UTKAL UNIVERSITY COST & MANAGEMENT ACCOUNTING (COMA)
Provides information to managers for planning, controlling & decision making.
The controller : The Chief Management Accountant The Controller is compared to a ships navigator, with the President (CEO) being the ships captain. ROLE OF THE ACCOUNTANT TO MANAGE INFORMATION An Information Technologist
SCORE KEEPING ATTENTION DIRECTING PROBLEM SOLVING CUSTOMER DRIVEN FOCUS IN MANAGEMENT ACCOUNTING SYSTEM
VISION STATEMENT OF MANAGEMENT ACCOUNTING GROUP AT JOHNSON & JOHNSON Delight our customers. Develop alternative measurement system. Keep it simple. Utilize 20% of time on Accounting & 80% on analysis. Be the best. ABILITIES & SKILLS for Management Accountants A Survey Communication (oral, written & presentation) skills Ability to work on a team Analytical / problem-solving skills Solid understanding of accounting Understanding of how a business functions. Computer skills THE MANAGEMENT ACCOUNTANT AND STRATEGIC DECISIONS The management accountant helps to formulate strategy by answering questions such as : Who are our most important customers ? How sensitive are their purchases to prices, quality, and service ? Who are our most important suppliers ? What substitute products exist in the market place, and how do they differ from our product? Is the industry demand growing or shrinking ? Is there overcapacity ?
IMPORTANCE OF COMA Helps in achieving the main objective of the organization Identifies unprofitable activities. Improves efficiency/Facilitates cost control. Helps in planning & preparation of budgets. Helps in inventory control. Facilitates decision making.
COMA Vs. FINANCIAL ACCOUNTING Similarities Both are branches of Accounting. Are concerned with systematic recording and presentation of financial data. Both follow same principles of Dr. and Cr. Both have the same source of recording transactions. Both have the common goal of assisting the organization they serve. Both are complementary to each other. COMA Vs. FINANCIAL ACCOUNTING : Differences Purpose Periodicity of reporting Customers served Audit Accounts prepared Tax assessment Actual and standard Profit and Loss Monetary and Non-monetary Relative efficiency Constrained by GAAP COST AND MANAGEMENT INFORMATION SYSTEM COST ACCOUNTING INFORMATION SYSTEM OPERATIONAL CONTROL SYSTEM
OBJECTIVES OF CMIS: To provide information for costing out services, products and other objects of interest to management. To provide information for decision making. To provide information for planning and control.
COST MANAGEMENT Identifies, collects, measures, classifies, & reports information Useful to managers in costing, planning, controlling, & decision making. Cost Accounting : Evolving into Cost Mgt. It is associated with Mgt. Accounting THE VALUE CHAIN OF THE BUSINESS FUNCTION R&D Design Production Marketing Distribution Customer service
Accounting helps managers: To administer each of the business functions. To coordinate the functions of value chain.
ENHANCING THE VALUE OF COMA SYSTEM Customer Focus Value Chain & Supply Chain Analysis Key Success Factors Cost & efficiency, Quality, Time, Innovation, etc. (Distinct or Extinct) Continuous Improvement (Kaizen) & Benchmarking
We are running harder just to stand still.
If youre not going forward, you are going backward.
QUESTIONS Management Accounting should not fit the straightjacket of Financial Accounting. Explain.
A leading management observer stated, The most successful companies are those that have an obsession for their customers. Is this statement pertinent to management accountants? Explain. CHANGE
Change is the only constant in todays world. MANAGEMENT AND COMA Provides adequate, timely and reliable information. Helps management in managing and controlling costs. Provides cost-benefit approach for resource allocation. Helps in decision making: Pricing Product-mix Profit-volume decisions Helps: Formulation & execution of budgets & standards. Helps in making special studies and investigations. Without proper cost and management accounting, decision would be like taking a jump in the dark. COST TERMINOLOGY Cost : Resources sacrificed or Amount of expenditure incurred Costing : Process of cost accumulation & cost assignment Cost Object : Anything for which a measurement of cost is desired. Cost Accumulation : Collection of cost data in some organized way. Cost Assignment : Cost Tracing & Cost Allocation. Cost Tracing : Assigning direct cost. Cost Allocation : Assigning indirect costs. Cost Driver : A variable that causally affects / influences costs over a given time span COST CLASSIFICATION
WHY ? To Achieve a Purpose / Objective Control, Decision Making To Facilitate Communication / Reporting COST CLASSIFICATION Behaviour Elements Control Decision Making Functions Nature
ELEMENTS OF COST MATERIAL : Direct Vs. Indirect LABOUR : Direct Vs. Indirect EXPENSES : Direct Vs. Indirect
Direct cost of a cost object : Traced in an economically feasible (cost effective) way.
OVERHEADS Manufacturing or Factory Office & Administration Selling & Distribution OTHER CONCEPTS OF COST Fixed, Variable & Semi-variable Controllable & Uncontrollable Relevant & Irrelevant Incremental & Decremental Shutdown & Sunk cost Traceable & Untraceable Joint cost & Conversion cost RELATIONSHIP OF COSTS Direct & Variable Direct & Fixed Indirect & Variable Indirect & Fixed METHODS & TECHNIQUES METHODS - Job Costing - Process Costing
TECHNIQUES - Marginal Vs. Absorption Costing - Standard Vs. Historical Costing COST ACCOUNTING OBJECTIVES : To determine product costs To facilitate planning & control To supply information for decision making IN GOD WE TRUST, EVERYBODY ELSE BRINGS DATA TO THE TABLE. INFOSYS COST ESTIMATION Statement of Cost : For each cost object or cost centre. Different Columns : Total cost / Cost per unit / Previous period costs / Budgeted costs / Variable & Fixed costs .. Sources of Data : F.A. & C.A. Time Period : A month or week WHY A COST SHEET ? Fixing selling price Submitting quotations Planning & control of cost To know relative efficiency of products Decision making STATEMENT OF COST COST SHEET Prime Costs or Direct Costs DM + DL + DE = PC Production or Works or Factory Costs PC + P. OH. = FC Office Costs or Cost of Production* FC + O. OH. = COP Total Cost or Cost of Sales COP + S. OH. = TC *Assumption : Office & Admn. Overheads relate to production.
TREATMENT OF STOCK Raw Material WIP Finished Goods
Treatment of the amount realized from the sale of scraps / wastes ? ITEMS NOT AFFECTING COST SHEET Income Tax Dividends to Share Holders Interest on Loans Capital Loss Donations Capital Expenditure Discount on Shares & Debentures Underwriting Commission Writing off Goodwill Commission to MD
ESTIMATED COST SHEET Considers all probable changes in cost Preparation : - Prepare a Cost Sheet - Establish relationship - Estimate OH costs - Prepare Estimated Cost Sheet CASE The following information are obtained from the records of AB cycles for the month of August: Direct materials : Rs. 19, 80, 000 Direct labour : 18, 00, 000 Factory overheads : 5, 80, 000 Administrative overheads : 3, 90, 000 Outputs for the month : 2,000 cycles. What price the company should quote for an order of 100 cycles? Note: Factory overheads are absorbed on the basis of direct labour and administrative overheads on the basis of works cost.
THE FOLLOWING DATA RELATE TO A COMPANY: Expected sales : 50,000 units Direct material cost : Rs. 2.50 per unit Direct labour cost : Rs. 2.00 per unit Variable Overhead : Rs.1.50 per unit Fixed cost : Rs. 1.50 per unit Selling price : Rs.10 per unit
The firm expects to get a special export order for 10,000 units at a price of Rs. 7.25 per unit. Advise whether the export order should be accepted or not. The company has a capacity to produce 60,000 units.
INFERENCES: An organization has different costs having different nature. Example: Fixed, Variable, Mixed Cost These costs behave differently to changes in the level of business activity. Understanding this relationship helps in planning, control and developing successful business strategies.
Cost of a product / process can be ascertained by : 1. Absorption costing 2. Marginal costing
ABSORPTION COSTING Traditional or full cost method : Cost of a product = V. C. + F. C. Variable costs are directly charged to the product. Fixed costs are apportioned on suitable basis.
DISADVANTAGES: It assumes that prices are simply a function of costs. It includes past costs which may not be relevant to the pricing decision at hand.
MARGINAL COSTING - Direct Costing / Variable Costing - A Technique of Costing Meaning : Ascertainment of marginal cost by differentiating between F.C. and V.C. and of the effect on profit of changes in volume or type of output.
Cost of a product : Only VCs are considered : Product cost FCs : Charged against the revenue of the period. FC = Period costs Valuation of inventory at M.C.
Contribution = C = S - V = F + P Price = M.C. + Contribution
MARGINAL COST
Economists : The cost of producing one additional unit of output is the marginal cost of production. Include an element of FC
Accountants : MC is equal to the increase in total VC.
SEGREGATION OF SEMI-VARIABLE COSTS
Levels of output compared to levels of expenditure Method : The variable element in semi- vc = Change in amt. of exp. Change in activity/qnty.
High-low method (Range Method) : Similar to the previous method
Methods of least squares Y = a + bx, where Y = Semi-VC, a = FC, b = VC, x = Production in units
ABSORPTION COSTING Vs. MARGINAL COSTING 1. Recovery of F.OH. Abs. Costing : Both F. OH. and V. OH. are charged to production Mar. Costing : Only V. OH. is charged to production and F.OH. transferred to P. & L. A/C. 2. Valuation of Closing Stock Abs. Costing : WIP at works cost and F. goods at cost of production. Mar. Costing : WIP and F. Goods -- Only VCs are considered. 3. Profit Vs. Opening and Closing Stock
UTILITY OF MARGINAL COSTING Helps in determining the volume of production. Helps in selecting production lines. Helps in deciding whether to shutdown or continue.
MARGINAL COSTING Vs. ABSORPTION COSTING
The following information relates to ABC Company for the year 2011-12:
Sales 10,000 units at Rs. 5 each; Production 15,000 units at the following costs: Rs. Direct materials 15,000 Direct labour 30,000 Variable expenses 6,000 Fixed expenses 12,000 Determine net profit.
Income Statement for the year 2011-12
Marginal Absorption costing Rs. Costing Rs.
Sales 50,000 50,000
Cost of Production: Direct materials 15,000 15,000 Direct labour 30,000 30,000 Variable overhead 6,000 6,000 Fixed overhead _ 12,000
51,000 63,000 Less Closing Stock 17,000 21,000 Cost of goods sold 34,000 42,000 Contribution (50,000- 34,000) 16,000 4,000 Less Fixed Overhead 12,000
Net profit 8,000
Valuation of closing stock: Marginal costing = (5000/15,000) x 51,000 = Rs. 17,000 Absorption costing = (5000/15,000) x 63,000 = Rs. 21,000 Note: Difference in profit is due to the difference in stock valuation.
CASE From the following cost, production and sales data of AB Motors Ltd., prepare comparative income statement for three years under (i) Absorption costing method, and (ii) Marginal costing method. Indicate the unit cost for each year under each method. Also evaluate closing stocks. The company produces a single article for sale.
PARTICULARS YEARS 2010 2011 2012 Rs Rs. Rs. Selling price per unit 20 20 20 Variable Mfg. Cost per unit 10 10 10 Total fixed manufacturing cost 5000 5000 5000 Opening stock - 500 Units produced 1000 1500 2000 Units sold 1000 1000 1500 Closing stock - 500 1000
BREAK-EVEN ANALYSIS Narrow Sense : Determination of that level of activity where total cost equals selling price.
Broad Sense : The system of analysis which determines the probable profit at any level of activity. Refers to Cost-Volume-Profit Analysis
BEP - Represents a minimum acceptable level of operation - Level of activity : Income equals Expenditure - No profit no loss point C = S - V = F + P
At BEP, P = 0; Thus, C = F
Or, Units at BEP x Contribution per unit = F
Or, BEP(units) = F / Contribution per unit
BEP (sales) = (F / Cont. per unit) x S.P. per unit = (F/C) x S = F/c/s = F / p/v ratio Contribution Margin Ratio = P/V ratio = Contribution / Sales = C / S = Change in Profit / Change in Sales
MOS = Total Sales BEP BREAKEVEN ANALYSIS FOR MULTIPLE PRODUCTS A multi products Company has a sales ratio of 2: 3: 5 for models X, Y and Z respectively. Total fixed cost for the year are Rs. 2,00,000. The other information are as follows:
Model X Model Y Model Z Sales Price Rs. 50 Rs. 25 Rs. 10 Variable Costs Rs. 30 Rs. 15 Rs. 8 Contribution Margin Rs. 20 Rs. 10 Rs. 2
WHAT IS ITS BEP ? BREAKEVEN ANALYSIS FOR MULTIPLE PRODUCTS A market basket approach is used to compute the breakeven point in units. The average market basket is based on the sales ratio and consists of 10 units with a total contribution of Rs. 80 = { (2 x Rs. 20) + (3 x Rs.10) + (5 x Rs.2) } BEP in market baskets = FC / Contribution of one baskets = Rs.200,000 / Rs.80 = 2,500 baskets.
To fill 2,500 baskets : The following units for each model. Model X : 5000 units ( 2,500 x 2) Model Y : 7500 units (2,500 x 3) Model Z : 12500 units (2,500 x 5) COST VOLUME PROFIT ANALYSIS Examines the behaviour of total revenues, total costs and operating income : As changes occur in the output level, the selling price, the variable cost per unit, and / or the fixed costs of a product. One of the decision models One aspect of CVP Analysis : BEP Analysis A useful technique for planning profits (budgeting), pricing decisions, sales-mix decisions and production capacity decisions. CVP Analysis evaluates the effects of: Price changes on Net Profit (NP) Volume changes on NP Price and volume changes on NP Changes in VC on NP Changes in FC on NP All four factors, viz., price, volume, VC and FC on NP. Sensitivity Analysis & Uncertainty A what-if technique Analyze the sensitivity of their decisions to changes in underlying assumptions. Managers use this technique to examine - How a result will change : If the original predicted data are not achieved or if an underlying assumption changes.
C-V-P ANALYSIS INCOME TAX I.T. : No effect on BEP S VC FC = Op. Income =Target Net Income / (1-T) Desired Sales in Units = ? Desired Sales in Rupees = ? DO-ALL SOFTWARE SP = Rs.2,000 per unit VC = Rs.1,200 per unit FC = Rs.20,000 The organisation anticipates selling 40 units.
1. Decision to Advertise Proposed Advertisement = Rs.5,000 Effect : Increase in Sales by 10% DECISION ? 2. Decision to reduce S.P.
Proposal : Reduce SP to Rs.1,750 Effect : Increase in Sales by 10 units Purchase from Whole-seller at Rs.1,150 per unit. DECISION ? RELEVANT COSTS & REVENUES Expected future costs Expected future revenues Differ among the alternative courses of action
Insourcing or Outsourcing products or services. Accepting or Rejecting special order. Shutdown or Continue. Qualitative & Quantitative Relevant Information COST ALLOCATION / APPORTIONMENT An inescapable problem in every organization. How should the costs of service departments be allocated among production departments ? How should the manufacturing overhead be allocated to individual products in a multi-product company ? The answers are seldom clearly right or clearly wrong. PURPOSES OF COST ALLOCATION
To provide information for economic decision : Pricing decisions; Make or buy decisions. To motivate managers and employees : To push high margin products or services To justify costs or compute reimbursement : Reimbursement for a consulting firm that is paid a percentage of the cost savings To measure incomes and assets for external reporting : - valuation of inventory
SURVEY OF COMPANY PRACTICE Why allocate corporate and other support costs to divisions and departments ?
U. S. A. To remind profit-center managers that indirect costs exist and that profit-center earnings must be adequate to cover those costs. To encourage use of central services. To stimulate profit-center managers to control service costs U. K. To acknowledge that divisions would incur such costs if they were not provided centrally. To make division managers aware that central costs exist. To stimulate divisional managers to put pressure on central support managers to control costs. To stimulate divisional managers to economize in usage of central services. CRITERIA FOR COST ALLOCATION DECISION CAUSE AND EFFECT: Rent- Floor area occupied BENEFITS RECEIVED: FAIRNESS OR EQUITY: Government contracting ABILITY TO BEAR: Corporate executives salaries on the basis of divisional operating income. COST POOL POSSIBLE ALLOCATION BASE Corporate executive Sales; Assets employed; salaries : Operating income Legal Department : Estimated time or usage; Sales; Assets Marketing Department : Sales; No. of sales personnel Payroll Department : No. of employees; Payroll Rupees Personnel Department : No. of employees; Payroll Rupees
ACCOUNTING AND CONTROL OF OH COSTS Classification Codification Collection Allocation and apportionment to cost centers Absorption in costs of products, services etc. WHY TO CLASSIFY? Effective cost control : Flexible Budgets Absorption of cost
COLLECTION OF MANUFACTURING OHs Material Issue Analysis Sheet / Material Abstract Wages Analysis Sheet Cash Book Subsidiary Records Plant Register : Depreciation Asset Register : Depreciation Journal : Outstanding expenses
DISTRIBUTION OF OVERHEAD COSTS Primary Distribution: Departmentalization of overhead to Production and service departments. Secondary Distribution: Re-distribution of service departments costs among production departments. Re-apportionment Final Distribution: Absorption Overhead costs of production departments are distributed among the units produced. CHALLENGE YOUR CURRENT PRACTICES AND ENHANCE YOUR HORIZON IIMB ACTIVITY BASED COSTING
REFINING A COSTING SYSTEM: WHY?
Intense competition Advances in IT
ABC system
Calculates the costs of individual activities: Assign costs to cost objects such as products and services On the basis of the activities needed to produce each product or service.
A SIMPLE COSTING SYSTEM: A single indirect cost rate to allocate cost to products Weak cause-and-effect relationship Cost Smoothing : Under-costing & Over-costing Product cost cross-subsidization ABC : BENEFITS Obtaining true product cost Cost Management Better decision making
PROCESS : ABC Direct cost tracing Indirect-cost pools Cost-allocation bases IMPLEMENTING ABC: Steps Identify the Products : Cost Objects Identify Direct Cost of the products Select the Cost Allocation Bases : For allocating indirect costs to the products Identify the Indirect Costs : Associated with each cost-allocation base. Compute the Rate per unit of each cost- allocation base : Used to allocate indirect costs to the products Compute the Total Indirect Costs allocated to the products Compute the Total Costs of the products : Adding all direct and indirect costs assigned to the product
PLASTIM CORPORATION Manufactures lenses for the rear lamps (tail lights) of automobiles Contract with G Motors : To supply CL5, a complex lens ($137 per lens) S3, a simple lens ($63 per lens) Operating at full capacity & incurs very low marketing costs. Minimal customer-service costs. Business Environment : Very competitive with respect to S3.
Process : Plastim Corporation Design products and processes Manufacturing operations Shipping and distribution
G. Motors purchasing manager : A new competitor offering to supply the S3 lens at a price of $53. Plastims management is worried. Options for Plastim:
Lower its selling price. Give up G. Motors business. Reduce cost.
Existing Costing System 60,000 15,000 S3 CL5
Total($) Per Unit($) Total($) Per Unit($) Direct Material 1125,000 18.75 675,000 45.00 Direct labour 600,000 10.00 195,000 13.00 Total Direct Cost 1725,000 28.75 870,000 58.00 Indirect cost Allocated 1800,000 30.00 585,000 39.00 Total Cost 3525,000 58.75 1455,000 97.00 Actual indirect Actual total cost in indirect cost pool cost rate = Actual total quantity of cost allocation base = 2385,000 / 39750(Labour Hours) = $60 per Labour hour S3 : Uses 30,000 labour hours = $1800,000 CL5 : Uses 9,750 labour hours = $585,000 Possible Reasons : Plastims technology and process are inefficient in manufacturing and distributing S3 lens. Ineffective cost management. Is costing system over-costing the S3 lens ?
SEVEN ACTIVITIES OF PLASTIM Design products and processes : $ 450,000 Set up of molding machines : $ 300,000 Manufacturing operations : $ 637,500 Cleaning and Maintenance : $ 270,000 Shipment set up : $ 81,000 Distribution : $ 391,500 Administration : $ 255,000 Guidelines for refining the costing system : Direct Cost Tracing To identify some costs or cost pools that can be reclassified as direct costs instead of indirect costs (improves cost accuracy) Example: Cleaning and maintenance activity
Indirect Cost Pools To create smaller cost pools linked to the different activities: Plastim : Subdivides- One direct activity cost pool & Six indirect activity cost pool
Cost Allocation Bases A measure of activity performed serves as the cost allocation base for each activity-cost pool Activity Cost Rates for IndirectCost pools
Activity Total Cost-allocation OH allocation Cost Base Rate Design $ 450,000 100 parts- $ 500 per part- square feet square foot Setups of $ 300,000 2000 $ 150 per setup- Molding Setup-hours hour Machines Manufacturing $ 637,500 12,750 operations Molding $ 50 per molding machine hours machine-hour Shipment $ 81,000 200 $ 405 per
shipment Setup
Distribution $ 391,500 67,500 $ 5.80 per cubic Cubic feet foot shipped Administration $ 255,000 39,750 $ 6.4151 per Direct manuf. Direct manuf. Labour hours labour hour Product Cost using ABC S3(60000) CL5(15,000) Total($) Per unit($) Total($) Per unit Direct Costs : Direct Materials1125,000 18.75 675,000 45.00 Direct Labour 600,000 10.00 195,000 13.00 Direct Mold Cleaning120,000 2.00 150,000 10.00 Total Direct Costs1,845,000 30.75 1,020,000 68.00
WHO SAID THESE WORDS ? A managers job is to pursue the interests of society. Customer is the only valid reason for the existence of a business. Entrepreneurship and innovation are not inborn characteristics. Management is neither an art nor a science, but a practice. PETER F. DRUCKER Father of Modern Management. The most enduring Management Thinker of our Time : Business Week Born in Austria:1909; Died in Los Angeles:2005 Studied Law in Germany at Hamburg University Received Ph.D. from Frankfurt University in International Law. Moved to London & Taught Economics. Married Doris & Moved to America as a Correspondent for several British Newspapers. Professor of Management at New York University.
Without proper cost and management accounting, decision would be like taking a jump in the dark.
COST ACCOUNTING SYSTEM Determines per unit cost. Helps management in planning and controlling costs. Provides information for decision making Used to develop timely information about: - Cost of producing specific products. - Cost of performing specific functions / services. CAS Most widely used in manufacturing companies Also used in services sector: Banks Accounting firms IT sector Govt. agencies
US congress has passed legislation requiring hospitals to measure and report the average unit cost of their product.
Why to find unit cost? Basis for inventory valuation. Measurement of cost of goods sold. Useful in fixing selling prices. Deciding : Products to manufacture. Evaluating the efficiency of operations Controlling costs. DESIGNING COSTING SYSTEM Cost-benefit Approach Tailored to fit the operations/functions Facilitate decision making
Costing System : Only one source of information for Managers combine non- cost information & non-financial performance measures BUILDING-BLOCK CONCEPTS Cost Object Direct Costs of a Cost Object Indirect Costs of a Cost Object Cost Tracing Cost Allocation Cost Pool & Cost Allocation Base
CAS DELL COMPUTER WIPRO
Will they have same CAS ? Two basic types of CA system: Two extremes of product costing : JOB ORDER COST SYSTEM PROCESS COST SYSTEM
JOB ORDER COST SYSTEM
Used by companies: Producing one-of-a-kind products Tailor products to the specifications of individual customers
JOB Represents the goods manufactured at one time to fill a particular order Unique Feature : Cost are accumulated separately for each job.
JOB COST SHEET : JOB-COST RECORD Heart of JOCS JOB COSTING A method of ascertaining cost. Also known as Specific Order Costing . Production : Always against customers orders and not for stock. Each Job : Different characteristics and needs special treatment. Each job undertaken : A cost unit or cost object. A separate job cost sheet : To ascertain profit or loss for each job . No uniformity in the flow of production from one department to another in respect of jobs.
GENERAL APPROACH TO J.C. Identify the Job : Cost Object Identify the Direct Costs of the Job Select Cost-Allocation Bases Identify the Indirect Costs Compute the Rate per Unit of Base Compute the Indirect Costs allocated Compute Total Cost of the Job
ACTUAL COSTING Vs. NORMAL COSTING Direct Cost : Actual Rates Actual Rates Indirect Cost : Actual Rates Budgeted Rates
Both Methods Use : Actual Quantities of Inputs for Tracing Direct costs Actual Quantities of Allocation Bases for Allocating Indirect Costs Some organizations use budgeted rates to assign both direct costs & indirect costs, to jobs. JOB COST SHEET Job Number ---------- Product -------------- Date Started ------------- Date Completed -------------- Number of units ------------ DIRECT MATERIAL Date Requisition Number Quantity Unit Price Cost
DIRECT LABOUR Date Time Card Number Hours Rate Cost
MANUFACTURING OVERHEAD Date Activity Base Application Rate Cost COST SUMMARY Cost Item Total Cost Unit Cost Total Direct Material used Total Direct Labour Manufacturing Overhead applied Cost of Finished Goods manufactured
J ob costing is a compromise between actual costing and standard costing. ACCOUNTING : Job Costing ACCOUNTING FOR DIRECT MATERIALS End of each week or month : Summary entry WIP Inventory Rs. 50,000 Materials Inventory Rs. 50,000 ACCOUNTING FOR DIRECT LABOUR End of each month or week WIP Inventory Rs.20,000 Direct labour Rs. 20,000 ACCOUNTING FOR OH COSTS End of each week or month: WIP Inventory Rs. 10,000 Manufacturing overhead Rs. 10,000 ACCOUNTING FOR COMPLETED JOB Finished goods Inventory Rs. 80,000 WIP Inventory Rs. 80,000 ABC Furniture (S. Drs.) Rs. 100,000 Sales Rs 1,00,000 Cost of goods sold Rs 80,000 Finished goods Inventory Rs. 80,000 CONTRACT COSTING One type of specific order costing Used in civil engineering works Each contract : Separate accounts for each contract
AS 7 : Construction Contracts Fixed Price Contracts Cost Plus Contracts
COSTS Materials Labour Direct Expenses Indirect Expenses Plant and machinery : Depreciation WIP : Presented in the Balance Sheet Balance Sheet as at.. Assets Amount Work in progress : Value of work certified Cost of work uncertified Less Reserve for unrealized profit Less Amount Received from contractee Profit on Incomplete Contracts: Work Completed : Less than 1/4th : No profit
Work Certified : More than 1/4th but less than half : Profit = 1/3 x Notional Profit x (Cash Received / Work Certified)
Work Certified : Half or more than half : Profit = 2/3 x Notional Profit x (Cash Received / Work Certified)
Contract is almost complete : Profit = Estimated Profit x (Work Certified / Contract Price) or, Estimated Profit x (Cash Received / Contract Price) PHARMACEUTICAL INDUSTRY Multi-Products Production in batches Identical products in a batch
Use Process Costing PROCESS COSTING
A method of costing Costing of process : Converting raw materials into finished products. Find Out : Cost of operating each process.
APPLICATIONS
Manufacturing Industries : Iron and Steel, Cement, Textiles, Soap Making, Biscuits, Food Products Mining Industries : Oil, Coal Chemical Industries : Drugs & Medicines Public Utility Services : Electricity, Water Supply
CHARACTERISTICS : Process Costing Production : Continuous Products : Processed in one or more processes. Products: Homogeneous, Identical and Standardized. The Finished Product of one process : Raw Material of the next process. Costs : Collected process-wise. Unavoidable wastage : Generally arises at different stages. Different products with or without by-products : Simultaneously produced.
JOB COSTING VS. PROCESS COSTING Job costing: Production is by specific orders. Process costing: Products are homogeneous. Costs are determined by jobs or batches. Costs are complied on time basis. Each job is separate and independent. Products lose their identity : continuous flow. There may or may not be any WIP. There is WIP as production is continuous. There is normally no transfers from one job to another. Products move from one process to another. Control is difficult. More managerial attention is required. Proper control is comparatively easier. Unit cost of a job is calculated. Unit cost of a process is calculated. AUSTRALIA : COSTING SYSTEM Textiles % Chemicals % Refining % Printing % Process 91 75 100 20 Job 18 25 25 73 Other 12 13 Normal Loss Inherent in the processing operation; Unavoidable. Cost of Normal Loss : Absorbed by good units produced. Abnormal Loss Caused by unexpected or abnormal conditions viz., carelessness, accident, bad plant design Value of Abnormal Loss =( Normal cost of Normal output / Normal output) x Units of Abnormal Loss Abnormal Gain Actual Loss < Expected Calculation : Similar to Abnormal Loss. Joint Products or Co-products Represent two or more products, Separated in the course of the same processing operation, Usually requiring further processing. Example : Oil Industry: Gasoline, Fuel Oil, Lubricants, Kerosene. By- product Recovered from materials discarded in a main process or from the production of some major products. WHY ALLOCATE JOINT COSTS? Computation of cost of goods sold, Cost reimbursement under contracts, Insurance-settlement computations. APPROACHES FOR ALLOCATING JOINT COSTS
Using market based data : Revenue Using physical measures : Weight INTER PROCESS PROFIT Out put of one process is transferred to a subsequent process at a price. WHY ? To show cost of production in relation to the market price. To make each process stand on its own efficiency and economies. To induce competition amongst different processes : Leads to cost control.
BALANCE SHEET: ADJUSTMENTS Adjust : The closing balance of inventories as it includes unearned profit.
Create : A provision to reduce the stock to actual cost price. EQUIVALENT FULL UNITS OR EQUIVALENT PRODUCTION EP : Production of a process in terms of completed units WIP : Creates problem to find out cost per unit. To overcome this problem : Express the partially completed units in equivalent full units of completed product. Material Cost per unit = Total cost of direct materials used / Equivalent full units produced Work done by a Manufacturing Department : Completing opening WIP units. Working on units started and completed. Working on closing WIP units.
STATEMENT OF EQUIVALENT PRODUCTION Units Portion Equivalent completed full in July units Opening WIP : (60% completed in June) 5,000 40% 2,000 Unit s started & Completed : 37,000 100% 37,000 Total units completed : 42,000
Closing WIP : (25% completed) 4,000 ` 25% 1,000
Total Equivalent Units : 40,000
STATEMENT OF EQUIVALENT PRODUCTION Estimate : The percentage of completion of opening WIP State : Opening WIP in equivalent completed units ( Apply the % work required to complete) Units completed during the period : Units representing opening WIP Units introduced and completed Closing WIP : State in equivalent completed units (apply the % work done) Normal Loss : Not taken for calculation of EP Abnormal Loss & Abnormal Gain : Treated like units finished and transferred to next process.
HMT Five Divisions : Machine Tools; Tractors; Industrial Machinery; Engineering and Components; Consumer Products . SEGMENT PERFORMANCE ANALYSIS AS- 17 : SEGMENT Business Segment Geographical Segment
Segment : A distinguishable component of an organization: Engaged in providing products and services Subject to risks and returns that different from other segments.
SEGMENT / DIVISION A sub-unit Headed by a man fully responsible for its operation. A Responsibility Center A Decision Unit
WHY DIVISIONALIZATION? Decentralization Measurement & evaluation of performance Training ground for top mgt. personnel Planning and allocation of resources. Controlling operations RESPONSIBILITY ACCOUNTING
--A Control Device R. A. collects and reports planned and actual accounting information about the input and output of responsibility centers.
Process of R.A. Identify : Responsibility Centers (Decision Units). Define : Extent of Responsibility for each R.C. Specify : Controllable and Uncontrollable Activities at Various Levels of Responsibility. Accounting system: To Accumulate Information of R. C. Prepare : Performance Reports.
Why responsibility Centers? Defines the corporate objectives and goals of R.C. Determines the contribution of a R. C. Provides a basis for evaluation. Motivates the managers. Provides a system of closer control. Helps Management by exception. Facilitates decentralization. Sets realistic plans and budgets for R.C.. Creates a sense of cost consciousness. Requirements of effective R. A. A sound organization structure. Dividing the organization into RCs. Accurate and acceptable budgets. Top management support. Healthy organizational environment COST CENTRE Manager : Accountable only for costs incurred. Output of cost center : Not measured in monetary terms. Evaluation : Actual cost vs. Budgeted cost Employed in : Legal Dept, Accounting Dept, Public Relation Dept, HR Dept.
REVENUE CENTRE Manager : Accountable for revenues only. Evaluation : Actual Revenue Vs. Budgeted Revenue Employed in : Sales Dept., Product Centre. PROFIT CENTRE Manager : Held responsible for both costs (inputs) and revenues (outputs), i.e., profits Inputs & outputs :Capable of financial measurement. Measures effectiveness and efficiency and motivates managers. Employed in: Production Dept., production centers. INVESTMENT CENTRE Manager : Responsible for costs, revenues & investment in assets used. Evaluation : By profit and ROI A measure of overall performance, and facilitates comparison. RESPONSIBILITY & CONTROLLABILITY Controllability : Degree of influence that a specific manager has over costs, revenues, & related items for which he or she is responsible. Manager should avoid over-emphasizing controllability & fixing blames. R.A. is more far-reaching : Emphasis on human aspects R.A. focuses on information, knowledge & behaviour, not on control. ASSIGNING REVENUE & COSTS TO SEGMENTS REVENUE : Assigning revenue : Electronic Cash Register
MEASUREMENT OF PERFORMANCE ROI Approach : Popular Approach Accounting Rate of Return Pioneer : Du Pont Co. Return on Sales x Investment Turnover
RI Approach :
Pioneer : General Electric Co. RI = Income Minimum Return on Investment EVA : A specific type of RI = After-tax operating income Weighted average cost of capital (Total Assets Current Liability) Return on Sales Income to Revenue (or Sales) Ratio A component of ROI
COMPARING PERFORMANCE MEASURES : ROI RI EVA ROS DESIGNING ACCOUNTING-BASED PERFORMANCE MEASURE(PM) Choose PM that align with Top Mgt.s Financial Goals. Choose the Time Horizon of each PM Choose Definition of components in each PM Choose a Measurement Alternative for each PM Choose a Target Level Performance Choose the Timing of Feedback. FINANCIAL PERFORMANCE MEASURES A Survey COMPANY COUNTRY PM Ford Motors US Income, ROS, ROI Guinness UK Income, RI, EVA Krones Germany Revenues, Income Mayne Nickless Australia ROI, ROS Mitsui Japan Revenues, Income Pirelli Italy Income, Cash-flow Swedish Match Sweden ROI SIX SIGMA Pioneer: Motorola A Management Philosophy Setting extremely high objectives Collecting data Analysing results Reduce defects in products & services STANDARD COSTING AND VARIANCE ANALYSIS Objective : Cost Control Accounting system : Historical Costing Standard Costing
Standard
A measure of desired performance. A predetermined criterion for evaluating the actual performance WHY STANDARDS ? Cost Control Pricing Decision Performance Appraisal Cost Awareness Management by Objective TYPES OF STANDARDS Ideal standards Expected standards Current standards Basic standards PROCESS OF DEVELOPING STANDARDS Varies from company to company : The standard committee Technical input Past experience Other inputs Coordination Standard Costing A control device Not a separate method of product costing Used with any method of product costing : Job or Process Costing Generally used in manufacturing concerns Standard Costing involves : Ascertainment of standard cost Measurement of actual cost Comparison Analysis of variance and taking appropriate action where desired
Cost Variances: Direct material cost variances Direct labour cost variances Overhead cost variances DIRECT MATERIAL COST VARIANCES 1. Material Cost variance = Standard cost for actual output - Actual cost of material used = Qs. Ps Qa. Pa 2. Mat. Price var. = Qa (Ps Pa) 3. Mat. Quantity var. = Ps (Qs Qa) = Usage Variance = Efficiency Variance 4. Mat. Mix var. = Ps (Smqa Qa) = Standard Price (Revised standard mix Actual mix) 5. Mat. Yield var. = Ps (Qs Smqa) = Sub-usage variance = (Actual yield Standard yield) x Standard cost per unit of output 1 = 2 + 3, 3 = 4 + 5 Note : Qs = Standard Quantity; Qa = Actual Quantity; Ps = Standard Price; Pa = Actual Price; Smqa = Standard Mix in Actual Quantity. DIRECT LABOUR COST VARIANCE 1. Labour Cost var. = Standard cost of labour for actual output Actual cost of labour = Hs.Rs Ha.Ra 2. Labour Rate of Pay var. = Ha (Rs Ra) 3. Labour Efficiency var.= Rs (Hs Ha) 4. L. Mix or Gang Composition var.= Rs (Smha Ha) 5. L. Net Efficiency var. = Rs (Hs Smha) 6. Idle Time var.= No. of Hours Lost (Abnormal) x Rs 1 = 2 + 3, 3 = 4 + 5 + 6 Note : Ha = Actual hours worked VARIABLE OVERHEAD VARIANCES Variable Overhead Cost Variance = St. V. OH Ac. V. OH = AO . SRO AO . ARO = SH . SVRH AH . AVRH Variable Overhead Spending Variance = AH(SVRH AVRH) Variable OH Efficiency Variance = SVRH(SH AH)
FIXED OVERHEAD VARIANCES Fixed Overhead Cost Variance = Standard Cost Actual Cost = AO . SRO AO . ARO = SH . SFRH AH . AFRH Fixed Overhead Expenditure Var. = Budgeted Cost Actual Cost = BO . SRO AO . ARO = BH.SFRH - AH.AFRH Fixed Overhead Volume Variance = Standard Cost Budgeted Cost = AO . SRO BO . SRO = SRO (AO BO) =SFRH (SH BH)
SALES VARIANCES Sales Value Var. = Actual Value of Sales Budgeted Value of Sales Sales Price Var. = Act. Quantity sold (AP SP) Sales Volume Var. = SP(AQ BQ) Sales Mix Var. = SP(AQ- Smqa) POSSIBLE CAUSES OF COST VARIANCES Mat. Price Var. : Changes in actual price, Failure to purchase anticipated quantity, Not taking cash discounts, Changes in freight cost Mat. Quantity Var. : Poor material handling, Inefficient machine operator, Pilferage, Waste, Labour Turnover. Lab. Efficiency Var. : Defective machine and equipment, Poor supervision, Inexperienced employee, Insufficient training, Poor working condition OH Volume Var. : Failure to use normal capacity, Lack of sales order, Machine break down, Defective materials, Labour troubles, Power failure OH Expenditure/Efficiency Var. = Same cause as Labour Efficiency Variance. RESPONSIBILITY FOR COST VARIANCES Variance Persons Responsible Mat. Price Variance : Purchase Agent or Purchase Manager Mat. Quantity Variance : Plant Supt. , Dept. Supervisors, Machine Operators, Quality Control Dept. Labour Rate of Pay Variance : Personnel Manager, Dept. Supervisors, Plant Superintendent Labour Efficiency Variance : Plant Superintendent OH Expenditure Variance : Variable portion : Foremen or Supervisor; Fixed portion: Top Mgt. OH Volume Variance : Top Mgt. Few businesses plan to fail, but many of those that flop, failed to plan.
BUDGETARY CONTROL BUDGETS AND PERFORMANCE REPORTS
MANAGER Feedback Managers plan & act using budgets
PERFORMANCE OPERATING PROCESS Managers evaluate using a report that compares actual results with budgets STRATEGY AND PLANS
LONG-RUN PLANNING LONG-RUN BUDGETS STRATEGY SHORT-RUN PLANNING SHORT-RUN BUDGETS Budget A financial and / or quantitative statement prepared and approved prior to a defined period of time , of the policy to be pursued during that period for the purpose of attaining a given objective. Planning for the future activities Survey of past events, present happenings and the future things. BUDGET Vs. STANDARD Standard : A carefully determined price, cost or quantity Budget : A broader term Budgeted Costs : Need not be based on standard Standard = Budget : When standards are used to obtain budgeted inputs or outputs Features of a budget: Comprehensive and coordinated plan of action based on the objectives of the organization. Plan for the operations and resources For a specified future period
Budgetary Control System:WHY? A tool for strategic planning & control Ensures economy in workings Promotes co-ordination & communication among subunits Management by exception Optimum utilization of resources Continuous review of performance Motivates managers & employees BUDGETING PROCEDURE Varies widely from company to company. Common steps: Obtaining estimates from each sub-unit or division or department. Co-coordinating estimates. Communicating the budget to responsible managers. Implementing the budget plan. Reporting interim progress: Performance Report Pre-requisite for Introduction of Budgetary Control BUDGET CENTRE ORGANISATION CHART BUDGET COMMITTEE BUDGET MANUAL BUDGET PERIOD PRINCIPAL BUDGET FACTOR FIXED BUDGET vs. FLEXIBLE BUDGETS
FIXED BUDGET Remain unchanged irrespective of level of activity obtained. Prepared for a particular level of activity Acts as a target for the forthcoming period Not adjusted with actual activity
FLEXIBLE BUDGETS Designed to change in relation to the level of activity attained Prepared for a range of activities Recognizes the behavior of costs: fixed ~ semi-fixed ~ variable Facilitates performance measurement and control BEHAVIOURAL DIMENTIONS OF BUDGETING Implications of Participative Budgeting Excessive Pressure Created by Budget Budgetary Slack (Cushion) Top Management Support Inter-Departmental Conflict OPERATING AND FUNCTIONAL BUDGETS Sales Budget Production Budget Production Cost Budget Direct Materials Budget Direct Labour Budget Factory Overhead Budget Cost of Goods Sold Budget Selling Expense Budget Administrative Expense Budget Budgeted Income Statement FINANCIAL BUDGETS Capital Expenditure Budget R & D Budget Cash Budget Budgeted Balance Sheet
NON-FINANCIAL BUDGETS - Space, Equipments, Workers MASTER BUDGET A comprehensive budget: A Tool for coordinating all budgets. Summarizes : Planned activities of all subunits of an organization. Incorporates: Summary of all functional budgets.
Reveals: Top management goals of incomes, expenditure, cash flows and financial position. ELEMENTS OF MASTER BUDGET Sales Forecast Production Schedule Manufacturing Cost Budget Operating Expense Budget Capital Expenditure Budget Budgeted Income Statement Budgeted Balance Sheet Cash Budget
BUDGET PRACTICES: Master Budget U.S. : 91% U.K. : 100% Japan : 93% Holland : 100% Australia : 100% BUDGET GOALS : U.S. : ROI Japan : Sales What reduces effectiveness of Budgeting? SURVEY OF CFOs IN THE U.S. : Lack of well-defined strategy Linkage of strategy to operational goals Lack of individual accountability for results. Lack of meaningful performance measures
SAIL Vs. TATA STEEL
ROLLING BUDGET A Continuous Budget A Plan : Always available for a specified future period Adding a period in the future as the period just ended is dropped ELECTROLUX : A four-quarter rolling budget KAIZEN BUDGETING Kaizen : Continuous Improvement Continuous Improvement Goals Incorporates continuous improvement during the budget period into the budget numbers JAPANESE COMPANIES Citizen Watch Co. ACTIVITY-BASED BUDGETING Incorporating Activity-based Cost Drivers into Budgets Focuses on the Budgeted Cost of Activities Budget for each Activity ZERO BASE BUDGETING A method of budgeting All Activities : Evaluated Every item of expenditure : Fully Justified Involves starting from scratch or zero
ZBB & GOVT.
STEPS OF ZBB Identify each separate activity : A decision package Evaluate : Each decision package Consider : Alternatives for each decision package. Rank : Decision packages - priority for resource allocation. Allocate :Resources to the packages.
Budgeting is the common accounting tool companies use for planning and controlling what they must do to satisfy their customers and succeed in the market place.