Application Rate Cost

COST SUMMARY Cost Item Total Cost Unit Cost Total Direct Material used Total Direct Labour Manufacturing Overhead applied Cost of Finished Goods manufactured “Job costing is a compromise between actual costing and standard costing.”

ACCOUNTING : Job Costing
ACCOUNTING FOR DIRECT MATERIALS End of each week or month : Summary entry WIP Inventory Rs. 50,000 Materials Inventory Rs. 50,000 ACCOUNTING FOR DIRECT LABOUR End of each month or week WIP Inventory Rs.20,000 Direct labour Rs. 20,000 ACCOUNTING FOR ‘OH’ COSTS End of each week or month: WIP Inventory Rs. 10,000 Manufacturing overhead Rs. 10,000 ACCOUNTING FOR COMPLETED JOB Finished goods Inventory Rs. 80,000 WIP Inventory Rs. 80,000 ABC Furniture (S. Drs.) Rs. 100,000 Sales Rs 1,00,000 Cost of goods sold Rs 80,000 Finished goods Inventory Rs. 80,000

CONTRACT COSTING AS – 7 : Construction Contracts
One type of specific order costing Used in civil engineering works Each contract : Separate accounts for each contract AS – 7 : Construction Contracts Fixed Price Contracts Cost Plus Contracts

COSTS Materials Labour Direct Expenses Indirect Expenses
Plant and machinery : Depreciation

WIP : Presented in the Balance Sheet
Balance Sheet as at….. Assets Amount Work in progress : Value of work certified Cost of work uncertified Less Reserve for unrealized profit Less Amount Received from contractee

Profit on Incomplete Contracts:
Work Completed : Less than 1/4th : No profit Work Certified : More than 1/4th but less than half : Profit = 1/3 x Notional Profit x (Cash Received / Work Certified) Work Certified : Half or more than half : Profit = 2/3 x Notional Profit x (Cash Received / Work Certified) Contract is almost complete : Profit = Estimated Profit x (Work Certified / Contract Price) or, Estimated Profit x (Cash Received / Contract Price)

PHARMACEUTICAL INDUSTRY
Multi-Products Production in batches Identical products in a batch Use Process Costing

PROCESS COSTING A method of costing
Costing of process : Converting raw materials into finished products. Find Out : Cost of operating each process.

APPLICATIONS Manufacturing Industries : Iron and Steel, Cement, Textiles, Soap Making, Biscuits, Food Products Mining Industries : Oil, Coal Chemical Industries : Drugs & Medicines Public Utility Services : Electricity, Water Supply

CHARACTERISTICS : Process Costing
Production : Continuous Products : Processed in one or more processes. Products: Homogeneous, Identical and Standardized. The Finished Product of one process : Raw Material of the next process. Costs : Collected process-wise. Unavoidable wastage : Generally arises at different stages. Different products with or without by-products : Simultaneously produced.

JOB COSTING VS. PROCESS COSTING
Job costing: Production is by specific orders. Process costing: Products are homogeneous. Costs are determined by jobs or batches. Costs are complied on time basis. Each job is separate and independent. Products lose their identity : continuous flow. There may or may not be any WIP. There is WIP as production is continuous. There is normally no transfers from one job to another. Products move from one process to another. Control is difficult. More managerial attention is required. Proper control is comparatively easier. Unit cost of a job is calculated. Unit cost of a process is calculated.

AUSTRALIA : COSTING SYSTEM
Textiles % Chemicals % Refining Printing Process 91 75 100 20 Job 18 25 73 Other 12 13

Normal Loss Abnormal Loss Abnormal Gain
Inherent in the processing operation; Unavoidable. Cost of Normal Loss : Absorbed by good units produced. Abnormal Loss Caused by unexpected or abnormal conditions viz., carelessness, accident, bad plant design Value of Abnormal Loss =( Normal cost of Normal output / Normal output) x Units of Abnormal Loss Abnormal Gain Actual Loss < Expected Calculation : Similar to Abnormal Loss.

Joint Products or Co-products
Represent two or more products, Separated in the course of the same processing operation, Usually requiring further processing. Example : Oil Industry: Gasoline, Fuel Oil, Lubricants, Kerosene. By- product Recovered from materials discarded in a main process or from the production of some major products.

WHY ALLOCATE JOINT COSTS?
Computation of cost of goods sold, Cost reimbursement under contracts, Insurance-settlement computations.

APPROACHES FOR ALLOCATING JOINT COSTS
Using market based data : Revenue Using physical measures : Weight

INTER PROCESS PROFIT Out put of one process is transferred to a subsequent process at a price. WHY ? To show cost of production in relation to the market price. To make each process stand on its own efficiency and economies. To induce competition amongst different processes : Leads to cost control.

BALANCE SHEET: ADJUSTMENTS
Adjust : The closing balance of inventories as it includes unearned profit. Create : A provision to reduce the stock to actual cost price.

EQUIVALENT FULL UNITS OR EQUIVALENT PRODUCTION
EP : Production of a process in terms of completed units WIP : Creates problem to find out cost per unit. To overcome this problem : Express the partially completed units in equivalent full units of completed product. Material Cost per unit = Total cost of direct materials used / Equivalent full units produced

Work done by a Manufacturing Department :
Completing opening WIP units. Working on units started and completed. Working on closing WIP units.

STATEMENT OF EQUIVALENT PRODUCTION
Units Portion Equivalent completed full in July units Opening WIP : (60% completed in June) 5, % 2,000 Unit s started & Completed : 37, % 37,000 Total units completed : 42,000 Closing WIP : (25% completed) 4,000 ` 25% 1,000 Total Equivalent Units : ,000

STATEMENT OF EQUIVALENT PRODUCTION
Estimate : The percentage of completion of opening WIP State : Opening WIP in equivalent completed units ( Apply the % work required to complete) Units completed during the period : Units representing opening WIP Units introduced and completed Closing WIP : State in equivalent completed units (apply the % work done) Normal Loss : Not taken for calculation of EP Abnormal Loss & Abnormal Gain : Treated like “units finished and transferred to next process”.

HMT Five Divisions : Machine Tools; Tractors; Industrial Machinery;
Engineering and Components; Consumer Products .

SEGMENT PERFORMANCE ANALYSIS
AS- 17 : SEGMENT Business Segment Geographical Segment Segment : A distinguishable component of an organization: Engaged in providing products and services Subject to risks and returns that different from other segments.

SEGMENT / DIVISION A sub-unit Headed by a man fully responsible for its operation. A Responsibility Center A Decision Unit

WHY DIVISIONALIZATION?
Decentralization Measurement & evaluation of performance Training ground for top mgt. personnel Planning and allocation of resources. Controlling operations

RESPONSIBILITY ACCOUNTING
--A Control Device “R. A. collects and reports planned and actual accounting information about the input and output of responsibility centers.”

Process of R.A. Prepare : Performance Reports.
Identify : Responsibility Centers (Decision Units). Define : Extent of Responsibility for each R.C. Specify : Controllable and Uncontrollable Activities at Various Levels of Responsibility. Accounting system: To Accumulate Information of R. C. Prepare : Performance Reports.

Why responsibility Centers?
Defines the corporate objectives and goals of R.C. Determines the contribution of a R. C. Provides a basis for evaluation. Motivates the managers. Provides a system of closer control. Helps “Management by exception”. Facilitates decentralization. Sets realistic plans and budgets for R.C.. Creates a sense of cost consciousness.

Requirements of effective R. A.
A sound organization structure. Dividing the organization into RCs. Accurate and acceptable budgets. Top management support. Healthy organizational environment

COST CENTRE REVENUE CENTRE
Manager : Accountable only for costs incurred. Output of cost center : Not measured in monetary terms. Evaluation : Actual cost vs. Budgeted cost Employed in : Legal Dept, Accounting Dept, Public Relation Dept, HR Dept. REVENUE CENTRE Manager : Accountable for revenues only. Evaluation : Actual Revenue Vs. Budgeted Revenue Employed in : Sales Dept., Product Centre.

PROFIT CENTRE INVESTMENT CENTRE
Manager : Held responsible for both costs (inputs) and revenues (outputs), i.e., profits Inputs & outputs :Capable of financial measurement. Measures effectiveness and efficiency and motivates managers. Employed in: Production Dept., production centers. INVESTMENT CENTRE Manager : Responsible for costs, revenues & investment in assets used. Evaluation : By profit and ROI A measure of overall performance, and facilitates comparison.

RESPONSIBILITY & CONTROLLABILITY
Controllability : Degree of influence that a specific manager has over costs, revenues, & related items for which he or she is responsible. Manager should avoid over-emphasizing controllability & fixing blames. R.A. is more far-reaching : Emphasis on human aspects R.A. focuses on information, knowledge & behaviour, not on control.

ASSIGNING REVENUE & COSTS TO SEGMENTS
Assigning revenue : Electronic Cash Register COSTS : Two Approaches Classify costs : Fixed & Variable Contribution Margin Approach Charge each segment : Traceable V.C. & Traceable F.C. Absorption Costing Approach

MEASUREMENT OF PERFORMANCE
ROI Approach : Popular Approach Accounting Rate of Return Pioneer : Du Pont Co. Return on Sales x Investment Turnover

EVA : A specific type of RI
RI Approach : Pioneer : General Electric Co. RI = Income – Minimum Return on Investment EVA : A specific type of RI = After-tax operating income – Weighted average cost of capital (Total Assets – Current Liability)

Return on Sales Income to Revenue (or Sales) Ratio A component of ROI
COMPARING PERFORMANCE MEASURES : ROI RI EVA ROS

DESIGNING ACCOUNTING-BASED PERFORMANCE MEASURE(PM)
Choose PM that align with Top Mgt.’s Financial Goals. Choose the Time Horizon of each PM Choose Definition of components in each PM Choose a Measurement Alternative for each PM Choose a Target Level Performance Choose the Timing of Feedback.

FINANCIAL PERFORMANCE MEASURES – A Survey
COMPANY COUNTRY PM Ford Motors US Income, ROS, ROI Guinness UK Income, RI, EVA Krones Germany Revenues, Income Mayne Nickless Australia ROI, ROS Mitsui Japan Revenues, Income Pirelli Italy Income, Cash-flow Swedish Match Sweden ROI

SIX SIGMA Pioneer: Motorola A Management Philosophy
Setting extremely high objectives Collecting data Analysing results Reduce defects in products & services

STANDARD COSTING AND VARIANCE ANALYSIS
Objective : Cost Control Accounting system : Historical Costing Standard Costing

A measure of desired performance.
Standard A measure of desired performance. A predetermined criterion for evaluating the actual performance

WHY STANDARDS ? Cost Control Pricing Decision Performance Appraisal
Cost Awareness Management by Objective

TYPES OF STANDARDS Ideal standards Expected standards Current standards Basic standards

PROCESS OF DEVELOPING STANDARDS
Varies from company to company : The standard committee Technical input Past experience Other inputs Coordination

Standard Costing A control device
Not a separate method of product costing Used with any method of product costing : Job or Process Costing Generally used in manufacturing concerns

Standard Costing involves :
Ascertainment of standard cost Measurement of actual cost Comparison Analysis of variance and taking appropriate action where desired

VARIANCES Favourable Variance & Unfavourable Variance
Controllable Variance & Uncontrollable Variance

Variances: Sales Variances Cost Variances Cost Variances:
Direct material cost variances Direct labour cost variances Overhead cost variances

DIRECT MATERIAL COST VARIANCES
1. Material Cost variance = Standard cost for actual output Actual cost of material used = Qs. Ps – Qa. Pa 2. Mat. Price var. = Qa (Ps – Pa) Mat. Quantity var. = Ps (Qs – Qa) = Usage Variance = Efficiency Variance 4. Mat. Mix var. = Ps (Smqa – Qa) = Standard Price (Revised standard mix – Actual mix) 5. Mat. Yield var. = Ps (Qs – Smqa) = Sub-usage variance = (Actual yield – Standard yield) x Standard cost per unit of output 1 = 2 + 3, 3 = 4 + 5 Note : Qs = Standard Quantity; Qa = Actual Quantity; Ps = Standard Price; Pa = Actual Price; Smqa = Standard Mix in Actual Quantity.

DIRECT LABOUR COST VARIANCE
1. Labour Cost var. = Standard cost of labour for actual output – Actual cost of labour = Hs.Rs – Ha.Ra 2. Labour Rate of Pay var. = Ha (Rs – Ra) 3. Labour Efficiency var.= Rs (Hs – Ha) 4. L. Mix or Gang Composition var.= Rs (Smha –Ha) 5. L. Net Efficiency var. = Rs (Hs – Smha) 6. Idle Time var.= No. of Hours Lost (Abnormal) x Rs 1 = 2 + 3, 3 = Note : Ha = Actual hours worked

VARIABLE OVERHEAD VARIANCES
Variable Overhead Cost Variance = St. V. OH – Ac. V. OH = AO . SRO – AO . ARO = SH . SVRH – AH . AVRH Variable Overhead Spending Variance = AH(SVRH – AVRH) Variable OH Efficiency Variance = SVRH(SH – AH)

FIXED OVERHEAD VARIANCES
Fixed Overhead Cost Variance = Standard Cost – Actual Cost = AO . SRO – AO . ARO = SH . SFRH – AH . AFRH Fixed Overhead Expenditure Var. = Budgeted Cost – Actual Cost = BO . SRO – AO . ARO = BH.SFRH - AH.AFRH Fixed Overhead Volume Variance = Standard Cost – Budgeted Cost = AO . SRO – BO . SRO = SRO (AO – BO) =SFRH (SH – BH)

SALES VARIANCES Sales Value Var. = Actual Value of Sales – Budgeted Value of Sales Sales Price Var. = Act. Quantity sold (AP – SP) Sales Volume Var. = SP(AQ – BQ) Sales Mix Var. = SP(AQ- Smqa)

POSSIBLE CAUSES OF COST VARIANCES
Mat. Price Var. : Changes in actual price, Failure to purchase anticipated quantity, Not taking cash discounts, Changes in freight cost Mat. Quantity Var. : Poor material handling, Inefficient machine operator, Pilferage, Waste, Labour Turnover. Lab. Efficiency Var. : Defective machine and equipment, Poor supervision, Inexperienced employee, Insufficient training, Poor working condition OH Volume Var. : Failure to use normal capacity, Lack of sales order, Machine break down, Defective materials, Labour troubles, Power failure OH Expenditure/Efficiency Var. = Same cause as Labour Efficiency Variance.

RESPONSIBILITY FOR COST VARIANCES
Variance Persons Responsible Mat. Price Variance : Purchase Agent or Purchase Manager Mat. Quantity Variance : Plant Supt. , Dept. Supervisors, Machine Operators, Quality Control Dept. Labour Rate of Pay Variance : Personnel Manager, Dept Supervisors, Plant Superintendent Labour Efficiency Variance : Plant Superintendent OH Expenditure Variance : Variable portion : Foremen or Supervisor; Fixed portion: Top Mgt. OH Volume Variance : Top Mgt.

Few businesses plan to fail, but many of those that flop, failed to plan.

BUDGETARY CONTROL BUDGETS AND PERFORMANCE REPORTS MANAGER Feedback
Managers plan & act using budgets PERFORMANCE OPERATING PROCESS Managers evaluate using a report that compares actual results with budgets

STRATEGY AND PLANS LONG-RUN PLANNING LONG-RUN BUDGETS STRATEGY
SHORT-RUN PLANNING SHORT-RUN BUDGETS

Budget “A financial and / or quantitative statement prepared and approved prior to a defined period of time , of the policy to be pursued during that period for the purpose of attaining a given objective.” Planning for the future activities Survey of past events, present happenings and the future things.

BUDGET Vs. STANDARD Standard : A carefully determined price, cost or quantity Budget : A broader term Budgeted Costs : Need not be based on standard Standard = Budget : When standards are used to obtain budgeted inputs or outputs

Features of a budget: Comprehensive and coordinated plan of action based on the objectives of the organization. Plan for the operations and resources For a specified future period

Budgetary Control System:WHY?
A tool for strategic planning & control Ensures economy in workings Promotes co-ordination & communication among subunits Management by exception Optimum utilization of resources Continuous review of performance Motivates managers & employees

BUDGETING PROCEDURE Common steps:
Varies widely from company to company. Common steps: Obtaining estimates from each sub-unit or division or department. Co-coordinating estimates. Communicating the budget to responsible managers. Implementing the budget plan. Reporting interim progress: Performance Report

Pre-requisite for Introduction of Budgetary Control
BUDGET CENTRE ORGANISATION CHART BUDGET COMMITTEE BUDGET MANUAL BUDGET PERIOD PRINCIPAL BUDGET FACTOR

FIXED BUDGET vs. FLEXIBLE BUDGETS
Remain unchanged irrespective of level of activity obtained. Prepared for a particular level of activity Acts as a target for the forthcoming period Not adjusted with actual activity FLEXIBLE BUDGETS Designed to change in relation to the level of activity attained Prepared for a range of activities Recognizes the behavior of costs: fixed ~ semi-fixed ~ variable Facilitates performance measurement and control

BEHAVIOURAL DIMENTIONS OF BUDGETING
Implications of Participative Budgeting Excessive Pressure Created by Budget Budgetary Slack (Cushion) Top Management Support Inter-Departmental Conflict

OPERATING AND FUNCTIONAL BUDGETS
Sales Budget Production Budget Production Cost Budget Direct Materials Budget Direct Labour Budget Factory Overhead Budget Cost of Goods Sold Budget Selling Expense Budget Administrative Expense Budget Budgeted Income Statement

FINANCIAL BUDGETS Capital Expenditure Budget R & D Budget Cash Budget
Budgeted Balance Sheet NON-FINANCIAL BUDGETS - Space, Equipments, Workers

MASTER BUDGET A comprehensive budget:
A Tool for coordinating all budgets. Summarizes : Planned activities of all subunits of an organization. Incorporates: Summary of all functional budgets.

MASTER BUDGET Normally comprises : Budgeted P.& L. A/C ;
Budgeted Balance Sheet; Budgeted Cash Flow Statement. Reveals: Top management goals of incomes, expenditure, cash flows and financial position.

ELEMENTS OF MASTER BUDGET
Sales Forecast Production Schedule Manufacturing Cost Budget Operating Expense Budget Capital Expenditure Budget Budgeted Income Statement Budgeted Balance Sheet Cash Budget

BUDGET PRACTICES: Master Budget
U.S. : 91% U.K. : 100% Japan : 93% Holland : 100% Australia : 100% BUDGET GOALS : U.S. : ROI Japan : Sales

What reduces effectiveness of Budgeting?
SURVEY OF CFOs IN THE U.S. : Lack of well-defined strategy Linkage of strategy to operational goals Lack of individual accountability for results. Lack of meaningful performance measures SAIL Vs. TATA STEEL

ROLLING BUDGET A Continuous Budget
A Plan : Always available for a specified future period Adding a period in the future as the period just ended is dropped ELECTROLUX : A four-quarter rolling budget

KAIZEN BUDGETING Kaizen : Continuous Improvement
Continuous Improvement Goals Incorporates continuous improvement during the budget period into the budget numbers JAPANESE COMPANIES Citizen Watch Co.

ACTIVITY-BASED BUDGETING
Incorporating Activity-based Cost Drivers into Budgets Focuses on the Budgeted Cost of Activities Budget for each Activity

ZERO BASE BUDGETING All Activities : Evaluated
A method of budgeting All Activities : Evaluated Every item of expenditure : Fully Justified Involves starting from scratch or zero ZBB & GOVT.

STEPS OF ZBB Identify each separate activity : A decision package
Evaluate : Each decision package Consider : Alternatives for each decision package. Rank : Decision packages - priority for resource allocation. Allocate :Resources to the packages.

“Budgeting is the common accounting tool companies use for planning and controlling what they must do to satisfy their customers and succeed in the market place.”

COST & MANAGEMENT ACCOUNTING

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