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Management Accounting

Sandeep Gokhale

Jamnalal Bajaj Institute

University of Mumbai

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Syllabus

• Relevance & Scope• C-V-P Analysis• Cost Classification• Marginal Costing• Standard Costing• Budgeting

• Balance Score card• Learning Curves• Profit Center Mgmt• Transfer Pricing• Over Head Allocations• Cost Sheet Analysis• Inventory Valuation

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References

• Charles Hongren• Khan & Jain• S.C.Maheshwari• Banerjee• Robert Kaplan

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FINANCIAL MANAGEMENT

Objective: Create share holder value

Methodology: Capturing of value at all Levels.

Scalability of Operations

Business Process restructuring

Enterprise resource management.

Vertically integrated operations.

Customer relationship Management

Effectiveness: Proximity of gross profit to net profit

Maximisation of EVA

EV / EBIDTA multiple

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Financial Management – an overview

Business environment

Planning Policies&Decisions

(Management Accounting)

Restructuring

Resource mobilisation

Treasury

Control&Information

( Audit & Taxation)

Valuation Technique

Financial Markets

Investor Wish List

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Financial Decision Areas

• Investment analysis• Working capital management• Sources and cost of funds• Determination of capital structure• Dividend policy• Analysis of risks & returns• Treasury - interest / exchange rate swaps• Restructuring of operations / term debt profile

• To result in shareholder wealth maximisation

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PROFIT AND LOSS ACCOUNT

For the Period 1st April to March 31st

Income:Gross sales from Goods & Services

Less: Excise Duty

Net Sales

Other Income

Non operating Income

Total Income

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Expenditure: Raw materials consumed

Manufacturing expenses

Administrative expenses

Selling expenses

WIP +FG adjustment

PBIDT (Gross Profit)

Less: Interest

Less Depreciation

PBT (Operating Profit)

Less: Tax

PAT (net profit)

Gross cash accruals : PAT + Depn

Net cash accruals : GCA - Dividend

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THE BALANCE SHEET

For the year ended March 31st 200...

Liabilities: Equity share capital

Reserves & Surplus

Term loan

Debentures

Fixed deposits

Other unsecured loans

Commercial bank borrowings

Creditors

Other current liabilities

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Assets: Gross fixed assets

Less: Acc. Depn

Net Block

Investments

Currents Assets: RM Stock

WIP

F.G.Stock

Debtors

Cash in bank

Loans & Advances

Misc.. expenditure

Deferred expenditure

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MANAGEMENT ACCOUNTING

It is the process of Identification, Measurement, Accumulation, Analysis, Preparation, Interpretation and Communication of financial information used by management to plan, evaluate and control an organisation and to ensure appropriate use of and accountability for its resources.

It is thus the process of :

Identification Measurement Accumulation Analysis Preparation and interpretation Communication

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Management accounting is for exercising internal control by the management and hence companies follow different techniques, methodologies to enable them to utilise the results obtained for optimal benefit.

Management accounting is used to:

Plan Evaluate Control Establish Accountability Short Term Business Decisions

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1. Financial accounting serves the interest of external users while management accounting caters to the needs of internal users.

2. Financial accounting is governed by the generally accepted accounting principles while management accounting has no set principles.

3. Financial accounting presents historical information while management accounting represents predetermined as well as past information.

4. Financial accounting is statutory while management accounting is optional.

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5. Financial accounting presents annual reports while management accounting reports are of both shorter and longer duration.

6. Financial accounting reports cover the entire organization while management accounting reports are prepared for the organization as will as its segments.

7. Financial accounting emphasises accuracy of facts whilemanagement accounting requires prompt and timely reporting of facts even if they are less precise.

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DISTINCTION BETWEEN MANAGEMENT ACCOUNTING AND FINANCIAL ACCOUNTING

MANAGEMENT ACCOUNTING FINANCIAL ACCOUNTING

1. PRIMARY USERS ORGANISATIONAL MANAGERS AT VARIOUS LEVELS.

OUTSIDE AGENCIES INVESTORS, GOVT., CLB, SEB ETC.

2. FREEDOM OF CHOICE

NO CONSTRAINTS OTHER THAN COSTS IN RELATION TO BENEFITS OF IMPROVED MANAGEMENT DECISIONS

CONSTRAINED BY STATUTES - TAX - CLB - SEB

3. BEHAVIOURAL IMPLICATIONS

CONCERN ABOUT HOW MEASUREMENTS AND REPORTS WILL INFLUENCE DECISION MAKING.

BEHAVIOURAL ASPECT IS SECONDARY. PRIMARY OBJECTIVE IS COMMUNICATION.

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4. TIME FOCUS FUTURE ORIENTATION

PAST ORIENTATION

5. TIME SPAN FLEXIBLE / NEED BASED DAILY, WEEKLY, MONTHLY, YEARLY.

LESS FLEXIBLE YEARLY.

6. REPORTS DETAILED CONCERN ABOUT DETAILS OF DIVISIONS OF THE ENTITY, PRODUCTS, DEPARTMENTS.

SUMMARY REPORTS - CONCERN WITH COMPANY AS A WHOLE.

7. INPUTS PREDETERMINED EVENTS

ACTUAL EVENTS

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EXTRACT OF FACTORY COST SHEET

A. Direct materials consumed = Opening Stock + Purchases - Closing Stock =________

B. Direct labour = ________ A+B = ________

(prime cost)C. Factory overheads: 1. Indirect materials 2. Indirect labour 3. Factory rent, insurance etc 4. Depreciation for factory 5. Salaries & wages of supervisory staff =_______

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D. = Opening WIP

E . = A+B+C+D = Factory cost of goods available for manufacturing.

F. = Closing WIP

G. = E -F Factory cost of goods manufactured.

H. = Finished goods opening stock.

I. = G + H = cost of goods available for sale.

J. = Closing finished goods.

K. = I - J = factory cost of goods sold.

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INCOME STATEMENT

Gross sales .........................Less : Excise dutyNet sales ....................Less : Factory cost of goods sold .............................Gross manufacturing profit .........................................Less : Selling & distribution expenses.Add : Income other than sales.PBIDTLess : DepreciationLess : InterestLess : TaxProfit after tax

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METHODS OF COSTING

1. Job costing

- Batch costing

- Contract costing

2. Process costing

3 .Multiple costing

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TECHNIQUES OF COSTING

Marginal costing

Absorption costing

Standard costing

Joint product costing

By-product costing

Activity based costing

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CLASSIFICATION OF COSTS

Elements

Functional

Behavioural

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CLASSIFICATION OF COSTS BY ELEMENTS

Direct materials Indirect materials Direct labour Indirect labour Factory overheads (variable) Factory overheads (fixed) Selling and distribution General administration Interest Depreciation

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CLASSIFICATION OF COSTS BY FUNCTIONS

Sales

Marketing

Production

Research & development

Personnel

Administration

Staff welfare

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CLASSIFICATION OF COSTS BEHAVIOURALLY

Variable costs : When costs change in direct proportion to changes in volume, it is called variable costs. Variable cost vary in proportionate with volume. Mathematically, a linear relationship could exist between variable costs and volume.

Fixed costs : When costs remain non-variable (fixed) to changes in volume, it is called a fixed cost. Fixed costs remain at the same level irrespective of changes in volume.

Semi fixed /semi-variable costs : Costs which are partially fixed and partially variable.

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BREAK EVEN ANALYSIS

Cost-volume-profit (CVP) analysis :

The technique to study the behaviour of profit in response to the changes in volume, costs and prices is called CVP analysis. Break even analysis is the most widely known form of CVP analysis.

Break even point :

It is that point of sales at which total revenue is equal to total costs. It is a no-profit, no-loss point.

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BREAK EVEN FORMULA

F = Total fixed costV = Total variable costT = Total costS = Total sales

Total fixed costBEP(Units) = ---------------------

Unit contributionwhere unit contribution = Unit sales - Unit variable cost.

Total fixed costBEP(Rs) = ---------------------- x Unit selling price.

Unit contribution

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•Margin of safety : The excess of actual or budgeted sales over break even sales is called

margin of safety.

Budgeted sales - Break even sales •Margin of safety ratio = ------------------------------------------

Budgeted sales•Break even point is a function of fixed cost, unit selling price and unit variable cost.

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PROFIT VOLUME RATIO (P/V RATIO)

It represents the rate at which the company isgenerating surplus in the financial system.

ContributionP/V = -----------------

Sales

Break even analysis:

Scenario 1 : Company having a high P/V ratio but also having high BEP. Reason : Fixed cost is high.

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Scenario 2 : Company having high selling prices but low P/V ratio, high BEP and a low M.O.S.Reason : High variable cost.

Scenario 3 : Company having high selling price, low variable cost, low M.O.S.Reason : Low volumes.

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PROFIT ANALYSIS

Impact of changing factors

Profits may be affected by the changes in the following factors.

1. Selling price

2. Volume

3. Variable costs

4. Fixed costs

5. A combination of all or any of the above factors.

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UTILITY OF CVP ANALYSIS

1. Understanding accounting data.

2. Diagnostic tool

3. Provides basic information for profit improvement 4. Risk implications for alternative action.

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LIMITATIONS OF CVP - ANALYSIS

1. Difficulty in segregation of fixed and variable costs.

2. The assumption that total fixed costs would remain unchanged over the entire range of volume is not valid.

3. The assumption of constant selling prices and variable costs is not valid.

4. Difficult to use in a multi-product company.

5. It is a short run concept with a limited use in long range planning.

6. It is a static tool.

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MARGINAL COSTING

Marginal costing is also called as direct costing.

It is a system of segregating costs between fixed and variable components and charging the product only the variable cost. It comprises of the prime cost and variable overheads. It highlights the concept of contribution margin, which is the excess of sales over variable costs.

Contribution = U.S.P - U.V.C

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ABSORPTION COSTING

Generally accepted conventional system of product costing and

external reporting. The basic premise on which this system

rests is that all costs, direct and indirect, should be charged to

the cost of goods in a given period.

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DIRECT COSTING VS. ABSORPTION COSTING

1. Sales equals production PA = PD

2. Production exceeds salesPA > PD

3. Sales exceeds production,PD > PA

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RECONCILIATION

Fixed cost Fixed cost PD + allocable to - allocable = PA

closing to opening inventory inventory

VALUATION OF INVENTORY

Direct costing : Only variable cost.

Absorption costing : Full cost

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APPLICATIONS OF MARGINAL COSTING

1. Segregation of fixed and variable costs

2. Emphasis on c-v-p relationship

3. Highlights contribution

4. Avoids allocation of fixed cost

5. Profit planning

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6. Decision making

Pricing special orders

Product mix decision

Make or buy

Sell or process further

Closing of operations

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SHORT RUN DECISION MAKING PROCESS USING MARGINAL COSTING

The following steps/ elements need to be analysed :

1. Identify and define the problem

2. Identify alternatives as possible solutions to the problem

3. Eliminate alternatives that are clearly not feasible

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LIMITATIONS OF MARGINAL COSTING

1. Difficulty in segregation of fixed and variable costs

2. Improper to exclude fixed manufacturing overheads from inventories

3. Wide fluctuations in profits

4. Only a short run profit planning and decision making technique

5. Non-acceptable for external reporting

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STANDARD COSTING

Standard costs are “scientifically predetermined costs”.

They are an estimate prepared in advance, co-relating to a technical specification of materials and labour.

VARIANCE ANALYSIS :

It is the difference between standard costs and actual costs.

Variances are of two types :

a. Favourable variance

b. Unfavourable variance

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STEPS IN STANDARD COSTING & VARIANCE ANALYSIS

1. Establish scientific standards for each element of cost.

2. Communicate these standards through budgets.

3. Cost comparison.

4. Variance analysis.

5. Corrective action.

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BENEFITS OF STANDARD COSTING

- Performance evaluation.

- Management by exception.

- Cost reduction.

- Planning and decision making.

- Optimal resource utilisation.

- Pricing decisions.

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ANALYSIS OF COST VARIANCES BY CAUSES

MATERIALS PRICE VARIANCE

1. Recent changes in purchase of materials.

2. Failure to purchase anticipated quantities when standards

were established resulting in higher prices owing to non-

availability of quantity purchase discounts.

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3. Not obtaining cash discounts anticipated at the time of

setting standards resulting in higher prices.

4. Substituting raw material differing from original

material specifications.

5. Freight cost changes and changes in purchasing and

storekeeping costs if these are debited to the materials

cost.

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MATERIALS QUANTITY VARIANCE

1. Poor material handling

2. Inferior workmanship by machine operators.

3. Faulty equipment

4. Cheaper, defective raw material causing excessive scrap

5. Inferior quality control inspection

6. Pilferage

7. Wastage due to inefficient production method

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LABOUR RATE VARIANCE

1.Recent labour rate changes within industry

2. Employing a worker of a grade different from the one

laid down in the standard

3. Labour strike leading to utilisation of unskilled help

4. Retaining skilled labour at higher rates, so as to

prevent resignations and job switching

5. Employee absenteeism

6. Paying a higher overtime allowance than provided for

in the standard

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LABOUR EFFICIENCY VARIANCE

1. Machine breakdown, use of defective machinery and

equipment.

2. Inferior raw materials.

3. Poor supervision.

4. Lack of timely material handling.

5. Poor employee performance.

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6. Inefficient production scheduling – delays in routing

work, materials, tools and instructions.

7. Inferior engineering specifications.

8. New inexperienced employees.

9. Insufficient training of workers.

10. Poor working conditions – inadequate or excessive

heating, lighting, ventilation etc.

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OVERHEAD VOLUME VARIANCE

1. Failure to utilise normal capacity

2. Lack of orders

3. Excess installed capacity

4. Inefficient utilisation of existing capacity

5. Machine breakdown

6. Defective materials

7. Labour inefficiencies

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BUDGETING

Definition : A budget is a quantified expression of the intentions of the management and operates in a fashion that enables attainment of orgainsational goals.

Elements of a budget are :

1. It is a comprehensive and co-ordinated plan.

2. It is expressed in financial terms.

3. It is a plan for the company’s operations and resources.

4. It is a future plan for a specified period.

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THE MAJOR PURPOSES OF BUDGETING ARE

1. To state the company’s goals.

2. To communicate expectations to all concerned.

3. To provide detailed plan of action for reducing uncertainty.

4. To co-ordinate activities and efforts in such a way so as to maximise resources.

5. Measure for controlling performance.

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TYPES OF BUDGETS

Comprehensive budgeting involves the preparation of a master budget. The three important components of master budget are : i) Operational / functional budgets. ii) Financial budgetsiii) Capital budgets

Budgeting concepts :- Budget period- Fixed time / rolling- A-priori Vs. Posteriori budgeting- Key factors.

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Facets of budgets

Name of budget

What it shows Prepared by Based upon Classification

Sales Estimated sales

Sales department

Historical analysis of sales. Business condition market analysis

Product-wise, territory or client wise monthwise

Production Quantity of production to be manufactured

Production Sales budget, production capacity, stock requirements.

Product-wise, department-wise monthly.

Materials Quantity & value of materials needed for production.

Production & costing

Production budget & stocks on hand.

Item-wise

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Name of budget

What it shows Prepared by Based upon Classification

Labour Labour hours and cost.

production costing.

Production budget Category skill-wise

Production overhead

Estimated overhead expenses for the production department.

Production costing

Production budget & fixed expenses.

Expense item-wise department-wise.

Selling & distribution

Estimated costs.

Sales Marketing information, past experience

Item-wise, territorywise, client-wise

Admin + finance

Estimated costs

Finance Past data. Item-wise

Master budget

Summary of p & l, balance sheet & cash flow.

Finance All operational budgets

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ESSENTIALS OF BUDGETING

The following are the important essentials for a successful budgeting exercise

1. Senior management support

2. Clear and realistic goals

3. Assignment of authority and responsibility

4. Creation of responsibility centres

5. Adaptation of accounting system

6. Full participation

7. Effective communication

8. Budget education

9. Flexibility

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PROCESS OF BUDGETARY CONTROLSpecification of organisational objectives and identification of key factors

Sales Budget

Production Budget

Budget for prime cost & overhead

Budget for sell & dist. cost

Cap. ExpendBudget

Cash Budget

AdministrativeCash Budget

Master Budget

Acc. Var analysis & Rep. Managerial action

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FUNCTIONAL / OPERATIONAL BUDGETS

1. Sales budget

2. Production

3. Material consumption

4. Purchase

5. Labour

6. Overheads

7. Marketing and selling

8. Administration and finance

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SALES BUDGET

The forecast of goods to be sold is the starting point in budgeting. The forecast is prepared after consideration of the following factors:

a) The quantity and value of past sales;

b) Competition and conditions within the particular industry;

c) General economic conditions;

d) Market research and salesmen’s estimates;

e) Sales mix – which is dependent on the relative product profitability

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STEPS

a) Sales forecast by product

b) Product mix : taking into consideration the manufacturing capacity and profitability of product lines.

c) By product type; area and mix which management believes it could sell to achieve company objectives.

d) Customer profile

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PRODUCTION BUDGET

The production budget is expressed in terms of physical units of products. The basic information required is:

Sales budget Units

Add: Closing stock requirements of finished goods

Units

Less: Opening stock of finished goods

units

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The production budget assists in making provision for the following:

a) The stock budgetb) Production planning – what, when and in what quantities

shall it be produced?c) The productive capacity requiredd) The plant utilisatione) In the light of production capacity and plant utilisation,

an estimate of additional facilities requiredf) Labour and material requirementsg) Cash requirements

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COST OF PRODUCTION BUDGET

a) Direct materials cost/usage budget

Basic information required:

i) Production budget

ii) Raw materials per unit of product by type and quantity

iii) Allowance for waste and scrap

iv) Rate per unit of raw material

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b) Direct labor cost budget

c) Basic information required:

i) The production budget

ii) Hours per unit in various producing departments.

iii) Rates per direct labor hour.

iv) Labor related costs and their treatment.

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c) Production overhead budget

Basic information required:

i) The behaviour of manufacturing overhead items of expenditure. A cost classification according to the behaviour of each element of cost.

ii) The classification of overhead departmentally (both producing and service departments) to meet the production target.

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PURCHASES BUDGET

Basic information required:

a) Production budget: raw materials by type and quantity required for production during the budget period.

b) Planned opening and closing stock requirements.

c) Materials allocated for incomplete order or special jobs.

d) Orders for materials already placed.

e) Economic size of the order – the actual quantity purchased at one time.

f) Availability of finance.

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PLANT UTILISATION BUDGET The plant utlisation budget is a forecast of the plant capacity

required (expressed in machine hours, direct labour hours, weight, number of products) to carry out the production programe as per the production budget. It is essential that the aim should be the most effective utilisation of capacity.

The plant utilisation budget determines for the budget period :

a) The machine load on individual machines within a cost center (or group of machines if they are identical) and the machine load on departments

b) The bottlenecks created by over-loadingc) Idle facilitiesd) Use of sub-contractorse) Purchase of additional plant and equipmentf) Changes necessary to the sales and production budgets, to

increase manufacturing capacity

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STEPS IN BUDGETING

1. Preparation of budgeta. Decide objectivesb. SWOT analysisc. Preparation of statementd. Anticipate performance indicators for evaluation.

2. Record actuals.

3. Comparison between actuals and budgets.

4. Variance analysis - controllable / uncontrollable.

5. Responsibility accounting.

6. Revision in budgets.

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FLEXIBLE BUDGETING

It is a budget which by recognizing the difference between fixed, semi fixed and variable costs, is designed to change in relation to the level of activity attained. It is a budget prepared for a range and is also known as variable budget or a sliding scale budget.

Steps in flexible budgeting:

1. Deciding the range of activity

2. Determine cost behaviour patterns

3. Selecting the activity levels to prepare budgets at those levels

4. Prepare budget at each activity level

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CASH BUDGET

It contains detailed estimates of cash receipts (cash inflows) and disbursements (cash outflows) for the period under review. It fulfills the following objectives:1. It indicates the effect on the cash position of seasonal requirements, large inventories, unusual receipts and delays in collection of receivables.2. Indicates cash requirements for working capital and fixed capital3. Indicates availability of cash for taking advantage of discounts4. Fund flow planning5. Asset liability planning6. Establishes/ determines external fund requirement

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ZERO BASE BUDGETING

ZBB is a method of budgeting whereby all activities are revalued each time a budget is formulated and every item of expenditure in the budget is fully justified. That is, ZBB involves starting from scratch or zero.

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Implementation of ZBB involves the following :

1. Each activity of the organisation is identified and called a decision package

2. Each decision package must be justified

3. If justified the minimum cost to sustain each decision package is determined

4. Alternatives for decision packages are evaluated

5. Managers rank their decision package in order of priority for resource allocation

6. Resources are allocated to the package

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ADVANTAGES OF ZBB

1. Allocation of resources by need and benefit.

2. Identifies and eliminates wastage's and obsolete operations .

3. Best possible methods of performing jobs is ensured.

4. Increased staff involvement which may lead to improved motivation and greater interest in job.

5. It increases communication and co-ordination within the organisation.

6. Managers become more aware of cost inputs which help in identifying priorities.

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DISADVANTAGES OF ZBB

1. Substantial Cost & time involved in preparing a large number of decision packages.

2. Managers could develop fear and feel threatened by ZBB.

3. Ranking of packages could result in departmental conflict.

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ADVANTAGES OF BUDGETING

1. Forced planning.

2. Co-ordinated operations.

3. Performance evaluation & control.

4. Effective communication.

5. Optimum resource utilisation.

6. Productivity improvement.

7. Profit mindedness.

8. Efficiency.

9. Cost control.

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LIMITATION IN USING THE BUDGETING SYSTEM

1. Management judgement.

2. Continuous adaptation.

3. Implementation.

4. Management complacency.

5. Unnecessary detailing.

6. Goal conflict.

7. Evaluation system.

8. Unrealistic targets.

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ALLOCATION OF OVERHEADS

Indirect, or overhead costs are difficult to be traced to products. However, these costs will have to be allocated to production departments and products for the purposes of

1. Valuation of inventory.

2. Controlling costs.

3. Decision making.

4. Product pricing.

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DEPARTMENTALISATION

For the purpose of accumulating costs, a company divides itself into departments or smaller units.

There are two broad categories of departments or cost centres.

Production cost centres.

Service cost centres.

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ALLOCATION PROCESS

i) Assignment of direct costs.

ii) Allocation of indirect costs (primary allocation).

iii) Allocation of service department costs (secondary allocation).

iv) Absorption of costs by products.

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ALLOCATION BASIS

1. Space related.

2. Value related.

3. Activity related.

4. Material related.

5. Utility related.

6. Labour related.

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METHODS OF ALLOCATION

1. Step ladder method.

2. Repeated distribution.

3. Matrix algebra.

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LEARNING CURVES AND NON LINEAR COSTS

The learning curve phenomena is based on the concept that cost,s tend to be non linear.

It is found that the cost of doing most tasks of a repetitive nature decrease as experience at doing these tasks accumulate.

Most experience curves, estimated on actual process, indicate that costs decline 20 to 30 percent each time accumulated experience doubles.

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Factors that lead to this long-run decline in costs include:

1. Labour efficiency.

2. New process and improved methods.

3. Product stadardisation.

4. Scale effect.

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In competitive scenarios this effect should net of inflation.

The learning curve phenomena is represented by the equation:

Y=A X -b

Y= average number of direct labour hours per unit

A= number of direct labour hours for the first unit

X= cumulative number of units produced

b= index of learning rate (o<b<1)

The direct labour hours (DLH) decreases exponentially with cumulative output.

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ACTIVITY BASED COSTING

In Activity based costing (ABC) costs are first traced to activities and then to products. It is a system which focuses on activities performed to produce products . Activities become the focal point of cost accumulation

ABC involves two primary stages

-Tracing costs to activities

-Tracing activities to products

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COSTS DRIVERS IN ABC

1. Number of receiving orders.

2. Number of purchase orders.

3. Number of dispatch orders.

4. Number of units.

5. Amount of labour cost involved.

6. Number of material handling man hours.

7. Number of direct labour hours.

8. Number of vendors/ suppliers.

9. Number of set up hours.

10. Number of employees.

11. Number of labour transaction.

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CLASSIFICATION OF ACTIVITIES

Activities are classified into one of the four activity categories:

1. Unit level activities

2. Batch level activities

3. Product level activities

4. Facility level activities

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ADVANTAGES OF ABC

1. ABC brings accuracy and reliability in product cost determination by focusing on cause and effect relationship in the cost incurrance.

2. More systematised/ logical way of tracing/ allocating fixed overheads.

3. Better mechanism for managing cost.

4. Better control over activities which generate fixed overheads.

5. Controlling activities which drive costs.

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PROFIT CENTRE MANAGEMENT

A profit centre is a responsibility centre where the manager is responsible for both costs and revenues and thus for profits.

A profit centre provides more effective assessment of performance as both costs and revenues are measured in financial terms.

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Organisation will be divided into:

- Profit center

- Cost center

- Service centre

Cost and service centres will at mutually agreed transfer price will pass on the cost to the profit centre.

Cost centres and service centres should not show any surplus.

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ADVANTAGES OF PROFIT CENTRES

1. Speed of operating decisions may be increased.

2. Quality of decisions tend to improve.

3. Corporate management may be relieved of day to

day decisions.

4. Profit consciousness is enhanced.

5. Better measurement of performance.

6. Organisation becomes profit conscious.

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DISADVANTAGES OF PROFIT CENTRES

1. Top management may lose control.

2. Competent managers may not exist to take decision in profit

centres.

3. Friction among centres.

4. Too much emphasis on short term profitability.

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TRANSFER PRICING

The fundamental principle is that the transfer price

should be similar to the price that would be charged if the

product would sold to outside customers or purchased from

outside vendors.

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Pricing mechanism used for inter divisional transfer of goods/ services in divisionalised/ profit centre managed companies. While determining transfer prices a number of criteria should be carefully followed:

1. Should help in accurate measurement of divisional performance.

2. Should motivate divisional management into maximising their divisions profitability and making decisions that are in the interest of the organisation as a whole.

3. Should ensure divisional autonomy and authority.

4. Goal congruent objectives.

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IDEAL SITUATION TO IMPLEMENT TRANSFER PRICING

1. Competent people.

2. Good atmosphere.

3. Market price.

4. Freedom to source.

5. Full flow to information.

6. Negotiations.

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TYPES OF TRANSFER PRICING

1. Market price based

2. Cost based price

3.Variable costa. Actual full costb. Cost plus approachc. Standard costd. Opportunity coste. Administered price based

4. Negotiated price based

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FACTORS INFLUENCING PRICING DECISIONS

Product pricing decisions are influenced by internal and

external factors which are as follows:

1. Cost data of the product which could be based upon

replacement, actual, standard or any other cost base.

2. Firms profit and other objectives.

3. Demand for the product and its elasticity.

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4. Nature of product and its life expectancy.

5. Pricing decision as a long run decision or a one time

spare capacity decision.

6. Type of competition and availability of “me too”

products.

7. Economic/ fiscal trends.

8. Seasonal or continual demand.

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INVENTORY MANAGEMENT AND VALUATION

Inventory comprises :

Raw material stock Work in progress Finished good stock

Inventory holding is depended upon:

- Nature of business Through put time Competitiveness in raw-material market Market for finished product Seasonality in demand

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Inventory management :

Optimise inventory levels to reduce inventory carrying / holding costs.

Objectives :

Reduce inventory to the lowest acceptable limit. Minimise inventory carrying cost. Minimise losses to price / exchange fluctuations. Identify slow moving items. Prevent stock out costs.

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INVENTORY VALUATION METHODS

1. LIFO (last in first out)

2. FIFO (first in first out)

3. Weighted average.

Choice of valuation system is important since it, - Influences book profits there by affecting the tax liability.

- Once adopted cannot be changed (prior approval of it department essential).