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Chapter-1
Overview of Management Control Systems
Synopsis
1.1 Conceptual foundation
1.1.1 Management
1.1.2 Control
1.1.3 Systems
1.1.4 Management Control System
1.2 Boundaries of Management Control
1.3 Characteristics of Management Control System
1.4 Structural Foundations of Management Control
The objectives of this chapter are:
Explain the need for Management Control Clarify the concept of Management Control Systems Discuss the boundaries of Management Control Focus on the characteristics of management control systems Review the structural foundations of Management ControlPrelude
India stands third, having the largest technically trained
manpower in the world. But theoretical technical knowledge is only
half the story, the other half being its practical applications. With the
liberalization of the Indian economy and globalization, there is now acut throat competition from various corners of the world. As a result,
there is now a race to secure a place for survival. In such a scenario,
Management Controlskills is the cry of the day.
There is some confusion in the use of three words, namely,
Management Control, Operational Control and Financial Control. In
order to understand the full and correct meaning of these words, we
have to first understand each of these words separately and then
discuss their interrelationship, need, cause and effect later.
Management, essentially, is the art and science of optimum
utilization of resources with maximum benefit to the society. When wetalk of resources, the general impression is of the natural resources
{minerals etc.) which are used by industry for making useful things.
However, resources also include men, money, materials, machinery,
and time. Naturally, to be effective, a manager has to control, and
control effectively. And in order to control effectively, he must know
the various alternative methods (or systems).
1.1 Conceptual Foundation
To study the subject, we must first understand the meaning of
three words, namely Management, Control and Systems.
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1.1.1 Management Management refers to the team of people
at the helm of affairs of an organization which is responsible for
running and guiding the destiny of the enterprise. Used as a verb, it
means getting things done through people. Incidentally, for the
purpose of our discussion, we intend to use it as a noun.
An organization is an inanimate creature. It, therefore, needs
people to run it and shape its destiny. These people are its leaders and
are known collectively as the Management. It is headed by a Chief
Executive Officer, who is known by various names namely Managing
Director, Executive Chairman, etc. Below him are a hierarchy of
managers.
The team has the responsibility for planning, organizing,
activating and formulation of the organizations strategies which are
expected to attain its objectives. Apart from this, they are also
responsible for coordination, directing, staffing, and managementcontrol by the use of people and resources (George R. Terry
Principles of Management).
1.1.2 ControlControl means making events conform to plans.
Thus, it presupposes the existence of plans. So, management has to
consciously plan the activities of a firm, namely decide what the entity
should do.
Reports containing information about actual outcomes are then
prepared. These are then compared against plans or norms.
Deviations from plan or norm are then isolated, analysed, and
classified by responsibility centres. Action is thereafter taken based on
the significance of variances, so as to prevent them from reoccurring.
Thus, essentially, control means identification of variances,
their causes, and corrective action.
1.1.3 Systems An organization is a system by itself. It
consists of a number of subsystems. A system may be defined as a
prescribed manner of carrying out repetitive activities. It involves
coordination.
Modem organizations and the environment in which they
operate are becoming more and more complex day by day moreproducts, more players, and rapidly changing technology and
markets. As a result of this complexity, no single individual or group
can evolve a solution which is considered optimal. Consequently,
there arises the need for various systems.
1.1.4 Management Control SystemManagement Control is a
type of planning and control activity that is done in an organization. It
is the process by which management influences other members of the
organization to implement the organizations strategies effectively and
efficiently.
A number of activities are involved in management controlnamely planning, coordination, communication, evaluation, decision
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making, and influencing others behaviour. Management control does
not necessarily mean that actions should conform to a plan. In case
the circumstances are now believed to be different from those
assumed during the preparation of plan, the planned actions may
cease to be appropriate. Thus, management control should anticipate
future situations.
The Chief Executive Officer and his team has the responsibility
for formulating the companys strategies that are expected to attain
the organizations objectives e.g. what business it should remain in or
new business it intends to enter into, or whether it would compete on
cost or quality etc. It is possible that the strategies may look
wonderful on paper. But, unless they are implemented, the
organization has nothing to gain.
Therefore, to stun up, management control system is a
systematic method used by management to exercise control over theimplementation of strategies.
1.2 Boundaries of Management Control
After having discussed in brief the meaning of Management
Control Systems, we next come to the boundaries (i.e. limits) that
distinguishes it from other planning and control systems namely
strategy formulation, operational control and financial control.
Strictly speaking, management control lies between strategy
formulation and operational control. Out of the three, strategy
formulation has been found to be the least systematic, operational
control the most systematic, and management control falling in
between the three. While strategy formulation focuses on the long run,
operational control on short-term operating activities, and
management control lies in between. Strategy formulation is based on
rough approximations of the future, operational control makes use of
current accurate data, and management control is in between.
Although each activity involves planning and control, the degree
varies. Planning is much more important in strategy formulation, both
planning and control processes are of equal importance inmanagement control, while the control process is much more
important in operational control. Financial control is systematic, uses
accurate data, and gives equal importance to planning and control.
The question is how do we distinguish the three terms from
management control? In order to do so, we must first know the
meaning of each of these terms.
Strategy formulation Strategy formulation is essentially a
planning process used by firms for deciding on the goals of the
organization and strategies to be used for achieving the goals.
Goals are the broad overall aims of any organization.Generally, the same are not changed. They may differ from
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organization to organization. Some firms have the goal of achieving a
large market share, in others it may be to earn a satisfactory return,
and still in others (non-profit organizations i.e. schools, colleges, etc.)
it may be to provide maximum service to the society with the available
funds.
There are a number of ways of achieving these goals. Strategies
basically are the plans for attaining the organizations goals. They are
important and comprehensive. Such plans state in general terms the
direction which top management would like the organization to follow.
A firm may choose a number of ways of achieving these goals. In case
the goal is to achieve a large market share, the firm may select such
industries, in suitable geographical areas, and profitable product
lines.
It may bench mark itself against its major competitors. Based
on this, its cost and price structure could be brought in line withthem. It may decide to manufacture and market the products or
market the products of other manufacturers. It decides the emphasis
to be placed on sales promotion, advertising, research and
development etc.
Once a firm has formulated its strategies, it operates in
accordance with it. During the annual strategic planning exercise,
some of these strategies may be reexamined, some may be changed, or
new strategies may be adopted. The need for changing strategies may
arise owing to a threat that is being perceived by the organization or to
benefit from a perceived opportunity.
Ideas to deal with threats or to take advantage of opportunities
may come from any part of the organization and at any time.
Distinction between Strategy Formulation and Management Control
Strategy formulation is concerned with the process of deciding
the organizations strategies while management control involves the
process of implementing strategies. Strategy formulation is an
unsystematic activity because it takes place as and when threats and
opportunities arise and suffice it to say, the same can arise any
moment. On the other hand, there is generally a fixed time table and aseries of steps in accordance with which management control takes
place.
During the process of strategy analysis, few people are generally
involved while in the case of management control, the involvement of
the whole organization takes place.
Operational ControlThe process used for ensuring that tasks
which are specified are carried out efficiently and effectively is known
as operational control. It involves the control of individual tasks.
Incidentally, the rules to be followed for accomplishing the tasks are
prescribed as part of the management control process.Operational control can be achieved through the medium of
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human beings or machines. Computers used in process control,
robots etc. are examples of machines used in operational control.
It must be noted that many operational control activities are
scientific in nature. This means, the relationship between cause and
effect, the action needed to bring an out of control situation back to
the desired state, or the optimum decision, are known within
acceptable limits. The economic order quantity, waiting time and other
techniques of operational research are used in task control.
There are different systems for different types of tasks. We have
the procurement system, sales system, cash management system,
quality control system etc.
Examples of operational control are scheduling of production,
maintenance of personnel records etc.
Distinction between Operational Control and Management Control
Operational Control focuses its attention on specific tasks whichare performed by organizational units while in the case of
management control the attention is on organization units.
Many task control systems are scientific in nature while this is
not so in the case of management control. Management control
involves the behaviour of managers as managers interact with other
managers and this cannot be shown in the form of equations.
Financial Control Financial Control is the process by which
management ensures that an organization carries out its financial
plan effectively and efficiently.
During each year, financial plans are prepared and submitted to
top management for the purpose of review and approval. Once they
are approved, the same is used as yardsticks or norms. Actual
outcomes are then compared to the plan or budget for different levels
of management and deviations ascertained. Variances which are
significant in nature are analysed by causes and responsibility centres
and reported to appropriate levels for information and corrective
action.
Financial control includes control of direct materials, direct
wages, direct expenses, manufacturing overheads, discretionaryexpenses, and revenue control.
Distinction between Financial Control and Management Control
Management control represents the whole while financial
control is a subset of management control.
As a matter of fact, management control involves the
implementation of an organizations strategies; financial control on the
other hand leads to the implementation of financial plans of an
organization.
The focus of management control is neither on the short run nor
on the long run. Financial control is concerned with the short run.
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1.3 Characteristics of Management Control Systems
We have seen from our earlier discussion that the management
control process begins after the formulation of the organizations goals
and strategies. It is a broad concept involving all interrelationships
between managers and their subordinates.
As pointed out earlier, planningand controlare common to all
systems. But planning is basically decision making an intellectual
process of finding out different courses of action, and selection of the
best, to meet the objective. This automatically leads the planner to self
appraisal long term objective plan of action.
An effective management control system must possess the
following characteristics:
1. Strategic Plan and its Communication: There should be a strategicplan and strategies should be communicated to the subordinates
who are responsible for their execution.2. Profit Plan and Budget: A profit plan or budget should exist. This
provides proper direction to the organization, sets forth standards
of measurement, and shows the desired profit-cost relationships. It
should be prepared on the basis of responsibility centres and
communicated to the people down the hierarchy who are
responsible for executing it.
3. Motivation of Subordinates: The subordinates must be motivated toact efficiently and effectively.
4. Effective Management Information System: It is necessary to havean effective management information system so that the
performance of the subordinates are measured and objectively
evaluated.
1.4 Structural Foundations of Management Control
The key pre-requisite to effective design of the management
control system is to recognize the main features of the various sub-
units in an organization. An organization converts inputs namely
money, raw materials, and human efforts into desired outputnamely
profit. The manager exercises control or authority over the inputs, andprocess is responsible for generating the desired output.
A firm is divided into simpler, more homogenous sub-units or
functions or departments. Each of these can be viewed as a process of
convening inputs into desired outputs. For instance, the marketing
department converts these finished goods into rupees or revenue, the
personnel department converts job applicants into supervisors,
salesmen, etc.
Each department is quite different from the other and these
differences are extremely important from the point of view of planning
and control. In describing each subunit of organizations from the viewpoint of designing appropriate planning and control mechanisms, the
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most important attribute of each subunit or department is whether its
outputs can be quantified and measured. The second major
distinguishing feature of various types of departments is whether the
process they use are well defined and understood.
Using these two major considerations, we can identify four types
of departments, as indicated in the under noted process output
matrix.
Known Type I Known Type II
MeasurableOutputs
Most Manufacturingdepartments (Focus onInput-output relation-ship. Efficiency)
Some Staff departments
such as legal, some
marketing departments
(Focus on Output)
Not-Measurable Type III
Some staff departmentssuch as personnel(Focus on Process,Procedures, andPractices)
Type IV
Some R&D departments(Focus on Inputs-Resource Allocation)
Fig. 1.1. Process Output Matrix
In the case of Type I departments, the process is Known and the
output is measurable. They are easiest to manage. Type II
departments where the process is unknown but outputs can be
measured, require control mechanism that focus on the extent towhich desired outputs are achieved. Type III departments are
extremely difficult to manage well. Although one can focus on whether
accepted practices and procedures are being followed carefully and in
a timely manner, it is often impossible to ascertain whether the
desired results are being obtained. Under Type IV departments fall
R&D units which are engaged in basic research. As both the process
and outputs are unclear, the quantity and the quality of inputs or
resources provided to these departments is to be managed.
QUESTIONS1. Why is management control important? (Ref. Prelude).2. What is meant by the term management control? (Ref. 1.1.4)3. (a) Discuss the boundaries of management control. (Ref. 1.2)
(b) Is there any difference between strategy formulation,
management control, operational control, and financial control?
(Ref. 1.2)
4. All Management Control Systems are effective. Discuss. (Ref. 1.3).5. What are the factors that should be considered while designing
management control systems? (Ref. 1.4).
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FORMULA AND BASIC STEPS
While solving the problems relating different chapters the
following Formula / steps / basic knowledge which must kept in
mind.
ELEMENT OF COST AND OUTPUT COSTING
1) When the closing stock of finished goods is not given Finding outclosing finished goods
Opening stock of finished goods x
Add purchase of manufactured goods xx
Add Goods produced during the period xx
xxxxx
Less : sale of goods xxxClosing finished goods xx
2) When the sales are not given Finding out salesOpening stock of finished goods xx
Add purchase of finished goods xx
Add goods produced during the period x
xxxxx
Less Closing stock of finished goods xx
Goods Sold xxx
3) When the goods produced is not givenFinding out goods producedClosing stock of finished goods xx
Add sales (Goods sold) xx
xxxx
Less opening stock of finished goods x
Less purchase of finished goods x
Goods produced / manufactured xx
4) When the opening stock of finished goods is not givenFinding out opening stock of finished goods
Closing stock of finished goods xx
Add sales (Goods sold) xx
xxxx
Less Goods produced xx
Opening stock of finished goods xx
5) Cost per unit =producedunitsofNo
productionofCost
6) Valuation of Closing stock of finished goodsIt is valued at cost per unit
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Value of closing finished goods = Cost per unit closing finished
goods
OR
Closing finished goods =
unitperCost
stockclosingofValue
7) Valuation of Opening stock of finished goodsThere are two methods for valuation.
1) If the purchase price of finished goods are givenIn such case opening stock of finished goods should be
valued at price of finished goods.
Value of opening stock = Opening finished goods
Purchase price of finished goods
2) If the purchase price is not given. In such case opening stockis valued at cost per unit.
Value of opening stock of finished goods = Cost per unit
opening finished goods
8) Selling expenses should be calculated based on the number ofunits sold.
Selling expenses = Number of units sold x selling expenses per unit
sold.
9) Adjustment of opening and closing stock of work in progress beforeworks cost.
10) Adjustment of opening and closing stock of finished goodsbefore cost of goods sold.
MATERIAL CONTROL
1) Re-order level = Maximum consumption Maximum Deliveryperiod RL = MaC MDP
Reorder level = Minimum stock + Average Consumptions (Safety of
stock) during normal delivery
Time (i.e Lead time consumption) i.e. Re-order level = Safety of
Stock + (Average consumption) (Lead Time)
OR
Re-order level = Normal Consumption (Minimum Stock Period +
Average Delivery) NC (MnSP ADP)
2) Minimum Stock Level = Reorder level - (Average Consumption Average Delivery Period) MiSL = RL (AC ADP)
Note :
a) Average Stock =2
Con.MaximumnConsumptioMinimum
(Normal)
b) Average Deliver period
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2
PeriodDeliveryMaximumPeriodDeliverMinimum
Safety Stock =days365
DemandAnnual
(Maximum Delivery period - Normal Delivery period)3) Maximum Stock level = Reorder level + ordering quantity -
minimum (Consumption Minimum Delivery Period)
MaSL = RL + EOQ - (MiC MiDP)
OR
Maximum Stock Level = Safety Stock + EOQ
(Minimum Stock Level + Ordering Quantity)
4) Average Stock level =2
LevelStockMaximumLevelstockMinimum
OR
Average Stock level = Minimum Stock Level +2
1Reorder quantity
5) Danger level = Minimum Consumption Emergency Deliveryperiod
6) EOQ (Economic Ordering Quantity)C
OA2EQOR
C
AO2EOQ
Where A = Annual Consumption
O = Ordering Cost or Buying Cost per order
C = Carrying Cost is storage Or Holding of inventory costs
Note : 1) Carrying Cost includes
Cost of Storage space
Cost of bins
Cost of Insurance
Cost of Spoilage
Cost of Obsolescence
Cost of..........i.e. Evaporation
Interest on Capitals invested
Cost of maintaining the materials to avoid deteriorationand cost storage.
2) Cost of Carrying is Calculated on material cost.
Cost of carrying cost = Material cost x carrying cost
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INVENTORY TURNOVER RATIO
Inventory Turnover Ratio =StockAverage
ConsumedMaterials
Inventory Turnover Ratio in days =
RatioTurnoverInventory
365
Total Inventory Cost = Ordering Cost + Carrying Cost + Purchase Cost
LABOUR COST
1) Labour Turnover Ratea) Separation method =
100periodtheduringworkersofnumberAverage
periodtheduringsSeparationofNumber
b) Replacement method =
100periodaduringworkersAverage
periodainreplacedworkersofNumber
c) Flux method =
100workersAverage
tsreplacemenofNoseparationofNo
2)Time wagesEarning = Time taken Time rate
3) Straight piece rateEarning = Output Piece rate per unit
Note : If the output not given
Earnings = Standard Time allowed Rate per hour
1) Differential piece rate(A) F.W. Taylors Plan
Earnings = output differential piece rate
Differential piece rate
Law piece rate = 80% of piece rate below standard.
High piece rate - 120% of piece rate at or above standard.
(A) Merrick differential piece rate system
Earnings = output differential piece rate
Three piece rates :1) The lowest rate is for the beginners
2) The middle rate is developing workers
3) Highest rate is for highly efficient workers
Rate of remuneration are :
Level of efficiency Rate
Below 83% Piece rate
upto 83% to 100% efficiency 110% piece rate
Above 100% efficiency 120% piece rate
Formula for Calculation efficiency
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Efficiency = 100outputstandard
outputActual
2) Combination of Time and piece rate1) Gantt Task and Bonus system.
Earnings = Time taken Time rate Bonus on Time wages(Time wages)
Wages computed is as follows :
Output Payment / Rate of Bonus
Output below standard Time wages (No bonus)
Output at standard Time wages + Bonus 20% of
Time wages
Output above standard High piece rate
Note: If high piece rate is not given in such case Time wages +
130% of Time wages.
2) Emerson efficiency plan :Earnings is calculated as follows :
Efficiency Payment
Below 3266 % Time wages (No Bonus)
66.66% to 100% Time wages + Bonus 20% of
Time wages
Above 100% Time Wages + 20% Bonus
Time wages + 20% Additional
Bonus for every 1%
Increase in efficiencyEarnings = Time wages + Bonus on Time wages
Time wages = Time taken Time rate
3) Bedaux Point SystemEarnings = Hours worked Rate per hour + Bonus
Bonus = hourperRate100
75
60
SavedPoints
PREMIUM BONUS PLANS :
1. Halsey Plan :Earnings = Time wages + Bonus
Time wages = Time taken Time rate
Bonus = 50% of Time Saved
So earnings = Time taken Time rate + of Time Saved Time rate
2. Halsey - Weir Premium PlanEarnings = Time wages + Bonus
Bonus = hourperRatesavedTime100
33 31
Earnings = rateTimesavedTime100
33rateTimetakenTime 3
1
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3. Rowan Plan :Earnings = Time Wages + Bonus
Bonus = rateTimetakenTimeTimeStandard
SavedTime
Earnings =rateTimetakenTime
timeStandard
savedTimerateTimetakenTime
OVERHEAD
Overhead Absorption Rate =absorptionforBasis
Overhead
(Overhead recovery rate)
Machine hour rate =hoursMachine
Overhead
Machine hour rate =hoursMachine
ExpensesMachine
Labour hour rate =hoursLabour
Overhead
Percentage of material cost = 100MaterialDirect
Overhead
Percentage of Labour Cost = 100hoursLabourDirect
Overhead
Labour hours = Daily working hours No of working days No of
workers in each Department
CONTRACT COSTING
Profit on incompleted Contract :
1) For the Contracts which have just started i.e. If the works certifiedis less than of contract price. No profit is transferred to profit &
Loss A/c. So entire profit retain as Reserve.
2) When the work certified is or more but less than of thecontract price. In such case the following formula is used to
determine the amount credited to Profit & Loss A/c.Profit & Loss A/c =
CertifiedWork
receivedCashProfitNational
3
1
OR
Profit & Loss A/c = receiveCashofPercentageProfitNational3
1
3) When the work certified is or more but less than of thecontract price. In such case 32 of notional profit is transferred to
P&L A/c.
Profit & Loss A/c = CertifiedWork
receivedCash
3
2ProfitNational
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Profit & Loss A/c = receiveCashofPercentageProfitNational3
1
4) If the work completed is 3/4 or rearing completion of the contracti.e. contract is almost complete. In such case profit transferred to
profit & Loss A/c. based on estimated profit.Profit & Loss A/c =
PriceContract
receivedCashProfitEstimated
Work Certified =receivedcashofPercentage
100receivedCash
OPERATING COSTING / SERVICE COSTING
1) Calculation of Number of Cost UnitsIn case of Bus/Passenger Transport.
Total Passenger Kilometer = No of buses Trips Distance
Seating Capacity of each bus No of
days percentage of seat occupied.
OR
Total passenger Kilometer = Total passenger carried during the
period total kilometers run during
the period.
In cased Goods Transport
Total Tonne Kilometer = No of Trucks Trips Distance
Loading Capacity Days percentage
of load Available.Total Tonne Kilometer = Total Tonnes carried Total Km. of
Trips Tonnes carried.
2) Calculation Kilometer runKilometer run = No of buses/Trucks Distance Trips
Days
3) Calculation of Total Passenger carried during the period.Total passenger = No of buses Trips Seating Capacity Days
4) Calculation of Total Tonnes carriedTonnes Carried = Total Tonnes carried during the period Total Kilometer run during the period.
In Case of Hotel
Room/Guest days = No of Rooms No of Weeks or month Days
in a week or month % of Room occupied.
OR
Guest days = No of Rooms No of days in a year No of
beds percentage of room occupied.
In case of Cinema Costing
Men shows = No of seats Daily shows No of days in a
year Capacity weightage.
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In case of Hospital Costing
Patient days = Number of days number of patients.
PROCESS COSTING
1.Normal loss = Input
percentage of loss on onput
2. Scrap = Input percentage of Scrap on input3. Normal output = Input Normal loss Scrap By Product4. Abnormal loss = Normal output Actual output5. Abnormal gain = Actual output Normal output6. Cost per unit =
outputNormal
productsbyofSalevalueScrapcostTotal
MARGINAL COSTING
Contribution = Sales Variable Cost
OR
Contribution = Fixed Cost + Profit
Sales Variable Costs = Fixed Costs + profit
OR
S V = F + P
From the above Equation if out of four three factors are in
the Equation. The fourth factor can be easily find out.
1. If Profit is not givenProfit = Sales Variable Cost Fixed Costor
Profit = Contribution Fixed cost
or
Contribution = Sales V
Pratio
Percentage of Profit = Percentage of margin of safety percentage of
V
Pratio
2. If Fixed Cost is not givenFixed cost = Contribution Profit
or
Fixed cost Contribution + Loss
or
Fixed cost = Total cost Variable Cost
Total Cost = Fixed Cost + Variable Cost
Fixed Cost = BEP Sales V
Pratio
At BEP sales contribution and Fixed Cost are equal. So at BEP
sales Contribution is the fixed cost
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Contribution = Sales V
Pratio
3. If Variable Cost is not givenVariable Cost = Total Cost Fixed Cost
orVariable Cost = Sales Contribution
or
Variable Cost = Sales Fixed cost profit
or
Variable cost in Percentage =SalesinChange
costtotalinChange
or
Variable Cost = Sales percentage of V.C. on Sales.
4. If Sales is not givenSales = Contribution + Variable cost
Sales Price unit =unitsofNumber
BEPatSales
Profit Volume Ratio (V
Pratio or PVR)
1)V
Pratio =
Sales
onContributi
2)V
Pratio =
Sales
CostVariableSales
3)V
Pratio =
Sales
ProfitCostFixed
4)V
Pratio =
SalesinChange
onContributiinChange
5)V
Pratio =
SalesinChange
Loss/ProfitinChange
6) Required Sales =
ratioV
P
ProfitDesiredCostFixed
Break Even Point (BEP)
1) BEP (Sales Value) =
ratioV
P
CostFixed
2) BEP (in units) =unitperonContributi
CostFixed
3) BEP (Sales Value) =unitperonContributi
unitperPriceSellingCostFixed
4) BEP (Sales Value) =(Total)onContributi
(Total)ValueSalesCostFixed
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5) BEP in Sales = Actual Sales Margin of Safety
Margin of Safety
Margin of Safety =
ratioV
P
Profit
Margin of Safety = Actual sales BEP Sales
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Nature and Significance of Cost Accounting
Need for Cost Accounting
Modern era is called the Industrial era. Everywhere there is a
vast development in the field of industry. On account of the
development of the industries, the modern industries require
minimum cost of production and as such maximization of profits. For
this purpose, they depend on the financial statements such as trading
profit and loss account and the balance sheet. But these financial
statements give information as whole. It means the entire industry is
treated as one unit, it is a difficult task to locate the errors. y But
modern management needs much more detailed information than /the
one supplied by these financial statements. Thus the Cost Accounting
has been primarily developed to meet that or the required need of the
management.Cost Accounting is a recent development. It is the branch of
financial accounting. It maintains the records unit wise, processwise,
jobwise, departmentwise. At the end, we can easily control or help in
reduction of costs by preparation of the statements unitwise or
jobwise. So, cost Accounting is developed basically to remove the
limitations of financial accounting.
Limitations Financial Accounting : Financial Accounting
suffers from the various draw backs. They are as follows :
1. Collective Information : Financial Accounting supplies the
information regarding profit and loss to the management collectively.
Where in the whole industry is treated as one unit. But it is a difficult
task for controlling or reducing the cost. Because if the factory is
under loss in any year or profit is decreased, then the management is
to locate the reasons, and also the person responsible. But in financial
accounts no one is. responsible because every person escapes from
his responsibility stating that his department is not responsible.
But in cost accounting the records are maintained units wise,
processwise or job wise and the responsibility can be fixed. It helps for
controlling and reducing the cost.2. Historical in nature : Financial accounts are prepared at the
end of the year. It means, for the whole year expenditure is incurred,
then after closing the accounts or at the end of the accounting year
calculation of how much expenditure is incurred and what will be the
costs per unit is made. There is no proper system of control and
calculation of the day to day cost.
Financial accounting is like a thermometer which can tell us the
temperature of the body only but cannot diagnose the disease.
3. Materials and supplies are not properly controlled.
(No proper methods for the control of materials and supplies)
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There is no proper method for controlling of materials and
supplies, which leads to loss wastages, deterioration, excessive scraps
and misappropriation of the materials.
4. Expenses are not classified : Expenses are not classified,
such as Controllable and Uncontrollable, Direct and Indirect and
Fixed and Variable.
These classifications help in controlling and reducing the cost.
For example: If the profits of the company are decreased as compared
to the previous year, the management has to find out the reasons as
to why the profits are decreased, whether it was due to direct
expenditure or indirect expenditure. But when the expenses are not
classified, it is difficult task to control or reduce the cost.
5. Fails to help in cost reduction : It is not possible to
maximize the profits, since cost reduction is not possible under the
financial accounting system. In the modern era, profits can bemaximized only by increasing the volume of sales and sales can be
increased if the prices charged are competitive and comparatively low.
6. Fails to provide cost information in price fixation : It is
very difficult to fix the prices of production on services, or tenders
because the financial accounts do not provide detailed cost
information.
7. Labour cost is not recorded Jobwise : In financial
accounting, labour costs are not recorded processwise or job wise. It is
very difficult to find out the cost per unit or process or job. There is no
system of incentives which may be easily used to compensate the
workers for their above standard performance.
8. Fails to provide information for appraisal and comparison :
Financial accounting does not provide information to the management
for appraisal and comparision of the profits under alternative
methods. Not only this, even it fails to provide useful information to
management for taking vital decisions such as replacement of labour,
introduction of new techniques or make or buy the products etc.
COST ACCOUNTINGIntroduction :
There is a quick deriving worlds of economic activity in this
modem world, when the competition is the deciding fate of commercial
and industrial units. Price of commodity or a service is the instrument
to measure its success or failure. If price is a policy, cost is the
determent of this price. It is the cost which makes a unit to flourish or
to kiss the dust. That is why every management should keep abreast
of its cost structure. So that it can create, substain and extend the
demand for them. Therefore cost acts as the spring board to take a
jump in the deep water of the business. Cost is the very foundation on
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which the super structure of business can be built. Cost, Costing,
Cost Accounting and Cost Accountancy
These three terms are often used interchangeably. However,
there is a definite distinction between these terms which should be
kept in mind while using these terms.
Cost :
For a common man cost of a meal is its price, and price implies
value expressed in terms of money. In fact, it should mean cost of
preparing and making the product (meals) ready for consumption.,
Therefore cost means a sacrifice. It is the amount of expenditure
incurred, on a given thing or in rendering service. It is nothing but on
outlay. In other words, it is the amount spent on given item.
Definitions :
1. W.M. Harpur A cost is the value of economic resources used as aresult of producing or doing the thing costed.
2. I.C.M.A. London Cost is the amount of expenditure incurred on orattributable to a given thing.
3. According to Oxford Dictionary, Cost is the price paid forsomething.
4.The committee on cost concepts and standards of AmericanAccounting Associations defined cost as follows :
Cost is a foregoing, measured in monetary terms incurred or
potentially to be incurred to achieve a specific objective.
5. Gordon Shilling Law defined Cost presents the resources that havebeen or must be scarified to attain a particular objective.
The resources may have tangible (e.g. Materials, Machinery)
or they may take the form of services (e.g. wages, rent power or
time spent).
Thus cost is the amount of resources given up in exchange
for same goods or services. The resources given up are generally in
terms of money or if not in terms of money, they are always
expressed in monetary units.
The term cost is a generic term purposely defined and used
in a variety of ways so as to encompass all the various types ofcosts. So the word cost is used in such a wide variety of ways that
it is advisable to use it with an adjective or phrase which will
convey the meaning intended.
Cost, Expenses, Loss
These are three different terms.
COST
It is the amount of expenditure incurred on or attributable to
cost, objective. It is a measure of resources that is or must be
sacrificed for a cost of objective, E.g. Factory overhead (manufactory
overhead is treated as cost) i.e. Asset included in the cost of finishedgoods inventory which is an asset unless sale is made as it is.
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DEFERRED COSTS
Deferred costs are the expenses, incurred but the economic
benefit is not received during the accounting period. Generally, it is
shown on the asset side of the Balance Sheet.
Examples :
Acquisition of plant & Machinery, Building Equipment cost of
inventory.
Prepaid rent and Insurance.
EXPENSES OR EXPIRED COSTS
When the amount is spent and the economic benefit is received
immediately is called expenses. It is charged to profit and loss a/c it is
also called as expired costs. Expired costs (expenses) are properly
deducted form the revenue to calculate the net income.
Expense is incurred that is used up in generating revenues. It is
paid or a promise to pay made for the benefits obtained.Examples of Expenses
Selling expenses
Distribution expenses
Administrative expenses.
Expenses may be described as the gone asset i.e. as the benefits
or resources used for of securing revenue.
LOSS
When the actual expenses exceed the incomes is called loss. In
other words no benefit is received from the cost incurred.
Thus when there is no matching concept (matching of revenues
and expenses) of economic benefit for expired cost is called loss.
Which is charged to Profit & Loss A/c.
Chart showing cost expenses and loss
Expenditure
Cost
Deferred Cost Expired Costor
Unexpired Cost
Balance Sheet Expenses Loss
Profit & Loss A/c
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Types of Costs
or
Different Cost Concepts
1) Historical Costs :
These costs are ascertained or collected after they are incurred.
These costs are past events or past mortem costs.
2) Future costs :
The costs which are expected to be incurred at a later point of
time.
3) Replacement cost :
It is the cost of replacement in the currentmarket.
In otherwords
Current cost of replacing an asset is based on the assumptions
that if the asset is replaced now the current market value will be
incurred for its replacement.4) Standard cost :
It is a predetermined cost based for each element of cost viz
material labour and overheads based on scientific study.
5) Estimated Cost :
It is an approximate assessment of what the cost will be. It is
based on past experience adjusted to anticipated future changes.
6) Product Cost :
The Cost which can be directly charged allocated and
apportioned to a product is called product cost.
7) Production Cost :
Prime cost plus absorbed production overhead is called
production cost.
8) Direct Cost :
The costs which can be identified with a specific product,
process and departments are called Direct Costs.
9) Prime Cost :
The aggregation of direct material cost, direct labour cost and
direct expenses is called Direct cost or Prime cost.
Note : According to the terminology of ICMA Landon The term directexpenses has been excluded from Prime Cost recently.
10) Indirect Cost :
The costs which cannot be identified to particular department
are called indirect cost.
11) Fixed Cost or Period Cost :
Fixed cost is a cost which does not change in total for a given
period of time despite the wide fluctuation in output. It is called
overhead / Expired cost.
These costs (Total amount) will remain the same irrespective of
output. Such costs are incurred for a period and that is why they arecalled period cost.
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12) Variable cost :
The cost which changes with the level of activity or output is
called variable cost.
In other words variable costs are the costs that vary directly and
proportionately with the output. E.g. Direct Material cost, Direct
Labour Cost.
13) Opportunity Cost :
The Maximum possible alternative income that is earned if the
resources are applied to some alternative use.
In other words, Opportunity cost is the cost of selecting one
course of action in terms of the opportunities which are given up to
carry out that course of action.
Definition :
Edward Hermanson and Salmonson define an opportunity cost
as the benefits lost by rejecting the best competing alternative to theone chosen. The benefit lost is usually the Net earnings or profits that
might have been earned from the rejected alternative.
From the above definition it is clear that the opportunity cost of
any asset is the amount that can be received if the asset is utilized in
its next best alternative. Opportunity costs are often market values.
In short, Opportunity cost is the value of a benefit, sacrificed in
favour of an alternative course of action.
14) Controllable cost :
It is the cost which can be controlled by managing properly at a
given organizational level E.g. Indirect labour, Power Costs.
15) Non-Controllable Cost :
The costs which are not controlled at any level of managerial
supervision.
16) Imputed cost or Notional Cost :
The costs which are not actually incurred but considered in cost
accounts are called Notional Cost.
According to ICMA London Notional cost as the value of a
benefit where no actual cost is incurred.
Examples of Notional Costa) Notional Depreciation :
It is fully written off in respect of asset but still having some
useful life.
b) Notional rent is charged on own premisesc) Provision for Interest on Own capital but actually no interest
is paid.
17) Joint Costs or Common Costs :
Joint costs arise where the processing of a single raw material
or production resources results in two or more different products
simultaneously.
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In other words when the raw materials are processed two or
more products are obtained, such products are known as Joint
products. Expenses on raw material is called Joint Cost.
Thus Joint Cost is the cost of two or more products that are
produced simultaneously by a single process and are not identifiable
as individual types of products until a certain stage of production
known as the split-off point is reached. Joint costs are distributed to
different products on suitable bases.
In short Joint Costs are total costs incurred upto the Point of
Separation.
Examples of Joint Cost
Kerosene
Fuel Oil
Gasoline
CoalFlour mill
18) Sunk cost and Sunk Loss :
These costs are the past costs, which are not taken into account
in decision making. In other words a cost which incurred or had been
already sunk in the past and is not relevant in a particular decision
making at the present time.
This is an irrecoverable cost as a result of discarding of an
asset. Thus, the Written Down Value (WDV) of a machine less
realizable value of scrap is the sunk cost and will not be taken into
consideration in the machine replacement decision. The loss will be
treated as the Sunk loss.
19) Programmed Cost :
These are costs relating to the top management decision for
example company incurred the expenditure under the government
programmes. E.g.
1) 20 Point programme initiated by the government.
2) Some of Employees will send to foreign trip for business. 20)
20) Differential Cost :
Change in total Cost from one level to another level of activity iscalled Differential Cost. It is also called incremental Cost. In short
It is the difference in total cost between alternatives calculated
to assist the decision making.
21) Discretionary / Managed Cost / Policy Cost
Expenditure incurred for Research and Development policy is
called policy cost.
These cost are of fixed nature and incurred in accordance with
the certain policy decisions of top management. These costs may not
have any particular relation to current level of activity i.e. Input and
output. Even expenditure may be incurred in excess of currentrequirements.
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Examples :
Research and Development
Employee Training programme
Advertising
Sales campaign
Donations etc.
There costs are also called managed cost.
In USA it is called programmed cost.
22) Conversion Cost :
The Cost or expense which is incurred for converting the raw
material into finished product is called Conversion Cost.
Examples :
Direct Labour
Direct Expenses
Factory OverheadIn other words Total amount of direct wages and Production
overhead in connection with converting raw materials into work-in-
progress and finished goods.
Note : Direct material cost is not included.
23) Relevant Cost :
The Costs which is appropriate to a specific management
decision is called Relevant Cost.
24) Set down cost :
The Cost incurred will be continued even if the plant is
temporarily shut down.
Examples :
Rent & Rates
Taxes
Maintenance
Depreciation
25) Postponable Cost :
The Cost which can be shifted to the future is called
postponable cost.
26) Out Pocket Cost :While imputed costs do not involve cash outlays, out of packet
costs signify the cash cost associated with an activity. Non-Cash
costs, such as depreciation are not included in out of packet costs.
In other words the cost which involves the cash outflow due to a
particular management decision.
Example : Depreciation on asset is an item of cost which will not
form part of outpocket cost, because it does not involve cash outflow.
27) Marginal Cost :
It is the cost of one unit of product of service. In other words, it
is the total of direct material, direct wages, direct expenses and
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variable overheads in relation to product or service, or process or
departments.
28) Traceable Cost :
A cost which can be directly identified with cost unit or cost
centre is called Traceable cost.
29) Capacity Cost :
It is an alternative term used for fixed cost. It represents costs of
providing facilities of a system for a particular period.
30) Committed Cost :
It is a fixed cost which advises on account of decisions of prior
period. The amount of committed cost is fixed by decisions which are
made in the past and are not subject to managerial control in the
present.
Example : Insurance Premium
RentDepreciation
31) Avoidable Cost :
It is the specific cost of an activity of business which can be
avoided if the activity did not exist.
32) Decision Driven costs :
The Costs incurred as per the policy decisions which will
continue to be incurred until the decisions are changed. Such costs
are not changed with the changes in the output.
33) Target Cost :
A Product cost is estimate on the basis of competitive market
prize. Such costs are called target cost.
34) Quality Related Costs :
The expenses incurred for ensuring and assuring quality are
called Quality costs.
35) Social Responsibility Cost :
In order to produce or provide social responsibility some
expenses are incurred. Such costs are social responsibility costs.
E.g. Pollution by industrial effluent.
ACCOUNTANTS AND ECONOMISTS CONCEPT OF COST
The term cost is wider in economics than in accounting. Both
discipline take into account all costs the organization actually incurs.
Accountants concept of Cost
Generally cost means expenses incurred for production of goods
and services. In other words Accountants cost is the cost incurred by
a firm on the factors/inputs hired by it from outside.
According to accountants cost includes cost of material, labour,
depreciation, interests and other expenses.
Thus the term cost in managerial sense includes that arerelated with production and selling of the organizations goods and
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services. / In short, companys revenues less the cost that are
incurred by producing and selling the goods and services sold equal
profit or loss.
The owners of the company decide how to use this profit. Profit
can be distributed to the owners, or they can be left in the
organization to finance further investment. The partly or total
distribution of profit to the owners provides them an interest return
for the financial means they invested in to the company. Hence, cost
in a managerial sense do no include interest for the owner s
investment into the company. These interests have to paid from profit.
In business management returns to owners have to paid from
profits.
Economist Concept of Cost
Cost means price, price means value expressed in terms of
money.Economic cost includes accounting cost and the cost the firm
would have incurred on those factors or inputs which are contributed
by entrepreneur.
According to economist cost is an opportunity cost. In
economics cost includes an adequate interest return on the capital
invested by the owners. Opportunity costs are the costs or
compensation for not exploited alternative opportunities. Thus
economics take into considerations that the owners could invest their
money differently than into his particular organization e.g. Bonds,
Shares Funds, property etc. As compensation for the (Secure) interest
returns the owners would get from these alternative investments, the
economist allocates an adequate interest return on the capital
invested into a company to the owners. Hence costs in an economical
sense includes all those costs that are necessary to keep the company
in business including a compensation for owners.
A famous economist J.M. Clerk in his book stated that Studies
in the economics of overhead costs is indicative of the fact that the
term cost has a wide variety of meanings and as such the same
should be defined and understood in its proper context. For example,To Customers,
Cost is the price he pays for a commodity
To the Economist
Cost includes explicit or accounting costs and also the imputed
costs.
Engineers
The engineer is concerned with the comparisions of total cost for
different kinds of plant.
Psychologist
The psychologist is concerned with psyctic costs of the nature ofmental dissatisfactions.
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Sociologist
Sociologist is concerned with the social costs. Such as the some
nuisance of a factory.
Distinguish between Accountants cost and Economist Cost
It is important to differentiate between accountants cost and
economic cost.
Points Accountants cost Economists Cost
1 Importance 1 The accountants view of cost
stresses out of pocket
expenses historical costs,
depreciation and other book
keeping entries
1 Economists focus on more
opportunity cost.
2 Labour costs 2 Expenditures on labour are
current expenses and hence
cost of production.
2 Labour is an explicit cost.
Labour services are contracted
at some hourly wage and it isassumed that this is also what
the labour could earn in
alternative employment.
3 Capital costs 3 Accountants are the historical
price of capital and apply
some depreciation rate to
determine current costs.
3 Economists refer to the
capitals original price as a
Sunk cost and instead regard
the implicit cost of the capital to
be what someone else would
be willing to pay for its use.
4 Cost ofEntrepreneurial
services
4 Accountants believe that theowner of a firm is entitled to
all profits. Revenues or losses
left over after paying all inputs
costs.
4 Economists consider theopportunity cost of time and
funds that owners devote to the
operation of their firms. Part of
accounting profits would be
considered as entrepreneurial
costs by economists.
5 Distinction of
costs
5 Costs are not distinguished. 5 Costs are distinguishes such as
fixed cost and variable costs.
6 Type of cost 6 It is a partial cost 6 It is a full cost
COSTING
As per the words of I.C.M.A. of London costing is the
Techniques and processes of ascertaining costs. These techniques
are the rules and regulations to govern or regulate the process of
ascertaining the costs or services. Therefore these rules and
regulations are carried from unit to unit immediately to the industry
and to the formation of policy. Thus costing is a routine work of cost
ascertainment.
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COST ACCOUNTING
Cost accounting means recording of expenditure and income in
a systematic way would be useful in arriving at the cost of production
process, etc.
Definitions :
Van Sickle defined Cost Accounting is the science of recording
and presenting business transactions pertaining to the production of
goods and services whereby these records become a method of
measurement of a means of control.
Gordon shilling law Cost Accounting is defined as the body of
concepts methods and procedures used to measure, analyse, or
estimate the cost profitability and performance of individual products
departments and other segments of a companys operations for either
internal or external use of both and to report on these questions to the
interested parties.According to H.J. Wheldon : Cost Accounting is the classifying,
recording and appropriate allocation of expenditure for the
determination of the costs of products or services, the relation of these
costs to sales values and the ascertainment of profitability.
Stallmen and Russel define to cost accounting as that portion of
the accounting discipline concerned the development of cost
information related to the activities of an economic entity. This
information may be estimated future costs developed for planning
purposes or accumulated actual costs directed toward the evaluation
of performance. It may emerge some what routinely out of a carefully
designed system which has been developed to provide information
regarding recurring activities or be the result of a special cost study
directed to an objectives not considered in the design of a regular
system.
According to Morse : Cost Accounting is the processing and
Evaluation of monetary and non-monetary data to provide information
for external reporting, internal planning and control of business
operations and special analysis and decisions.
According G. Gillespie : Cost Account is a set of procedures fordetermining the cost of product and various activities involved in its
manufacture and sales and for planning and measuring performance.
According to Charles T. Hongren : Cost Accounting is a
Quantitative method that accumulates, classifies summarizes and
interprets information for three major purposes :
a) Product Costingb) Operational Planning and Control andc) Special Decisions.
Gerald E. Nicholas defines Cost Accounting as a system of cost
accumulation and classification of product costing and managerialplanning control and decision making purposes.
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ICMA London defines cost accounting as Process of accounting
for cost from the point at which expenditure is incurred or committed
to the establishment of its ultimate relationship with cost centres and
cost units. In its widest usage, it embraces the preparation of
statistical data, the application of cost control methods and
ascertainment of profitability of activities carried out or planned.
From the above definitions, it is clear that cost accounting is the
process of accounting for costs which begins with the recording of
income and expenditure and ends with the preparation of statistical
data.
The cost accounting provides data on the costs incurred in the
distribution of product, and in the administration of the organization.
Cost accounting consists of the methods and procedures
applied to ascertain actual costs for the activities performed in a
business enterprise. Cost accounting provides a means of evaluating aproposed activity by analysing its different cost generating
components and determining cost estimates those components and
for the overall activity.
Thus cost accounting is used to accumulate costs and report
business activities to the needs of management and should be
adaptable to the changing and specific requirement and management
style.
Cost Accounting is the science, art and practice of cost control
of a cost Accountant.
SCIENCE
It is a science because it has its own set of principles which are
applied to solve the problems of commerce and industry.
In other words, Science, includes the systematic knowledge
which a cost accountant should process for proper discharge of his
responsibilities.
ART
It is also an art because it demands a commanding ability,
talent, skill, rich fund of knowledge to solve the problems. These
problems include the ascertainment of costs, control of costs,ascertainment of profitability, replacement of plants by new and
improved ones, etc.
PRACTICE
It is a practice as it warrants ceaseless efforts of presenting the
information to suit the needs of management in making vital decision.
Thus Cost Accounting is a specialized branch of accounting that
pertains to the activities of classification, accumulation, assignment
and control of cost. Broadly, cost accounting includes three things:-
(1)Cost ascertainment(2)Cost presentation(3)Cost control
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COST ASCERTAINMENT
The main object of cost accounting is to ascertain the cost of
production of goods, services and jobs. First of all the expenses
incurred are collected and classified for calculating the cost of
production. Then these expenses are presented in the form of cost
sheet for ascertaining cost of production.
COST PRESENTATION
It provides the cost data to the management. Cost data helps
the management to take vital decisions. It involves the presentation of
right cost data to the right personnel, at the right time in the proper
form. It presents data in the form of statement called the Cost Sheet.
COST CONTROL
Cost control is the guidance and regulations by executive action
of the costs of operating of the undertaking. Cash Control is achieved
by setting the targets of performance, collecting actual cost forachieved responsibility. Comparing actuals with targets and reporting
to the management about variation from targets so that necessary
action is taken on responsible employees in respect of controllable
items. For controlling the cost, the following steps are taken :
(1)To fix the production and expenses target(2)To compare the actual production or expenses with standard and
to find out the differences.
(3)To find out the reasons for the variances.(4)To take the action to eliminate the variances.
Cost Control and Cost Reduction One should not get confused
with cost control and cost reduction are not one and the same.
Meaning of Cost reduction :
The achievement of real and permanent reduction in the unit
cost of goods manufactured or services rendered without reducing the
quality of the product.
Therefore cost reduction is not cost control.
Differences between Cost Control and Cost reduction
Cost Control Cost Reduction
1 It is the effort towards achieving the costreduction.
1 It is the final result
2 It is a preventive function 2 It is a corrective function
3 It is not dynamic approach 3 It is a dynamic and continuous approach
4 The process of cost control is to set up a
target like any other control measure
4 It is the final achievement in the process
of cost control
5 Cost control assumes existence of
standards
5 It assumes existence of concealed
potential savings in the standards which
are challenged and costs are reduced
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SCOPE OF COST ACCOUNTING
(coverage of the study of cost accounting )
Scope of cost accounting means what exactly we study in cost
accounting. So the scope of cost accounting is wide. It covers the
following aspects.
1) Cost ascertainment2) Cost presentation3) Cost control.
The above points have already been explained
Difference Between Costing and Cost Accounting :
One should not get confused with the words Costing and Cost
Accounting. These words are used interchangeably in common usage.
There is a vast difference between these two terms. Costing is
arithmetic process employed to find out the cost of a product or
service.Cost Accounting denotes frame work for ascertaining cost and is
employed to forecast and control costs. It is a very comprehensive
term.
Therefore, we can say that Cost Accounting is costing but only
costing is not Cost Accounting. In other words costing is the childhood
state of cost accounting.
COST ACCOUNTANCY
It is the widest of all terms and it embraces not only Costing
and Cost Accounting but also Cost Control, Cost Audit and Budgetary
Control.
Definition
ICMA London defined Cost Accountancy as the application of
costing and cost accounting principles methods and techniques to the
science, art and practice of cost control and ascertainment of
profitability as well as presentation of information for the purpose of
managerial decision making.
According to the above definitions the term Cost Accountancy
includes costing, cost accounting, Budgetary Control and Cost Audit.
Cost Accountancy is used to describe the principles,conventions techniques and systems which are employed in a
business to plan and control the utilization of its resources.
Cost Control
Cost control is the guidance and regulation by executive action
of the costs of operating and undertaking.
Budgetary Control
It means the fixation of budgets or estimated cost and
comparison of actual cost with the budget fixed.
Cost Audit
Cost audit is the verification of the correctness of cost accountsand check on the adherence to the cost accounting plan.
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NATURE OF COST ACCOUNTANCY
Cost accountancy is a science an art and a practice
SCOPE OF COST ACCOUNTANCY
It has a vast scope. It includes many aspects. They are
Costing
Cost Accounting
Cost Control
Budgetary Control
Cost Audit
The above points are already explained.
Distinction between Cost Accounting and Cost Accountancy
Points Cost Accounting Cost Accountancy
1 Objectives 1 The main objective of cost
accounting is to ascertain the
cost of production andprofitability of the industry
1 The main objectives of cost
accounting are to ascertain the
cost of production profitabilityof the industry and to help in
controlling the cost.
2 Term used 2 This term is used in the
narrow sense as it records
expenditure, incomes and
allotment of costs to the cost
centres for ascertaining only
cost of production
2 It is a widely used term which
includes costing, cost
accounting and cost
accountancy.
Aims or Objectives of Cost AccountingMost specifically cost accounting is charged with four tasks.
However, the authors like T. Long, Wildson, Big, and even some
Indian authors have given as many as 20 objectives. Keeping aside the
tug, we can see that reflective of all the projective objectives of cost
accounting in the letters of the word AIMS.
In other words there are four main objectives of cost accounting.
A = Ascertaining and analysing cost and income.
I = Insists on cost control or Inventory control.
M = Matching costS = Securing control over cost and operating efficiency.
A = Ascertaining and analysing cost and income :
The first aim is to ascertain and analyse cost and income of a
given enterprise with the intention of having comparison of divisions
at a given level of activity. So that it is possible to assess, the
operating efficiency of each division, department, product etc. Cost
accounting has developed a definite procedure, for analysising,
productwise, customerwise etc.
I = Inventory valuation or Insist on cost control :
Second aim is to accumulate and utilize the cost data for thepurpose of controlling cost. The object of control is to maintain the
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cost at minimum point, cost control consists of examination of each
element of cost, in the light of benefit obtained. So that each rupee
spent brings back optimum return. Such control is achieved through
budgeting, budgetary control and standard costing.
M = Matching Cost :
The third aim is to have matching cost and revenues. It is
important that cost and income data should present the various of
elements cost with reference to the sales for a given period of time.
S = Securing control over costs and operating efficiency :
Costs are classified and records are maintained jobwise,
processwise. Standard time is fixed for completion of work. If the work
is not completed within the stipulated time, necessary action should
be taken against such workers.
Secondly the workers who complete the work within the time
stipulated, for them incentives should be provided. In this way costand efficiency are controlled.
FUNCTIONS OF COST ACCOUNTING
In order to realize the objectives cost accounting has to perform
the following functions.
1) Recording : Cost Book Keeping2) Cost Analysis3) Cost Control4) Cost Comparison5) Quotation6) Cost Planning7) Cost budgeting8) Reporting9) Providing cost information for decision making
1) Recording :
Recording of relevant transaction is the primary function of cost
accounting. Various accounts are maintained according to the
principles of cost accounting. This helps for ascertainment of cost.
2) Cost Analysis :
It means costs are classified into different groups, viz. directcost and indirect cost; normal cost or abnormal cost, etc.
3) Cost Control :
Cost accounting establishes ideal standard costs. Afterwards
comparison of standard cost with actual cost and analysis of
variances to their causes and remedial measures.
4) Cost Comparision :
This is the function of comparing of cost for ascertainment of
profitabilities, projects, proposals, plans and actions. This comparison
helps to take the right decisions at crucial points of time.
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5) Quotation :
It estimates the cost of job or work order more scientifically to
quote the price.
6) Cost Planning :
Each element of cost should be properly planned and expenses
incurred accordingly. The overall cost planning helps the management
in order to activate the objectives.
7) Cost Budgeting :
This function helps to formulate the cost budgets. The budget
means fixing the overall limit of expenses and the cost information
guides to be within the set framework.
8) Reporting :
Revealing and reporting inefficiencies of various elements of cost
units, cost centres, products etc to management.
9) Providing cost information for decision making
ORIGIN AND GROWTH OF COST ACCOUNTING
The evolution of cost accounting is a major progress of human
civilization.
There is evidence that costing was practiced by the Sumerians
in Mesopotamia in 5000 B.C. and it was well-developed in Florence in
the middle-ages. It is reasonable to assume that people at different
periods employed some measures of cost accounting at least to
ascertain the prices to be charged to customers.
The earliest reference to cost accounting is traceable in Robert
Loders accounts 1610-20.
Until 1800 cost accounting was in the domain of the engineer,
because the first book devoted to cost accounting with the title
Factory Accounts was published by Emile Garcke and J.M. Fells in
1883. The work includes as an appendix, a summary of the factory
and workshop Acts of 1878 and 1883. However, electrical and
mechanical engineers were concerned initially with cost records and
with cost accounts. As such memoranda by engineers for engineers
were too important to be left to accounts.Continuous efforts were put to improvise system of cost
accounting both in theory and practice.
A comprehensive book on Cost Accounting Theory and practice
was published by J.L Nicholson from New York in 1913.
The most rapid developments in cost accounting took place after
1914 with the growth of heavy industry and mass production
methods, when costs (i.e. overheads) other than materials and labour
constituted a significant portion of total cost of production. The
scientific management movement led by Taylor gave impetus to the
development of cost accounting because it contributed to the use of
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standard costs in planning manufacturing operations and in
evaluating performance.
The institute of cost and works accountant was established in
U.K. in 1919 to give a proper shape to the cost accounting profession.
In India Institute of cost and works accounting come into
existence through on act passed in the parliaments in 1959. Its head
office is in Kolkotta.
Most importance was given to cost accounting when the
Government of India introduced cost audit under section 233-B of the
Indian companies Act, 1956 and framed cost accounting record rules
in 1968 for this purpose.
At present 44 products come under the fold of cost audit and
the companies producing these products have to maintain cost
accounting records and subject the same to cost audit every year.
Advantages of cost accountingCost accounting is a tool of management. It provides
management with records of the costs of products, operations or
functions. It compares actual costs and expenses with predetermined
budgets and standards. A good system of cost accounting will provide
the following benefits to the management. Advantages to the
management :
1. It discloses profitability of activities.2. It helps in cost control.3. It helps in inventory control.4. It aids in formulating policies.5. It helps in decision making.6. It guides in fixing selling prices.7. It discloses idle capacity.(1) It discloses profitability of activities : Cost accounting discloses
the departmentwise profit or loss. Hence it helps the management for
taking vital decision i.e. if any department or job or process discloses
any loss, the management will findout the reasons for such losses and
take the necessary steps so as to make it profitable.
(2) It helps in cost control : The main object of cost accounting is tocontrol cost. For this purpose budgets will be fixed and the actual
expenses and budgeted expenses will be compared. In case the actual
expenses exceed the budgeted expenses, the management will find out
the reasons for such increased expenses and take the necessary steps
to reduce the cost.
(3) It helps in inventory control : Cost accounting helps the
management for inventory control. For control of inventory, various
techniques are adopted, such as fixing the stock levels, economic
ordering Quantity (i.e. EOQ), Materials turnover ratio, ABC analysis or
pricing of materials.
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(4) It aids in formulating policies : Cost accounting supplies the cost
data which will help the management for formulating the policies for
production, pricing and for preparing tenders and quotations.
(5) It helps in decision making : Cost accounting provides the cost
data and other information which will help the management for
decision making as to whether goods should be produced in own
factory or buy them in open market.
(6) It guides in fixing selling prices : Cost data helps the
management for fixing selling prices particularly during depression
period.
(7) It discloses idle capacity : Some organizations may not be
working with full capacity due to some reasons, such as shortage of
raw materials, lack of demand for goods etc. Cost accounting helps for
finding out idle capacity of machineries. The management will take the
necessary steps to utilize the machinery with full capacity.Advantages to the workers :
1. It rewards the efficient workers.2. It helps for fixing the standard of efficiency of workers.3. It provides job security.(1) It rewards the efficient workers : In cost accounting, wages are
paid generally on piece rate system on the basis of output. Ultimately,
each worker produces more goods in order to earn more wages. Hence
the efficient workers will be benefited by way of wages and bonus, if
any.
(2) It helps for fixing the standard of efficiency : It evaluates the
standard of efficiency of the workers through time and motion study
which helps them for merit rating and job promotions.
(3) It helps for job security : Generally, the efficient workers are not
terminated from their services.
Advantages to Government :
1. It helps in preparing National plans for economic development.2. It facilitates the assessment of excise duty and income tax and
formulation of policies regarding industry, export, import and
taxation.3. Cost accounting provides the cost data which will help the
government for fixing wages, price control, granting of subsidy etc.
4. Cost accounting provides the government for evaluation ofefficiency of public sector undertakings and to take steps for
improving the performance of such undertakings.
Advantages to the Society :
1. People will get better quality goods at a reasonable price.2. Curbing inflationary trend in the economy.3. Public feel that the prices charged by the concerns are fair and
reasonable.
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Advantages to the Creditors :
1. It helps the creditors and investors to judge the financial positionand creditworthiness of the business. In other words, the creditors
and the investors will findout the solvency of the concern on the
basis of the cost data before sanctioning the loans.
2.The cost reports are useful to the creditors for ascertaining thefuture prospectus and profitability of the enterprise.
Disadvantages of cost accounting :
1. Absence of a ready made system2. Cost differences.3. Cost data have no usefulness in themselves.4. It is not true or exact cost.(1) Absence of ready made system : In cost accounting, there are no
fixed rules for ascertaining the cost because the different techniques
are adopted for ascertaining the cost of production by costaccountants.
(2) Cost differences : Since the uniform procedure is not followed by
the cost accountants in ascertaining the cost of production, there will
be difference in the cost arrived by one cost accountant to the other
one.
The following are the reasons for the differences :
(a)Inclusion or exclusion of certain items.(b)Use of different methods for pricing of materials.(c)Use of different methods of classification of expenses.(d)Use of different methods of payment of wages.(e)Use of different methods of absorption of overheads.
(3) Cost data have no usefulness in themselves : The cost data
becomes useful if the management takes actions at right time,
otherwise such data will not be of any use. So the success or failure of
cost accountant depends upon the management ability and
willingness to take the proper decisions at right time.
(4) It is not true or exact cost : Cost ascertained by the cost
accountant is not a true or exact cost because the cost statements are
mainly on the basis of estimations and omission of certain items ofincomes and expenses therein.
Objections against cost accounting :
1. It is unnecessary : Maintenance of cost records is unnecessary. It
is a duplication of work. Because, already records are maintained
under the financial accounting. It gives profits or loss. Even some of
the industries are functioning prosperously without any costing
system.
2. It is expensive : Installation of a costing system is quite expensive.
It is an additional expenditure to the management. In addition to the
financial accounting records, separate cost accounting records are tobe maintained. This causes to increased expenditure.
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9 Use of
Statistical
Techniques
9 Use of statistical techniques
like chart graph etc is very
less
9 Charts, Graphs, diagrams, are
used in this system for
infomsatory reports to
management.
The following examples shows the difference between cost and
financial accounts.
Illustration : 1 The following data relating to Mallikarjun company for
the year ending 31-12-1990.
Rs. Rs.
Materials : Product A 10000 Wages : Product A 7000
Product B 5000 Product B 4000
Product C 3000 18000 Product C 4000 15000
Manufacturing Expenses 1000 each product.
Salaries: Product A 2000 Selling Exp.:Product A 5000
Product B 2500 Product B 2500Product C 1500 6000 Product C 500 8000
Sales A Rs. 35,000 B Rs. 12,000 and C Rs. 13,000. You are
required to show how the profit or loss ascertained in cost, and
financial accounts.
Solution :
Ascertainment of profit or loss as per financial Account Trading
and Profit & Loss a/c
Particulars Rs. Particulars Rs.
To Materials 18,000 By Sales 60,000
To Wages 15,000
To Manufacturing expenses 3,000
To Gross profit 24,000
60,000 60,000
To Salary 6,000 By Gross profit 24,000
To Selling expenses 8,000
To Net profit 10,000
24,000 24,000
Systems of costing : In costing systems the different ways areadopted for charging costs to the product or service or Job.
The following are the different systems of costing :
(1) Historical costing (2) Standard costing
(3) Estimated costing (4) Continuous costing
(1) Historical costing : In historical costing, first of all expenses are
incurred then the cost of product or service is ascertained. It is similar
to post mortem examination. It is also known as Post costing or Actual
or traditional costing.
Advantages :
(1)It is an accurate costing system.
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(2)It is the most suitable system for cost plus contract costing.(3)It helps to make comparison of costs of different periods.Disadvantages :
(1)It is not suitable to the management for control of costs(2)It does not provide any measures for assessing the efficiency of the
costing department.
(2) Standard Costing : It is a pre-determined costs. It means cost is
ascertained in advance on the basis of standard costs. Such standard
costs are useful for comparision of actual costs with standard costs
and if there is way variance between these costs the necessary steps
can be taken to find out the reasons for such variance.
Advantages :
(1)It helps for comparision of Actual costs with Standard costs.(2)It helps for evaluating the efficiency of a concern.(3)It helps for formulating the policies for cost control.(4)It helps for fixing the selling price of the product.(3) Estimated costing : In this system the costs are estimated well in
advance by taking into consideration the probable changes in costs of
materials, labour and overheads in future. Accordingly the costs are
estimated on the basis of past experience and forecasts.
Advantages :
(1)It helps for preparation offenders, quotations and budgets.(2)It helps for compa
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