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BITSPilaniPilani Campus

Manufacturing Organization

and Management

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BITSPilaniPilani Campus

Cost ControlLecture 14

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BITS Pilani, Pilani Campus

In a manufacturing concern account ing

act ivi t iesare usually divided into two parts:

Financial accounting

Cost accounting

Introduction

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Financial accounting deals with

The business as a whole,

At the end of a designated accounting period it

produces information about the current financial

status of the business,

As well as the amount of profit or loss incurred during

the period in question.

This information is in the form of balance sheets,

profit and loss statements.

Intro

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Cost accounting practices are not regulated but serve

to provide manufacturing managers with data and

analysis of costs of particular processes, jobs or

departments within the company.

Such cost accounting practice becomes the basis ofcost controls systemsand budgetary control plans.

They are essential in the operation of a modern industrial

enterprise for they permit management to plan ahead

and to know when to make changes in order to fulfill theplan.

Intro

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Balance sheets and profit and loss statements do not

reveal how profitable one product is versus another, or

whether one plant produces more efficiently than

another.

Although the stockholder or investment analyst may carelittle about details of efficiency and cost since to them the

overall profit of the business is sufficient, management

must take a different point of view.

Naturally, management is interested in maintaining theoverall position of the company.

Role of Cost Accounting

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The overall position of a company can include such measuresas how successfully it competes, how it is perceived by its

customers, competitors, and investors and its capacity for

future growth.

To ensure the overall position, it must have some indication ofcosts and profits as the accounting periods goes along.

In todaysindustrial world a company cannot afford to wait and

see how profits turn out at the end of the year.

Management must know at any point during the year the

approximate position of costs and profits so that it may take

corrective action before it is too late. This function is called

cost controland to achieve it, cost accountingis necessary.

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Cost accounting is the job of taking overall business

costs and separating them into greater detail according

to unit of product produced, operation performed, or

orders.

For a company that manufactures only one product andonly one size and style, cost accounting can be done by

considering the cost per unit by dividing the total cost

figure by number of units produced.

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Cost accounting provides information for thefollowing purposes:

1. Cost determination : The costs and expense of a business arerecorded, classified, and allocated to various jobs, departments,products, or services.

2. Costs for pricing :Once costs are determined, the information also serves as a guideregarding prices to be quoted to customers.

Even though selling prices are governed only partly by the costs ofproduction, in the long run the selling price must at least equal the

costs of production, or there will be serious consequence to the profitand loss statement.

3. Cost for managerial decision:

In a sense, both cost determination and cost for pricing provide basesfor managerial decisions.

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Although managerial decision making actually becomes muchmore complex than the statement above implies, cost informationmay be helpful in making decision that have to do with

(a) Whether to add a new product, or to drop one that is nowbeing produced

(b) Whether to manufacture a certain unit, or buy it on the

outside, and(c) Whether to add certain sales terrories and drop others.

4. Cost control:One of the more essential purposes of cost accounting is control ofexpenditures.Such control leads to efficiency in the use of labor, materials machines

and plants.Although to a large extent selling prices are determined by competition,the profit-making capacity of a business is guided by the efficiency withwhich costs are controlled.

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There are three basic cost elements:

1. Direct material cost,

2. Direct labor cost,

3. Overhead.

Basic Cost Elements

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Direct material cost is the cost of the material that can beidentified directly with the product that is delivered to the

customer.

Indirect material in general may be thought of as those items

used in the manufacture of a product that do not become an

integral part of it. Costs of these materials become overheadcosts. (Ex: light bulbs to light area, cleaning rags, sand

papers, hand tools).

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The direct labor costs are the costs of labor that can beidentified directly with the manufacture of the product that is

delivered to the customer.

If an item of direct labor becomes so small as to have little

dollar value, it may be more feasible to consider it as indirect

labor. (Ex: maintenance work, cleaning work, clerical work) Overhead costs are often defined as all manufacturing costs

other than direct material and direct labor or other than prime

costs.

Overhead costs may be indirect material and indirect labor.

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Let us consider how these cost figures are obtained,particularly on per unit or per-product basis. Directmaterial and direct labor present little difficulty.

One can generally measure the amount of direct materialused per unit of product. Because material costs can be

determined from vendors invoices and if product yieldsare known, the direct material dollars per unit can easilybe obtained.

Most factories require their employees to keep timerecords. From these records the number of direct labor

hours spent on any product or order can be determined. Knowing hourly rates and units of output, one can easilycompute direct labor dollar cost per unit.

Obtaining Unit Costs

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Common bases for the allocation of overhead costs are

1. Number of employees

2. Direct labor costs

3. Direct labor hours

4. Direct material costs

5. Machine hours

6. Floor area

7. Prime Costs

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We have speaking of cost determination and costallocation strictly in the historical sense. In other words,our discussion so far has looked at cost after theaccounting period is over and products have been storedin the warehouse; and we have then tried to determine

costs on a per unit basis. Such figures are interesting and helpful to some extent,but they are not completely adequate.

In managing operations, we need sufficient informationabout what future costs should be so that bids may be

placed on jobs, selling prices may be estimated ahead oftime, and a basis for corrective action may be provided.

The use of standard costs is helpful both in predictivework as well as in control.

Past versus Future Costs

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Whether one is developing standard costs or historical costs, theproblems involved will vary depending on whether one followsthe job-order cost method or the process-cost method.Sometimes it is necessary to combine the two methods, but forthe most part the method one uses depends upon the type ofmanufacture.

The job-order cost method collects the cost of jobs that are keptseparate during the manufacture or construction period. Thecost unit is the job, the order, or the contract and the accountssow the cost of each order.

This method assumes that the jobs can be physically identifiedand separated from each other.

A variation of the job-order cost method is the costing of ordersby lots. In many shops it is much more convenient andeconomical to consider a product in lots of a dozen or a hundredrather than individually.

Job Order Costs and Process Costs

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At some time or other almost every company has hadsome kind of program of cost reduction.

The precise reason for any particular program of costreduction may vary considerably from time to time and

from company to company, but all such programs havein common the basic need to reduce costs of operationsbelow their present level.

Specific reasons could be the softening of the economygenerally, particularly rough competition in a specific

product line, or a wish to reduce the selling price of aparticularly product and thereby broaden its market.

Cost Reduction and Cost Control

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In the previous sections we outlined the use of coststandards as a device for controlling manufacturing

operations.

Cost accounting, although not a control device itself,

provided the necessary information for setting up coststandards.

Budgets are also used for cost control purposes and are

discussed in that role in the pages that follow.

Budgetary Control

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We normally think of budgets in terms of a number ofdollars and a list of items on which those dollars will bespent.

A business budget differs somewhat from these common

concepts in as much as it must be more detailed. It willspecify units to be produced, broken down into sizes andstyles, as well as costs of production.

In fact, a considerable part of the budget comes from theuse of the estimated cost breakdown.

The budget can then be thought of as an overall plan forthe operation of the business in terms of sales,production, and expenditures.

Budgets and Their Use

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The preparation of a budget being with an estimate ofsales for the year ahead.

Techniques for making such forecasts are discussed

from sales forecasts production requirements can be

determined, taking into account the inventory situation. The production estimate then becomes the basis for

determining material, personnel, plant, and equipment

requirements and the costs allied with each.

Fixed and Flexible Budgets

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Examining the breakdown of costs that appears on aflexible budget, one finds certain costs, such as rent,taxes, and insurance, that is constant event asproduction varies.

Other cost items, such as wages and materials, vary as

production costs suggest the construction and use ofonce in the basic nature of production costs suggest theconstruction and use of breakeven charts.

A breakeven chart shows the cost of production atvarious levels of output as well as the income from sales

at the same output levels. It must be assumed that allgoods produced are sold, or else the chart has littlemeaning.

Breakeven Charts

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Attempts are often made to apply the breakeven charttechnique to the company as a whole.

If the company produces and sells but one product, suchan attempt will be relatively successful.

On the other hand, of a number of products are

produced and sold, summary figures of sales and costsmay not have too much meaning.

Variation in product mix will cause variations in summaryfigures, which might in turn lead to erroneousconclusions.

It makes much better sense to divide the organizationinto units or centers and to compute costs and profits foreach of the various units.

Profit Centers

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In this chapter we have discussed the use of accounting,especially cost accounting in the management of amanufacturing enterprise. Before ending the chapter itmay be well to emphasize that cost accounting is ameans to an end and not an end in itself.

This familiar and overused phrase is particularlyapplicable in this case, for often we become overawedwith the apparent accuracy of cost figures, with thepossible result that the company is being operated for

the convenience of the cost accounting department. Cost accounting is a tool or an aid to good management,

the same as many other functions are aids.

All must be kept within the proper framework so that thecompany as a whole may prosper.

Accounting and Management

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Thank You

MM ZG511-L14

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Transcript of MM ZG511-L14