COST & MANAGEMENT ACCOUNTINGCOST & MANAGEMENT ACCOUNTING

Prof. Ranjan Kumar Bal

UTKAL UNIVERSITY

COST & MANAGEMENT ACCOUNTING COST & MANAGEMENT ACCOUNTING (COMA)(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 ACCOUNTANTROLE OF THE ACCOUNTANT • TO MANAGE INFORMATION

• An Information Technologist

SCORE – KEEPING ATTENTION DIRECTING PROBLEM SOLVING

CUSTOMER – DRIVEN FOCUS IN CUSTOMER – DRIVEN FOCUS IN MANAGEMENT ACCOUNTING SYSTEMMANAGEMENT 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 ABILITIES & SKILLS for Management Accountants – A SurveyManagement 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 THE MANAGEMENT ACCOUNTANT AND STRATEGIC DECISIONSSTRATEGIC 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 COMAIMPORTANCE OF COMA 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 COMA Vs. FINANCIAL ACCOUNTING SimilaritiesSimilarities

• 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 : COMA Vs. FINANCIAL ACCOUNTING : DifferencesDifferences

• 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 COST AND MANAGEMENT INFORMATION SYSTEMINFORMATION 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 MANAGEMENTCOST 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 FUNCTIONTHE 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 SYSTEMENHANCING 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 We are running harder just to stand still.”just to stand still.”

“If you’re not going forward, “If you’re not going forward, you are going backward.”you are going backward.”

QUESTIONSQUESTIONS• “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.

CHANGECHANGE

Change is the only constant in today’s world.

MANAGEMENT AND COMAMANAGEMENT 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 TERMINOLOGYCOST 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 CLASSIFICATIONCOST CLASSIFICATION

WHY ?

• To Achieve a Purpose / Objective

Control, Decision Making

• To Facilitate Communication / Reporting

COST CLASSIFICATIONCOST CLASSIFICATION

Behaviour Elements Control Decision Making Functions Nature

ELEMENTS OF COSTELEMENTS 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.

OVERHEADSOVERHEADS

• Manufacturing or Factory

• Office & Administration

• Selling & Distribution

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

RELATIONSHIP OF COSTSRELATIONSHIP OF COSTS

• Direct & Variable

• Direct & Fixed

• Indirect & Variable

• Indirect & Fixed

METHODS & TECHNIQUESMETHODS & TECHNIQUES

METHODS

- Job Costing

- Process Costing

TECHNIQUES

- Marginal Vs. Absorption Costing

- Standard Vs. Historical Costing

COST ACCOUNTINGCOST ACCOUNTINGOBJECTIVES :

• 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 ESTIMATIONCOST 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 ?WHY A COST SHEET ?• Fixing selling price

• Submitting quotations

• Planning & control of cost

• To know relative efficiency of products

• Decision making

STATEMENT OF COSTSTATEMENT OF COSTCOST 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 STOCKTREATMENT OF STOCK Raw Material WIP Finished Goods

Treatment of the amount realized from the sale of scraps / wastes ?

ITEMS NOT AFFECTING COST SHEETITEMS 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 SHEETESTIMATED COST SHEET• Considers all probable changes in cost

• Preparation :

- Prepare a “Cost Sheet”

- Establish relationship

- Estimate OH costs

- Prepare “Estimated Cost Sheet”

CASECASEThe 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. 2.50 per unit Direct labour cost : Rs. 2.00 per unit Variable Overhead : Rs.1.50 per unit

Fixed cost : Rs. 1.50 per unitSelling price : Rs.10 per unit

The firm expects to get a special export order for 10,000 units at a price of Rs. 7.25 per unit. Advise whether the export order should be accepted or not. The company has a capacity to produce 60,000 units.

INFERENCES: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- Direct Costing / Variable Costing

- A Technique of CostingMeaning :

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 COSTINGABSORPTION 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 COSTINGUTILITY 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 2011-12:

Sales 10,000 units at Rs. 5 each; Production 15,000 units at the following costs:

Rs.Direct materials 15,000Direct labour 30,000Variable expenses 6,000

Fixed expenses 12,000Determine net profit.

Income Statement for the year 2011-12

Marginal Absorption

costing Rs. Costing Rs.

Sales 50,000 50,000

Cost of Production:Direct materials 15,000 15,000Direct labour 30,000 30,000Variable overhead 6,000 6,000Fixed overhead _ 12,000

51,000 63,000Less Closing Stock 17,000 21,000

Cost of goods sold 34,00042,000Contribution(50,000- 34,000) 16,000

4,000

Less Fixed Overhead 12,000

Net profit 8,000

Valuation of closing stock:Marginal costing = (5000/15,000) x 51,000

= Rs. 17,000Absorption costing = (5000/15,000) x 63,000

= Rs. 21,000Note: Difference in profit is due to the difference in

stock valuation.

CASEFrom 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 2010 2011 2012 Rs Rs. Rs.Selling price per unit 20 20 20Variable Mfg. Cost per unit 10 10 10 Total fixed manufacturing cost 5000 5000 5000 Opening stock - 500Units produced 1000 1500 2000 Units sold 1000 1000 1500 Closing stock - 500 1000

BREAK-EVEN ANALYSISNarrow 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

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 BREAKEVEN ANALYSIS FOR MULTIPLE PRODUCTSMULTIPLE 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. 25 Rs. 10 Variable Costs Rs. 30 Rs. 15 Rs. 8 Contribution Margin Rs. 20 Rs. 10 Rs. 2

WHAT IS IT’S BEP ?

BREAKEVEN ANALYSIS FOR MULTIPLE PRODUCTSBREAKEVEN ANALYSIS FOR MULTIPLE PRODUCTSA 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 : 12500 units (2,500 x 5)

COST –VOLUME – PROFIT ANALYSISCOST –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: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 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 ANALYSISC-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 SOFTWAREDO-ALL SOFTWARE

• SP = Rs.2,000 per unit• VC = Rs.1,200 per unit• FC = Rs.20,000The organisation anticipates selling 40 units.

1. Decision to AdvertiseProposed Advertisement = Rs.5,000Effect : Increase in Sales by 10%DECISION ?

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 & REVENUESRELEVANT 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 / APPORTIONMENTCOST 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 ALLOCATIONPURPOSES 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 PRACTICESURVEY OF COMPANY PRACTICEWhy allocate corporate and other support costs to Why allocate corporate and other support costs to

divisions and departments ?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 DECISIONCRITERIA 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 BASECOST 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 COSTSACCOUNTING AND CONTROL OF OH COSTS

Classification Codification Collection Allocation and apportionment to cost centers

Absorption in costs of products, services etc.

WHY TO CLASSIFY?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 OHsCOLLECTION 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 COSTSDISTRIBUTION 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 CHALLENGE YOUR CURRENT PRACTICES AND ENHANCE PRACTICES AND ENHANCE

YOUR HORIZON”YOUR HORIZON”IIMBIIMB

ACTIVITY BASED COSTINGACTIVITY BASED COSTING

REFINING A COSTING SYSTEM: WHY?

• Intense competition

• Advances in IT

ABC systemABC 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 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 : BENEFITSABC : BENEFITS

• Obtaining true product cost

• Cost Management

• Better decision making

PROCESS : ABCPROCESS : ABC

• Direct cost tracing

• Indirect-cost pools

• Cost-allocation bases

IMPLEMENTING ABC: StepsIMPLEMENTING 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 CORPORATIONPLASTIM 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 CorporationProcess : 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:Options for Plastim:

Lower its selling price. Give up G. Motor’s business. Reduce cost.

Existing Costing SystemExisting Costing System 60,000 15,000S3 CL5

Total($) Per Unit($) Total($) Per

Unit($)Direct Material 1125,000 18.75 675,000 45.00Direct labour 600,000 10.00 195,000 13.00Total Direct Cost 1725,000 28.75 870,000 58.00Indirect costAllocated 1800,000 30.00 585,000 39.00Total Cost 3525,000 58.75 1455,000 97.00

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 = $1800,000CL5 : Uses 9,750 labour hours = $585,000

Possible Reasons :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 PLASTIMSEVEN 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 :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 poolsActivity – Cost Rates for Indirect–Cost poolsActivity Total Cost-allocation OH allocation

Cost Base RateDesign $ 450,000 100 parts- $ 500 per part-

square feet square footSetups of $ 300,000 2000 $ 150 per setup-Molding Setup-hours hourMachinesManufacturing $ 637,500 12,750operations Molding $ 50 per molding machine hours machine-hourShipment $ 81,000 200 $ 405 per

shipmentSetup

Distribution $ 391,500 67,500 $ 5.80 per cubic

Cubic feet foot shippedAdministration $ 255,000 39,750 $ 6.4151 per

Direct manuf.Direct manuf.

Labour hours labour –hour

Product Cost using ABCProduct Cost using ABC S3(60000)

CL5(15,000)

Total($) Per unit($) Total($) Per unit

Direct Costs :Direct Materials1125,000 18.75 675,000 45.00

Direct Labour 600,000 10.00 195,000 13.00

Direct Mold Cleaning120,000 2.00 150,000 10.00

Total Direct Costs1,845,000 30.75 1,020,000 68.00

Indirect Costs :Design activity costs: S3, 30 parts-sq.ft.*$4,500 135,000 2.25CL5, 70 parts-sq.ft.*$4,500 315,000 21.0Setup activity costs:S3, 500 setup-hours*$150 75,000 1.25CL5, 1,500 setuphours*$150 225,000 15.00Manufacturing operationsActivity costs:S3,9,000 mouldingMachine hours*$50 450,000 7.50CL5,3,750 mouldingMachine hours* $50 187,500 12.50

Shipping setup activity:S3, 100 shipments*$405 40,500 0.67CL5, 100 shipments*$405 40,500 2.70 Distribution activity:S3,45,000 cubic feet Shipped*$5.80 261,000 4.35CL5, 22,500 cubicfeet shipped*$5.80 130,500 8.70Administration activity:S3,30,000 dir. Manuf. Labour-hours*$6.4151 192,453 3.21CL5,9,750 Dir. Manu. Labor-hours*$6.4151 62,547 4.17Total indirect costs: 1,153,953 19.23 961,04 64.07

Total Costs $ 2,998,953 $49.98 $1,981,047 $132.07

WHO SAID THESE WORDS ?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. DRUCKERPETER 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 Without proper cost and management accounting, management accounting,

decision would be like decision would be like taking a jump in the dark.”taking a jump in the dark.”

COST ACCOUNTING SYSTEMCOST 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.

CASCAS

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?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 SYSTEMDESIGNING 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 CONCEPTSBUILDING-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

CASCAS• DELL COMPUTER

• WIPRO

Will they have same CAS ?

Two basic types of CA system:Two basic types of CA system:

Two extremes of product costing :

• JOB ORDER COST SYSTEM

• PROCESS COST SYSTEM

JOB ORDER COST SYSTEMJOB ORDER COST SYSTEM

Used by companies:• Producing “one-of-a-kind” products• Tailor products to the specifications

of individual customers

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

JOBJOB• 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 COSTINGJOB 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.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 COSTINGACTUAL 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 SHEETJOB COST SHEETJob Number ---------- Product --------------Date Started -------------Date Completed --------------Number of units ------------

DIRECT MATERIALDate Requisition Number Quantity Unit Price Cost

DIRECT LABOURDate Time Card Number Hours Rate Cost

MANUFACTURING OVERHEADDate Activity Base Application Rate Cost

COST SUMMARYCOST SUMMARYCost 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.”

ACCOUNTINGACCOUNTING : Job Costing : Job CostingACCOUNTING FOR DIRECT MATERIALS

End of each week or month : Summary entryWIP Inventory Rs. 50,000

Materials Inventory Rs. 50,000ACCOUNTING FOR DIRECT LABOUR

End of each month or week WIP Inventory Rs.20,000

Direct labour Rs. 20,000ACCOUNTING FOR ‘OH’ COSTS

End of each week or month:WIP Inventory Rs. 10,000

Manufacturing overhead Rs. 10,000ACCOUNTING 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 COSTINGCONTRACT COSTING One type of specific order costing Used in civil engineering works Each contract : Separate accounts for each

contract

AS – 7 : Construction ContractsFixed Price ContractsCost Plus Contracts

COSTSCOSTS– Materials– Labour– Direct Expenses– Indirect Expenses– Plant and machinery :

Depreciation

WIP : Presented in the Balance SheetWIP : Presented in the Balance Sheet

Balance Sheet as at…..Assets Amount

Work in progress :• Value of work certified• Cost of work uncertifiedLess Reserve for unrealized profit Less Amount Received from contractee

Profit on Incomplete Contracts: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 INDUSTRYPHARMACEUTICAL INDUSTRY

• Multi-Products• Production in batches• Identical products in a batch

Use Process Costing

PROCESS COSTINGPROCESS COSTING

• A method of costing

• Costing of process : Converting raw materials into finished products.

• Find Out : Cost of operating each process.

APPLICATIONSAPPLICATIONS• 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 CostingCHARACTERISTICS : 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 COSTINGJOB 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 SYSTEMAUSTRALIA : COSTING SYSTEMTextiles

%

Chemicals %

Refining

%

Printing

%

Process 91 75 100 20

Job 18 25 25 73

Other 12 13

Normal Loss• 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?WHY ALLOCATE JOINT COSTS?

• Computation of cost of goods sold,

• Cost reimbursement under contracts,

• Insurance-settlement computations.

APPROACHES FOR ALLOCATING APPROACHES FOR ALLOCATING JOINT COSTSJOINT COSTS

• Using market based data : Revenue

• Using physical measures : Weight

INTER PROCESS PROFITINTER PROCESS PROFITOut 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: ADJUSTMENTSBALANCE 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 FULL UNITS OR EQUIVALENT PRODUCTIONEQUIVALENT 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 :Work done by a Manufacturing Department :

• Completing opening WIP units.

• Working on units started and completed.

• Working on closing WIP units.

STATEMENT OF EQUIVALENT PRODUCTIONSTATEMENT OF EQUIVALENT PRODUCTION Units Portion Equivalent

completed full in July units

Opening WIP :(60% completed in June) 5,000 40% 2,000

Unit s started & Completed : 37,000 100% 37,000

Total units completed : 42,000

Closing WIP :(25% completed) 4,000 ` 25% 1,000

Total Equivalent Units : 40,000

STATEMENT OF EQUIVALENT PRODUCTIONSTATEMENT 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 WIPUnits 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”.

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

SEGMENT PERFORMANCE ANALYSISSEGMENT PERFORMANCE ANALYSISAS- 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 / DIVISIONSEGMENT / DIVISION• A sub-unit • Headed by a man fully responsible

for its operation.• A Responsibility Center • A Decision Unit

WHY DIVISIONALIZATION?WHY DIVISIONALIZATION?

• Decentralization

• Measurement & evaluation of performance

• Training ground for top mgt. personnel

• Planning and allocation of resources.

• Controlling operations

RESPONSIBILITY ACCOUNTINGRESPONSIBILITY 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.Process of R.A.• 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?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.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• 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• 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 & CONTROLLABILITYRESPONSIBILITY & 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 ASSIGNING REVENUE & COSTS TO SEGMENTSTO SEGMENTS

REVENUE :• 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 PERFORMANCEMEASUREMENT OF PERFORMANCE

ROI Approach : Popular Approach

Accounting Rate of Return

• Pioneer : Du Pont Co.

• Return on Sales x Investment Turnover

RI Approach :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 SalesReturn on Sales• Income to Revenue (or Sales) Ratio

• A component of ROI

COMPARING PERFORMANCE MEASURES : ROI RI EVA ROS

DESIGNING ACCOUNTING-BASED DESIGNING ACCOUNTING-BASED PERFORMANCE MEASURE(PM)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 FINANCIAL PERFORMANCE MEASURES – A SurveyMEASURES – 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 SIGMASIX SIGMA• Pioneer: Motorola• A Management Philosophy• Setting extremely high objectives• Collecting data• Analysing results• Reduce defects in products &

services

STANDARD COSTING AND STANDARD COSTING AND VARIANCE ANALYSISVARIANCE ANALYSIS

Objective : Cost Control

Accounting system :

Historical Costing

Standard Costing

StandardStandard A measure of desired

performance. A predetermined criterion for evaluating the actual performance

WHY STANDARDS ?WHY STANDARDS ?• Cost Control

• Pricing Decision

• Performance Appraisal

• Cost Awareness• Management by Objective

TYPES OF STANDARDSTYPES OF STANDARDS

Ideal standards Expected standards Current standards Basic standards

PROCESS OF DEVELOPING PROCESS OF DEVELOPING STANDARDSSTANDARDS

Varies from company to company :

• The standard committee

• Technical input

• Past experience

• Other inputs

• Coordination

Standard CostingStandard 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 involvesStandard Costing involves : :• Ascertainment of standard cost

• Measurement of actual cost

• Comparison

• Analysis of variance and taking appropriate action where desired

VARIANCESVARIANCESFavourable Variance & Unfavourable Variance

Controllable Variance & Uncontrollable Variance

Variances:Variances: Sales Variances Cost Variances

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

DIRECT MATERIAL COST VARIANCESDIRECT MATERIAL COST VARIANCES1. Material Cost variance = Standard cost for actual output -

Actual cost of material used = Qs. Ps – Qa. Pa

2. Mat. Price var. = Qa (Ps – Pa)3. Mat. Quantity var. = Ps (Qs – Qa) = Usage Variance

= Efficiency Variance4. 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 output1 = 2 + 3, 3 = 4 + 5Note : Qs = Standard Quantity; Qa = Actual Quantity;

Ps = Standard Price; Pa = Actual Price; Smqa = Standard Mix in Actual Quantity.

DIRECT LABOUR COST VARIANCEDIRECT LABOUR COST VARIANCE1. 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 = 4 + 5 + 6Note : Ha = Actual hours worked

VARIABLE OVERHEAD VARIANCESVARIABLE OVERHEAD VARIANCES

Variable Overhead Cost Variance = St. V. OH – Ac. V. OH = AO . SRO – AO . ARO

= SH . SVRH – AH . AVRHVariable Overhead Spending Variance

= AH(SVRH – AVRH)Variable OH Efficiency Variance

= SVRH(SH – AH)

FIXED OVERHEAD VARIANCESFIXED 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 VARIANCESSALES 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 VARIANCESPOSSIBLE 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 VARIANCESRESPONSIBILITY FOR COST VARIANCESVariance 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, Few businesses plan to fail, but many of those that flop,but many of those that flop,

failed to plan.failed to plan.

BUDGETARY CONTROLBUDGETARY CONTROL BUDGETS AND PERFORMANCE REPORTS

MANAGER FeedbackManagers plan &act using budgets

PERFORMANCEOPERATING PROCESSManagers evaluate usinga report that comparesactual results with budgets

STRATEGY AND PLANSSTRATEGY AND PLANS

LONG-RUN PLANNING LONG-RUN

BUDGETS

• STRATEGY

SHORT-RUN PLANNING SHORT-RUN

BUDGETS

BudgetBudget “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. STANDARDBUDGET 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: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?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 PROCEDUREBUDGETING PROCEDUREVaries 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 Pre-requisite for Introduction of Budgetary ControlBudgetary Control

• BUDGET CENTRE

• ORGANISATION CHART

• BUDGET COMMITTEE

• BUDGET MANUAL

• BUDGET PERIOD

• PRINCIPAL BUDGET FACTOR

FIXED BUDGET vs. FLEXIBLE BUDGETSFIXED BUDGET vs. FLEXIBLE BUDGETS

FIXED BUDGET• 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 BUDGETINGBEHAVIOURAL DIMENTIONS OF BUDGETING

• Implications of Participative Budgeting

• Excessive Pressure Created by Budget

• Budgetary Slack (Cushion)

• Top Management Support

• Inter-Departmental Conflict

OPERATING AND FUNCTIONAL BUDGETSOPERATING 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 BUDGETSFINANCIAL BUDGETS• Capital Expenditure Budget• R & D Budget• Cash Budget• Budgeted Balance Sheet

NON-FINANCIAL BUDGETS - Space, Equipments, Workers

MASTER BUDGETMASTER 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 BUDGETMASTER 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 BUDGETELEMENTS 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 BudgetBUDGET 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?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 BUDGETROLLING 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 BUDGETINGKAIZEN 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 BUDGETINGACTIVITY-BASED BUDGETING

• Incorporating Activity-based Cost Drivers into Budgets

• Focuses on the Budgeted Cost of Activities

• Budget for each Activity

ZERO BASE BUDGETINGZERO BASE BUDGETING

A method of budgeting All Activities : Evaluated Every item of expenditure :

Fully Justified Involves starting from scratch or zero

ZBB & GOVT.

STEPS OF ZBBSTEPS 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.

““BudgetingBudgeting is the common is the common accounting toolaccounting tool companies use for companies use for

planning planning andand controlling controlling what what they must do to satisfy their they must do to satisfy their

customerscustomers and succeed in the and succeed in the market placemarket place.”.”