COST & MANAGEMENT ACCOUNTING (COMA)
PGP-I (2005-2007) : Term-II
(Prof. R. K. Bal)

COURCE OUTLINE



COURSE OBJECTIVES:

Accounting is the language of business. While the primary focus of Financial Accounting is providing information for use of external stakeholders, Cost and Management Accounting provides timely and relevant information to managers for planning, control and decision making. The objective of this course is to familiarize the students with the cost and management accounting principles, techniques and methods, and their application in the process of managerial decision making .

TOPICS TO BE COVERED :
· Introduction to Accounting; Accounting: the Language of Business; Accounting: an Information System ; Outputs of Accounting System; Users of Accounting Information .
· Financial Accounting, Cost Accounting and Management Accounting ; Cost Management and Accounting System; Strategic Decisions and the Management Accountant.
· Cost and Cost Terminology ; Direct Cost and Indirect Cost; Cost Tracing and Cost Allocation ;Cost Behavior Patterns : Variable Cost and Fixed Cost.
· Statement of Cost ; Total Cost and Unit Cost ; Prime Cost and Conversion Cost ; Product Cost and Period Cost
· Absorption Costing and Marginal Costing
· Cost-Volume-Profit Analysis and Managerial Decision Making
· Activity Based Costing ; Cost Allocation ; Allocation of Support Department Cost and Common Costs.
· Cost Accumulation Systems : Job Costing and Process Costing ; Joint Product and By-product; Inter-process Profit and Equivalent Production .
· Responsibility Accounting and Responsibility Centers; Segment Performance Analysis.
· Budgetary Control System ; Flexible Budgets ; Master Budgets ; Zero Base Budgeting.
· Variance Analysis: Evaluation of Cost and Sales Variances ; Variances & Management Control.
· Decision Making and Relevant Cost
· Balanced Scorecard.
EVALUATION:
· Quizzes, assignments and presentations : 30%
· Mid-term examination : 30%
· End-term examination : 40%

BOOKS FOR REFERENCE
1. Horngren, Foster & Datar - Cost Accounting : A Managerial Emphasis(Pearson)
2. Horngren, Sundem & Stratton – Introduction to Management Accounting (Pearson)
3. Jawahar Lal - Cost Management (Tata McGraw)
4. Nigam & Sharma - Cost Analysis & Control: A Managerial Emphasis(Himalay)

COST AND MANAGEMENT ACCOUNTING
GLOSSARY


Absorption Costing (Conventional Costing )
The traditional method of recording and reporting cost for income determination. Here, cost of a product consists of variable costs and fixed costs.
Abnormal Gain
Gain which arises when actual loss is less than expected.
Abnormal Loss
Loss which is caused by unexpected or abnormal conditions, viz., carelessness, accidents, bad plant design.
Breakeven point
The level of activity where total cost equals sales revenue.
By product
Recovered from materials discarded in the main process or from the production of some major product.
Contribution Margin
The difference between revenue and variable cost
Cost
The amount of expenditure incurred on, or attributable to a thing.
Cost Accumulation
Collection of cost data in some organized way by means of an accounting system.
Cost Assignment
Encompasses both (i) tracing accumulated costs that have a direct relationship to a cost object and (ii) allocating accumulated costs that have an indirect relationship to a cost object.
Cost Centre
An organizational unit responsible for costs
Cost Object
Anything for which a measurement of costs is desired.
Cost Driver
Which has a strong influence on the amount of cost incurred. Cost driver selected is called activity base.
Differential Cost (Incremental Costs)
Cost incurred as a result of taking on an additional piece of business.
Direct Cost
The costs which can be traced to a cost object in an economically feasible ( cost-effective ) way.
Direct Costing ( Marginal Costing )
A system of costing under which only variable production costs are considered as product costs, and fixed costs are treated as period costs.
Direct Labour Cost
The cost of any operation performed by a productive worker directly for the conversion of raw materials into finished products.
Factory Overhead
A major manufacturing cost element containing all manufacturing expenses other than direct material and direct labour.

First In First Out (FIFO)
A method of inventory pricing which assumes that the order in which materials are received in the stores is the order in which materials are issued from the stores.
Fixed Costs
Costs that remain unchanged in total for a given time period despite changes in the level of activity.
Indirect Cost
Which can not be traced to a cost object in an economically feasible way
Indirect Material
The cost of material which is not classified as becoming a part of the product(i.e., direct material) but which facilitates the production process.
Joint Products
Products that are produced by a single process but are not identifiable as individual products until some definite point in the manufacturing process.
Job Last In First Out (LIFO)
A method of pricing inventory issues which assumes that the material which is acquired last is issued first.
Margin of Safety
The amount by which actual sales exceed break-even sales.
Normal Loss
Loss which is inherent in the processing operation and is unavoidable.
Prime Cost
The sum of the direct manufacturing cost elements, e.g., direct material, direct labour, direct expenses.
Process Costing
A technique of accumulating costs when the production is large quantities of similar or identical units of standardized products.
Responsibility Centre (Segment)
An` organizational unit which is held accountable for performance in fairly specific terms.
Semi-variable Cost
A cost which is partly fixed and partly variable
Standard Cost
A predetermined cost which is a measure of acceptable performance established by management.
Sunk Cost
Cost which have already been incurred and which can not be reversed.
Variable Costs
Costs which are dependent upon the level of activity for the amount of their incurrence.
ACCOUNTING :
Accounting is the language of business.
Accounting is an information system.

ACCOUNTING SYSTEM :
Provides database or data warehouse for decision making.

OBJECTIVES OF ACCOUNTING SYSTEM :
1. Internal Reporting
2. External reporting 1. Internal Customers
2. External Customers · Financial Statements
· Tax Returns
· Managerial Data and Reports
· Special Reports

COST & MANAGEMENT ACCOUNTING (COMA)

COMA provides information to managers for planning, controlling & decision making.

The controller: The Chief Management Accountant

“The Controller is compared to a ship’s navigator, with the President(CEO) being the ship’s captain.”

ROLE OF THE ACCOUNTANT:
To manage information

o SCORE – KEEPING
o ATTENTION DIRECTING
o 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.
· · Identifies unprofitable activities.
· Improves efficiency / Facilitates cost control.
· Helps in planning & preparation of budgets.
· Helps in inventory control.
· Facilitates decision making.
· Helps in achieving the main objective of the organization
MANAGEMENT AND COMA
· Provides management 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 in making special studies and investigations.
· Assists and participates in the formulation and execution of budgets and standards. 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 in term of price and quality ?
· Is the industry demand growing or shrinking ?
· Is their over capacity ? COMA Vs. FINANCIAL ACCOUNTING
SIMILARITIES
- Both are branches of Accounting.
- Are concerned with systematic recording and presentation of financial data.
- Both follow same principles regarding Dr. and Cr.
- Both have the same source of recording transactions.
- Both have the common goal of continuously assisting the organization they serve.
- Both are complementary to each other.
DIFFERENCES :
1. Purpose
2. Periodicity of reporting
3. Customers served
4. Audit
5. Accounts prepared
6. Tax assessment
7. Actual and standard
8. Profit and Loss
9. Monetary and Non-monetary
10. Relative efficiency
11. Constrained by GAAP OBJECTIVES OF CMIS:
1. To provide information for costing out services, products and other objects of interest to management.
2. To provide information for decision making.
3. To provide information for planning and control.

THE VALUE CHAIN OF THE BUSINESS FUNCTION

The value chain is the sequence of business functions in which utility is added to the products or services in an organization. These business functions are:

Strategy and Administration

R&D Design production marketing distribution customer service

Modern Cost Accounting Or Management Accounting

Accounting helps managers:
a. To administer each of the business functions.
b. To coordinate their functions.

1. For each of the following activities, identify the main role the accountant is performing- Problem Solving (P), Score-keeping(S), or Attention Directing (A). a. Prepare a schedule of depreciation for boat hull and deck molds.
b. Analyzing the desirability of using standard Volvo-penta boat engines in a new boat model
c. Preparing the daily report of the number of hull defects found during the quality check on the Sport Boat assembly line.
d. Explaining the Commodore Yacht Division’s monthly performance report.
e. Interpreting differences between actual results and budgeted amounts on the Prototyping Department’s monthly performance report.
f. Preparing a monthly statement of boat sales, by model and customer, for the company’s vice president of sales.
g. Analyzing for the Design Team the impact on product costs for a new dashboard-odometer display.
h. Preparing a cost comparison of two plywood manufacturers for use by the purchasing manager

2. Classify each of the cost items (a-h) into one of the business functions of the value chain.
a. Cost of toll-free telephone line used for customer inquires about product specifications, performance, and warranty coverage.
b. Cost of sales and promotional materials for use at boat shows.
c. Labor costs of workers in the Cabinetry Department of the production facility.
d. Cost of the industry research report on boat industry trends.
e. Equipment and trucks purchased for transporting finished boats to retail outlets such as the Boat Tree
f. Boat hull and deck mold-fabrication costs.
g. Cost of a new CAD design station used by the Design Department.
h. Cost of upholstered seats for Commodore yachts.
STS

In general, ‘cost’ means the amount of expenditure incurred on or attributable to a thing. Resource sacrificed or forgone to achieve a specific objective is also called ‘cost’.

ELEMENTS OF COST
There are broadly three elements of cost.

Material
The substance from which the product is made is known as material. It may be raw or a manufactured state. It can be direct as well as indirect.

Direct Material : All materials which becomes an integral part of the finished product and which can be conveniently assigned to specific physical units is termed as Direct Material. The following are some of the examples of direct material :
· All materials or components specifically purchased, produced or requisitioned from stores.
· Primary packing material (e.g., carton, wrapping, cardboard, boxes, etc.)
· Partly produced or purchased components

Indirect Material : All materials which is used for purposes ancillary to the business and which can not conveniently be assigned to specific physical units, is termed as ‘indirect material’. Consumable stores, oil and waste, printing and stationery material, etc., are a few examples of indirect material.

Labour
For conversion of materials into finished goods, human effort is needed. Such human effort is called labour. Labour can be direct as well as indirect.

Direct Labour : Labour which takes an active and direct part in the production of a particular commodity is called direct labour. Direct labour costs are, therefore, specifically and conveniently traceable to specific products.

Indirect Labour : Labour employed for the purpose of carrying out tasks incidental to goods produced or services provided is indirect labour. Such labour does not alter the construction, composition or condition of the product. It can not be practically traced to specific units of output. Wages of store-keepers, foremen, time-keepers, directors’ fees, salaries of salesmen, etc., are all examples of indirect labour costs.

Expenses
Expenses may be direct or indirect.

Direct Expenses : These are expenses which can be directly, conveniently and wholly allocated to specific cost centers or cost units. Examples of such expenses are : hire of some special machinery required for a particular job or contract, etc.

Indirect Expenses : These are expenses which can not be directly, conveniently and wholly allocated to cost centers or cost units. Examples of such expenses are rent, lighting, insurance charges, etc.

Overheads

The term overhead includes indirect material, indirect labour and indirect expenses. Thus, all indirect costs are overheads.
A manufacturing organization can be broadly divided into three divisions.
· Factory or Works, where production is done
· Office and administration, where routine as well as policy matters are decided.
· Selling and distribution, where products are sold and finally dispatched to the customers.
Overheads may be incurred in the factory or office or selling and distribution divisions. Thus, overheads may be of three types.

Factory Overheads: They include:
· Indirect material used in the factory such as lubricants, oil, consumable stores, etc.
· Indirect labour such as gate-keeper’s salary, time-keeper’s salary, works manager’s salary, etc.
· Indirect expenses such as factory rent, factory insurance, factory lighting, etc.

Office and Administration Overheads : They include:

· Indirect material used in the office such as printing and stationery material, brooms and dusters, etc.
· Indirect labour such as salaries payable to office manager, office accountant, clerks, etc.
· Indirect expenses such as rent, insurance, lighting of the office.

Selling and Distribution Overheads : They include:

· Indirect material used such as packing material, printing material and stationery material, etc.
· Indirect labour such as salaries of salesmen and sales manager, etc.
· Indirect expenses such as rent, insurance, advertising expenses, etc.

Fixed Cost: These are the costs which remain constants irrespective of the quantum of output within and up to the capacity that has been built up. Examples of such costs are; rent, insurance charges, management salary, etc. Fixed cost remain constant per unit of time. As a result, they decrease per unit with every increase in output and vice versa. Fixed cost sometimes are also referred to as period costs. They can further be divided into i. Committed fixed cost and ii. Discretionary fixed costs.

Committed Fixed Costs consists largely of those fixed costs that arise from the possession of plant, equipment and a basic organizational structure. For example, once a building is constructed and plant is installed, nothing much can be done to reduce the costs such as depreciation, property taxes, insurance and salaries of the key personnel, etc., without impairing the organization’s competence to meet the long-term goals.

Discretionary Fixed Costs are those which are set at fixed amount for specific time periods by the management in the budgeting process. These costs directly reflect top management policies and have no particular relationship with volume of output. These costs can therefore be reduced or eliminated entirely, if the circumstances so require. Examples of such costs are: research and development costs, advertising and sales promotion costs, donations, management consulting fees, etc. these costs are also termed as managed or programmed costs.


Variable Costs: These are the costs which vary in direct proportion to output. They increase or decrease in the same proportion in which the output increases or decreases. The example of such costs are direct material, direct labour, power etc.Variable costs may be said to be constant per unit of output.

Semi-variable Costs: These are the costs which do vary but in indirect proportion to output. They are made up of both fixed and variable cost elements such as depreciation, repairs, light, heat, telephone, etc
etc. Identification of fixed and variable elements of semi-variable costs is important for the management for planning their business activities.

Step Costs: Fixed cost in general remain fixed over a range of activity changes. For example, a foreman can supervise a given number of workers. Beyond this number, it is necessary to hire a second foreman, then a third and so on. Similarly, the rental cost of delivery vehicles also follows the same pattern.



Direct and indirect Cost

Direct Costs: These are costs which can be directly, conveniently and wholly traced to a product, service or job. Example of such costs are: direct material, direct labour and direct expenses.
Indirect costs: These are costs which can not be directly, conveniently and wholly identified with a specific product, service or job. They include all overhead costs such as salaries of time keepers, store keepers, foreman, printing and stationery costs, etc. Indirect or overhead costs are apportioned to different jobs, products or services on a reasonable basis. For example, the indirect factory labour cost may be apportioned over different jobs according to their direct labour cost.

Shut Down and Sunk Costs

Shut Down Costs: These represent the fixed costs which have to be incurred even during the period when a factory is shut down on account of some temporary difficulties, viz., shortage of raw materials, non-availability of requisite labour force, etc. during this period, though no work is done, the fixed costs, such as rent, insurance, depreciation, maintenance, etc. for the entire plant have still to be incurred. Such costs of the idle plant are known as shut down costs.
Sunk Costs: These are historical or past costs, that is, costs which have been incurred as a result of a decision-made in the past. Such costs cannot be reversed or revised by subsequent decisions. Investments in plant and machinery, building, etc. are some prominent examples of such costs. Sunk costs are considered not relevant for decisions concerning the increase in the present profit levels.

Controllable and Uncontrollable Costs

Controllable Costs: These are costs which can be influenced by the action of a specified member of an organization. For example, the foreman of a production department can control the utilization of power or raw materials in his department. These are, therefore, controllable costs as far as he is concerned.
Uncontrollable Costs : These are costs which cannot be influenced by the action of a specified member of an undertaking. For example, the foreman of a production department can control the wastage of power in his department, but he can not control the power which is being wasted in the power house itself resulting in higher cost per unit of power to him. Similarly he can not control the increase in the cost of materials consumed in his department if the purchase department , which is the supplying department, buys the materials at higher prices due to its own inefficiency. Such costs are controllable at some other level of the management.

Imputed or Hypothetical Costs: These are costs which do not involve cash outlay. They are not included in cost accounts but are important for making managerial decision making. If two projects required unequal outlays of cash, the management must take into consideration interest on capital to judge the relative profitability of the projects.

Differential, Incremental or Decremental Costs: The difference in total costs between two alternatives is termed as differential cost. In case the choice of an alternative results in increase in the total costs, the resulting decrease is known as decremental costs. While assessing the profitability of a proposed change, the incremental costs are matched with incremental revenues.

Out-of-Pocket Costs: Out-of-Pocket cost means the present or future cash expenditure regarding a certain decision which may vary, depending upon the nature of the decision made. For example a company has its own trucks for transporting raw materials and finished products from one place to another. It seeks to replace these trucks by employing public carriers of goods. In making this decisions, of course, the depreciation of the trucks is not to be considered, but the management must take into account the present expenditure on fuel, salary to drivers and maintenance which have to be incurred in cash. Such costs for arriving at a decision are termed as out-of-pocket costs.

Opportunity Costs: Opportunity cost refers to the advantage, in measurable terms, which has been foregone on accounting of not using the facilities in the manner originally planned. For example, if an owned building is proposed to be utilized for housing a new project plant, the likely revenue, which the building could fetch, if rented out, is the opportunity cost which should be taken into account while evaluating the profitability of the project.

Traceable, Untraceable and Joint Costs

Traceable Costs: These are costs which can be identified or traced to specific products, services or units of the company such as raw material and labour, etc.
Untraceable Costs: These are costs which cannot be identified with a department process or product. Such costs are also termed as common costs, as they are incurred collectively for a number of products or cost centers e.g., overheads incurred for the factory as a whole. As such they are apportioned among various products or cost centers using suitable criterion.
Joint Costs; whenever two or more products are produced out of one and the same raw material or process, the cost of material purchased and the processing are called joint costs. Take the example of an oil refinery, where a range of products such as bitumen, petrol, kerosene, disel, etc. are derived in the process of refining crude oil. All these products have joint costs comprising the cost of crude and the cost incurred in the course of refining. These joint costs are then apportioned to various products on some basis.

Conversion Cost: The cost of transforming direct materials into finished products, exclusive of direct material cost, is known as conversion cost. It is usually taken as the aggregate of the cost of direct labour, direct expenses and factory overheads.


Relevant Cost
Relevant costs are those future costs which differ between alternatives. Relevant costs may also be defined as the costs which are affected and changed by a decision. On the contrary, irrelevant costs are those costs which remain the same and not affected by the decision whatever alternative is chosen.
The above classification and concepts of costs help the management in the decision making process. For example, segregation of cost into fixed and variable elements will help the management in analyzing the total cost. Similarly, segregation of cost into controllable and uncontrollable categories will help the management in fixing responsibilities of different executives for unfavorable cost variances.

CASE – THREE DOG BAKERY
For Three Dog Bakery(TDB), “going to the dogs” has been a good thing! Founded by Dan Dye and Mark Beckloff in 1989 with little more than the desire to satisfy the finicky palate of their beloved 114-pound, deaf Grate Dane, Gracie, the company has grown from a single store in downtown Kansas City, Missouri, to more than 30 world-wide locations. Their dog treats are made from wholesome ingredients such as flour, eggs, carrots, spinach, peanut butter , and carob, and they have clever names such as Snickerpoodles, Scottie Biscottis, Rollovers, Pup Tarts, and Great Danish. Some of the treats are frosted with honey-yogurt icing and decorated with colorful, edible flourishes. Special occasion cakes, such as carrot cake or carob chip, can be personalized by an in-store pastry chef. More than a few customers have entered the bakery stores to buy snacks before realizing the treats were for dogs, not people. In all, the company makes more than 125 different low-fat treats. Selling prices range from a few cents for a small dog biscuit to more than $20 dollar for a special order cake.
TDB has a 40,000-square-foot centralized baking commissary in downtown Kansas city that prepare 70% of the goodies sold. Except for slower summer months, the commissary runs 24 hours a day, seven days a week. Items consist of baked biscuits and carob-dipped goodies that can pack and ship well. The commissary has one main assembly line with stations for mixing ingredients, manual placement of cut or extruded biscuits on backing sheets, baking ovens, cooling, manual carob dipping (for selected items), hand-packing into trays or containers, shrink-wrapping, and boxing. Most trays hold 12 specialty biscuits each and are packed by hand. There is also a conveyer belt for the automated packing of small biscuits into 7-ounce tubs. Employees are cross-trained to perform multiple assembly-line functions and can work on every type of biscuit the plant produces.
For the remaining 30% of finished goods, each store has a specially outfitted kitchen that prepares cakes, brownies, tarts, and other delicate or frosted items. Prepackaged mixes, created at the commissary, are used to assure consistent quality from store to store. Retail bakeries also sell non-edible pet items, such as collars, leashes, shampoo, logo t-shirts, hats and coffee mugs. Some of the stores host birthday parties and “yappy hours” for in-store dog socialization. Customers do not have to come to Three Dog Bakery retail store to buy merchandise, however. The company has a whimsical Web site (www.threedog.com) and a healthy mail-order business through its cat - oops! - Dogalog. PetsMart stores in the United States stock Three Dog Bakery treats, too. Sales are split evenly between the three sales channels: retail, direct-to-consumer, and wholesale.
Annual revenues exceed $20 million for this privately held company. As for the pet market itself, there are more than 60 million pet dogs in the United States, with nearly every owner buying anywhere from one to five packages of treats per month. Two thirds of pet owners give their pets gifts, more than half give Christmas presents, and 25% give birthday gifts. Pet owners spend in excess of $20 billion annually industry wide on animal products, food and services. Owners who spend more than $300 per year on their dogs tend to be younger, earn higher incomes, be married, and have no children.

QUESTIONS

1. To what cost objects could Three Dog Bakery trace its costs?
2. Classify the following cost items as direct (D) or indirect (I) and fixed (F) or variable (V) with respect to the production department (you will have two answers for each item D or I; F or V):
a. Salary of the production-department
manager who oversees manufacturing
b. Salaries of founders Dan Dye and
Mark Beckloff.
c. Cardboard trays used to package sets of 12
specialty biscuits
d. Salary of the graphic designer who prepares the
Dogalog illustrations and layout.
e. Annual maintenance service agreement for the
shrink-wrap machine.
f. Wages paid to assembly line workers who mix
Snickerpoodle ingredients in batches.
g. Air-conditioning costs for the entire baking commissary.
h. Cost of four eggs, and carob icing for Rollover biscuits.

3. The company produces its Dogalog on a quarterly basis and mails copies to customers on the company’s mailing list. Is the cost of producing and mailing the Dogalog considered an inventoriable cost or a period cost? Why?
4. What sectors - manufacturing, merchandising or service - does Three Dog Bakery operate in? Why are they classified this way?



COMPONENTS OF TOTAL COST

Prime Cost : It consists of cost of direct material, direct labour, and direct expenses. It is also known as basic, first or flat cost.

Factory Cost : It comprises prime cost and in addition, works or factory overheads which include costs of indirect material, indirect labour and indirect factory expenses. This cost is also known as works cost, production or manufacturing cost.

Office Cost : It comprises of factory cost and office and administration overheads. This is also termed as Cost of production.

Total Cost : It consists of office cost and selling & distribution overheads. This is also termed as cost of sales.
It may be noted that some accountants do not use the term office cost at all. They prefer to use the term total cost after adding office and administration overheads and selling and distribution overheads to work cost. However, we have presumed that office and administration overheads exclusively relate to production. The selling and distribution overheads are inclusive of any office and administration overheads which may have been incurred in respect of sales.

STATEMENT OF COST
The elements or components of total cost can be presented in the form of a statement, popularly known as ‘cost sheet’. The cost sheet may be prepared separately for each cost center. It may have columns to show total cost, cost per unit, together with the relevant figures of the previous period.
The techniques of preparing a cost sheet can be understood with the help of an Illustration.

From the following details relating to a company, let us prepare a cost sheet showing different components of cost :
Rs. Rs.

Raw Materials consumed 80,000
Wages paid to Labourers 20,000
Directly chargeable expenses 4,000
Oil and Waste 200
Wages of Foremen 2,000
Stores Keeper’s Wages 1,000
Electric Power 400
Lighting: Factory 1,000
Office 400
1,400
Rent: Factory 4,000
Office 2,000 6,000


Repairs and Renewals:
Factory Plant 1,000
Machinery 2,000
Office Premises 400 3,400
Depreciation:
Office Premises 1,000
Plant and Machinery 400 1,400

Consumable stores 2,000
Manager’s Salary 4,000
Director’s fees 1,000
Office printing and Stationery 400
Telephone charges 100
Postage and Telegrams 200
Salesmen’s commission and salary 1,000
Traveling expenses 400
Advertising 1,000
Warehouse charges 400
Carriage outwards 300


Cost sheet for January :
Rs. Rs.
Direct Materials: Raw Materials 80,000
Direct Labour: Wages paid to Labourers 20,000
Direct Expenses: Direct chargeable expenses 4,000

PRIME COST 1,04,000
Add; Factory Overheads:
Indirect material:
Consumable Store 2,000
Oil and Waste 200
2,200
Indirect Labour:
Wages of Foremen 2,000
Storekeeper Wages 1,000
3,000
Indirect Expenses:
Electric Power 400
Factory Lighting 1,000
Factory Rent 4,000
Repairs and renewals:
Plant 1,000
Machinery 2,000
3,000
Depreciation:
Plant and machinery 400 8,800 14,000

FACTORY OR WORKS COST 1,18,000

Add: Office or Administrative Overheads:
Indirect material:
Office printing & Stationery 400
Indirect Labour:
Manager’s Salary 4,000
Director’s fees 1,000
5,000


Indirect Expenses:
Office lighting 400
Office Rent 2,000
Repairs & Renewals premises 400
Depreciation on premises 1,000
Telephone Charges 100
Postage and Telegrams 200
4,100 9,500

TOTAL COST OF PRODUCTION 1,27,500
Add: Selling & Distribution overheads:
Indirect Labour:
Salesmen’s commission & Salary 1,000
Indirect Expenses:
Traveling Expenses 400
Advertising 1,000
Warehouse Charges 400
Carriage outward 300
2,100 3,100

COST OF SALES 1,30,600

TREATMENT OF STOCK IN COST SHEET
1. Stock of raw material
2. Stock of W.I.P.
EXAMPLE OF COST SHEET
The following data have been extracted from the books of ABC Ltd.
Opening stock of raw materials ……….. : 25,000
Closing stock of raw materials- - … . : 30,000
Purchases - ; 90000
Expenses on purchase of raw materials : 5, 000
Wages : Direct …………………………………. … : 80,000
: Indirect………………………………. ….. : 10,000
Direct expenses…………………………………….. : 15,000
Consumption of Indirect materials…………………. : 2,000
Rent : Factory…………………………………….. : 5,000
: Office………………………………………. : 4,000
Depreciation : plant and machinery…….. : 6,000
: Office Furniture…………… : 3,000
Salary : Office…………………………………….. : 75,000
: Salesmen……………………………….. : 60,000
Other Factory Expenses……………………….. : 12,000

Other Office Expenses………………………… . : 17,000
Bad debts written off……………………………. : 2,500
Advertisement Expenses……………………… : 11,000
Carriage outward…………………………………. : 14,000
Advance income Tax paid……………………. : 20,000
Materials used for primary packing……… : 16,000
Packing materials used in selling…………. : 3,500
Cost of opening stock of Finished Goods : 40,000
Cost of closing stock of Finished product : 35,000
Sales……………………...........……………………………500,000

Prepare cost sheet.
ESTIMATED COST SHEET

Considers all probable changes in the elements of cost.

EXAMPLE:

The following information are obtained from the records of AB cycles Ltd for the month of August.
Direct materials : 6, 80, 000
Direct labour : 6, 00, 000
Factory overheads : 2, 80, 000
Administrative overheads: 1, 60, 000

Outputs for the month: 1,000 units. 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.

DIFFERENT COSTS FOR DIFFERENT PURPOSES

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.
· It does not provide information which aids decision making in a rapidly changing market environment.
CASE

THE FOLLOWING DATA RELATES TO A COMPANY:
Expected sales : 50,000units
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. 7.75 per unit. Advise whether the export order should be accepted or not. The company has a capacity to produce 60,000 units.
INFERENCES:
1. An organization has different costs having different nature. 2. These costs behave differently to changes in the level of business activity.
3. Understanding this relationship helps in planning, control and developing successful business strategies.
SEGREGATION OF SEMI-VARIABLE COSTS
1. Levels of output compared to levels of expenditure Method : 2. High- low method (Range Method): Similar to the previous method
3. Degree of variability method.
4. Scatter graph method.
5. Methods of least squares Y = Semi-VC, a = FC, b = VC, x = Production in units
- a technique of costing
· Ascertainment of M.C. 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 · FCs are 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.

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. are 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
1. Helps in determining the volume of production.
2. Helps in selecting production lines.
3. Helps in deciding whether to shut down or continue.
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
Less Fixed Overhead 12,000
Net profit 4,000 8,000
Valuation of closing stock:
Marginal costing = 5000/15,000 * 51,000 = Rs. 17,000
Absorption costing = 5000/15,000 * 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
2000 2001 2002
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 : It refers to a sense of determination of that level of activity where total cost equals selling price.

Broad Sense : It refers to that 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 where income equals expenditure
· No profit no loss point Sales for a desired profit
= (FC+ desired profit) / p/v ratioC = 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 / p/v ratio
P/V ratio = Contribution / Sales = C / S
= Change in Profit / Change in Sales
MOS = Total Sales – BEP

BREAKEVEN ANALYSIS FOR MULTIPLE PRODUCTS

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. 200,000. 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

A market basket approach is used to compute the breakeven point in units. CASE-1 Selling price per unit: Rs. 25 per unit
Variable manufacturing cost: Rs 10 per unit
Fixed factory overhead: Rs. 60 lakhs
Variable office expenses: Rs. 3 per unit
Fixed administration overhead: Rs 36 Lakhs
a. Determine BEP
b. Find out the units to be sold to earn a profit of Rs. 36 Lakhs.

CASE-2
Mahalaxmi seamless Ltd manufactures seamless rolled pipes which are used in petrochemicals and oil exploration. Some data about the company are given below:
(Rs. in crores)
2003-2004 2004-2005
Sales 1450 1590
Net profit/loss (10) 18

Can you determine the cost structure of MSL in terms of fixed and variable cost? At what level of total income will MSL breakeven?
CASE-3 Plant-1 Plant-2
Capacity operation: 100% 60%
Sales: Rs. 600lakhs Rs. 240lakhs
V.C.: Rs. 440 lakh Rs. 180lakh
F.C.: Rs. 80 lakh Rs. 40lakh

They decided to merge. Calculate:
§ Capacity of the merged plant to operate at break-even.
§ Profit on working at 75%of the merged capacity. CASE-4
AB. Ltd. C. Ltd.
Rs. Rs.
Sales: 1,50,000 1,50,000
V.C. : 1,20,000 1,00,000
F.C. : 15,000 35,000
Profit: 15,000 15,000

a. Calculate: BEP for each business
b. State which business is likely to earn greater profit in conditions of :
i. Heavy demand for the product.
ii. Lower demand for the product.

COST - VOLUME RELATIONSHIPS
To study the cost behaviour, look for some measurable concept of volume or activity that serves as cost driver.
Cost Driver: Which has a strong influence on the amount of costs incurred. Cost driver selected is called activity base.
Activity Base: It may be:
- Units of key production input: tons of raw material, direct labour hours, worked machine hours.
- Units of outputs: units produced, units sold, sales revenue.
Examples of Activity Base:
Automobile: Miles driven
Airlines: passenger-miles flown
Retail stores: total sales
NOTE: after selecting an appropriate activity base, operating costs are classified into fixed, variable and semi-variable.
· One of the decision models
· One aspect of CVP Analysis is break- even 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
· Volume changes on NP
· Price and volume changes on NP
· An increase or decrease in VC on NP
· An increase or decrease in FC on NP
· All four factors, viz., price, volume, VC and FC on NP.
CVP ANALYSIS

CASE – 1:
The management of the ABC processing company has engaged you to assist in the development of information to be used for managerial decisions.

The company has the capacity to process 20,000 tons of cottonseed per year. The yield from a ton of cottonseed is as shown below.

Product Average yield Average selling Total Oil 400 pounds 0.25 per pound 100
Meal 600 pounds 160.00 per ton 48
Hulls 800pounds 100.00 per ton 40
Lint 200 pounds 0.06 per pound 12

2,000 pounds 200

· There are 2,000 pounds in a ton.

A special marketing study revealed that the company can expect to sell its entire output for the coming year at the average selling prices listed above.
You have determined the company’s cost structure to be as follows:

Cost of cottonseed : Rs.80 per ton.
Processing costs:

Variable: Rs. 26 per ton of cottonseed processed
Fixed: Rs. 340,000 per year at all levels of production

Marketing costs: Rs. All variable Rs. 44 per ton of all products sold
Administrative costs: All fixed Rs. 300,000 per year at all levels of
production and sales activity

Instructions:

a. Compute per ton of cottonseed : 1) the contribution margin and 2) the contribution margin ratio.
b. Compute the break-even sales volume in : 1) rupees and 2) tons of cottonseed..
c. Assume that the company’s budget calls for an operating income of Rs. 240,000. Compute the sales volume required to reach this profit objective, stated 1) in rupees and 2) in tons of cottonseed.
d. Compute the maximum amount that the company can afford to pay per ton of raw cottonseed and still break-even by processing and setting 16,000 tons during the current year.


CASE – 2:

Rainbow paints operates a chain of retail paint stores. Although the paint is sold under the rainbow level, it is purchased from an independent paint manufacturer. Mr. Walker, president of Rainbow paints, is studying the advisability of opening another store. His estimates of monthly costs for the proposed location are:

Fixed costs:

Rent and occupancy costs……………………… Rs. 3.160
Salaries………………………………………… Rs. 3,640
Others…………………………………………. Rs.1,200
Variable cost including cost of paints…………. Rs. 6 per gallon

Although Rainbow stores sell several different types of paint, monthly sales revenue consistently averages Rs. 10 per gallon sold.

Instructions:

a. Compute the contribution margin ratio and the break-even point in rupee sales and in gallons sold for the proposed store.
b. Draw a monthly cost-volume-profit graph for the proposed store, assuming 3,000 gallons per month as the maximum sales potential.
c. Walker thinks that the proposed store will sell between 2,200 and 2,600 gallons of paint per month. Compute the amount of operating income that would be earning per month at each of these sales volumes.



CASE – 3:

ABC Company manufactures three different products. The estimated demand for the products for the current year is such that production will not be able to keep pace with incoming orders. Some pertinent data for each product are listed below :

Product Estimated Sales Direct Direct Variable
Unit Sales Price Material Labour manufacturing
Cost Cost Overhead
Rs. Rs. Rs. Rs.

A 15,000 20 3 10 1
B 8,000 12 1 5 1
C 2,400 17 2 10 1

Direct labour costs an average of Rs. 10 per hour.

Instructions

a. prepare a schedule showing the contribution margin per one unit of each product and also the contribution margin per one hour of direct labour applied to the production of each class of product. b. If you were able to reduce the production of one of the products in order to meet the demand for the others what would that product be? Why? Assume that available direct labour hours represent the scarce resource which limits total output.
c. Assume that the 15,000 hours of direct labour now used to produce product A are used to produce additional units of product B. what would be the effect on total contribution margin.

CASE – 4

The following figures have been extracted from the books of accounts of ABC Ltd. Which produces a wide range of products which may be classified into three main groups:

Product group Annual Sales Variable Cost
Rs. Rs.

A 30,00,000 10,00,000
B 30,00,000 20,00,000
C 35,00,000 30,00,000

The total fixed cost is Rs.25,00,000
Draw a Break-even chart and find BEP

CASE – 5

The XYZ Ltd. Currently operating at 80% capacity, has the following profit and loss Account for the year ended 31st March 2005.

Sales………………………………………………………… Rs. 3,20,000

Less Costs :

Direct material Rs. 1,00,000
Direct Labour 40,000
Variable overheads 20,000
Fixed Overheads 1,30,000
2,90,000

Profit : 30,000

It has just received an offer of an overseas order that would require the use of half the factory’s capacity. The order, which must be taken in full or rejected completely, must be supplied at price less 10% below current domestic price.

Management has the following choices:
i. Reject order and carry on with domestic sales only.
ii. Accept order, split capacity equally between overseas and domestic sales, and turn away domestic demand; or
iii. Increase factory capacity so that they can accept the export order and maintain the present domestic sales level by:
a. buying a machine that will increase factory capacity by 10% and fixed cost by Rs. 20,000; and
b. working overtime at time and a half to get a balance of required capacity.
Which is the most profitable alternative?

CASE – 6

The SS Ltd. Makes only one product. The result of the first quarter of the year revealed the following:

Sales in units 10,000
Loss in Rs. 10,000
Fixed cost ( for the year Rs. 1,20,000) 30,000
Variable costs per unit in Rs. 8
The finance manager who feels perturbed suggests that the company should at least break-even in the second quarter with a drive for increased sales. Towards this, the company should introduce a better packing which will increase the cost by Re.0.50 per unit.

The sales manager has an alternative proposal. For the second quarter additional sales promotion expenses can be increased to the extent of Rs. 5000 and a profit of Rs5000 can be aimed during the period with increased sales.
The production manager feels otherwise to improve the demand, the selling price per unit has to be reduced by 3%, as a result, the sales volume can be increased to attain a profit level of Rs. 4,000 for the quarter.
Evaluate these three proposals and calculate the additional sales volume that would be required in each case.
CASE – 7

Auto Ltd. Can produce a single product of 9,00,000 units at its full capacity. The current selling price is Rs. 65 per unit. Cost figures for the current year are given below:

Variable Costs :
Direct materials per unit Rs. 30
Direct labour per unit Rs. 15
Fixed Costs for the current year: Rs.60,00,000

During the next year, the company anticipates sharp fall in demand for its products. The plant is estimated to be operated at 20% capacity only.

If the plant is closed down, the fixed cost is likely to be reduced to Rs. 20,00,000. Moreover, the following additional costs are to be incurred:
ii) For putting the plant to operation again Rs. 30,000 i. Compute the BEP and the net profit earned for the current year assuming the plant operated at its 80% capacity.
ii. Advise management whether to continue in operation or close down during the next year.

CASE – 8 : ALMO COMPANY
Almo Company manufactures and sells adjustable canopies that attach to motor homes and trailers. For its 2005 budget, Almo estimated the following:

Selling price $400
Variable cost per canopy $200
Annual fixed costs $100,000
Net income $240,000
Income tax rate 40%

The May financial statements reported that sales were not meeting expectations. For the first five months of the year, only 350 units had been sold at the established price, with variable costs as planned and it was clear that the net income projection for 2005 would not be reached unless some actions were taken. A management committee presented the following mutually exclusive alternatives to the president.

a. Reduce the selling price by $40. The sales organization forecasts that at this significantly reduced price, 2,700 units can be sold during the remainder of the year. Total fixed costs and variable cost per unit will stay as budgeted.
b. Lower variable cost per unit by $10 through the use of less expensive direct materials and slightly modified manufacturing techniques. The selling price will also be reduced by $30, and sales of 2,200 units are expected for the remainder of the year.
c. Reduce fixed costs by $10,000 and lower the selling price by 5%. Variable cost per unit will be unchanged. Sales of 2,000 units are expected for the remainder of the year.

Required 1. If no changes are made to the selling price or cost structure, determine the number of units that Almo Company must sell (a) to break even, and (b) to achieve its net income objective.
3. Determine which alternative Almo should select to achieve its net income objective.
CASE – 9 : THE PTO DIVISION
The PTO division produces the same power takeoff units in two plants, a new plant in Peoria, and an older plant in Moline. The PTO division expected to produce and sell 192,000 power takeoff units during the coming year. The following data are available for the two plants:


Peoria Moline

Selling Price $150.00 $150.00
Variable mfg. cost per unit $72.00 $88.00
Fixed mfg. cost per unit 30.00 15.00
Variable marketing and dist. cost per unit 14.00 14.00
Fixed marketing and dist. cost per unit 19.00 14.50 ------------- ------------
Total cost per unit 135.00 131.50
--------- ----------
Operating income per unit $15.00 $18.50
----------------------------------------
Production rate per day 400 units 320 units

All fixed costs per units are calculated based on a normal year consisting of 240 working days. When the number of working days exceeds 240, variable manufacturing costs increased by $3.00 per unit in Peoria and $8.00 per unit in Moline. Capacity for each plant is 300 working days per year.
Wishing to take advantage of the higher operating income per unit at Moline, PTO’s production manager has decided to manufacture 96,000 units at each plant. This production plan results in Moline operating at capacity (320 units per day x 300 days) and Peoria operating at its normal volume (400 units per Day x 240 days).

Required:
1. Calculate the breakeven point in units for the Peoria and Moline plants.
2. Calculate the operating income that would result from the production manager’s plan to produce 96,000 units at each plant.
3. Determine how the production of the 192,000 units should be allocated between the Peoria and Moline plants to maximize operating income for the PTO division.

CASE – 10 : STORE 24

Modern convenience stores realize they have to offer more than late-night hours and diverse product assortment; they have to change with times or face extinction. Over the years, they have added new products and services, such as motor fuel, lottery tickets, and even internet shopping and delivery services. A work through any convenience store is likely to reveal in excess of 3,000 different products and services, available in many cases, 24 hours a day, seven days a week. There are over 24,000 convenience stores scattered across the United States. The convenience store industry generated $269.4 billion in sales in 2000.
Store 24 Headquartered in Waltham, Massachusetts, operates 82 stores in its chain of convenience stores. Locations are primarily in the Northeastern United States; where there are about 2,200 convenience stores-approximately 9% of the country’s total. The average sale is $3.00, with a gross margin of 30%. As part of an accounting class assignment, Maria Lopez made a visit to the Store 24 headquarters to learn more about the company. The class instructor directed the students to find a local business that uses cost-volume-profit (CVP) analysis for decision making, and identify a scenario where CVP analysis was used. Since Maria worked part-time at the Store 24 in her neighborhood after school, she wanted to use her employer for the assignment.
Paul Doucette, Store 24’s chief finance officer, agreed to meet Maria and help with her assignment. Paul assembled a set of reports and information Maria might find useful for the assignment. Paul told Maria that Store 24 uses CVP analysis in many situations. For example, company managers recently evaluated preparing in-store deli sandwiches for lunchtime customers versus pre-packaged deli sandwiches provided by an outside supplier. The effect on income of the stores sales mix also has been reviewed, and sensitivity analysis had been performed to see the effect of changing the selling price of milk
One recent use of CVP analysis that Paul thought would make a good illustration for Maria was its decision surrounding the sale of money orders at its stores. Paul explained this was a new product area for the company- a “financial service”, much like what a bank would offer. By offering this new service, Store 24 hoped bank would offer. By offering this new service, Store 24 hoped to boost its customer count. Previous studies had shown that customers were likely to buy more than just the items they originally intended to purchase. Store 24 wanted to boost sales revenue by giving customers another reason to come into the store- and buy more than intended.
Paul outlined for Maria the following information related to the analysis. The price of renting the machine used in each store to prepare money orders is $25 per month. For each money order processed, Store 24 paid a processing fee for five cents. After conducting an informal survey of banks and other local business that offered money order services, Store 24 found most charging 99 cents for each money order transaction. Store 24 decided to price its money order fee at 69 cents to undercut the local competition. Paul estimated that a money order transaction would take one counter clerk 90 seconds to complete, versus only 30 seconds for ringing up a product sale. The average hourly wage rate for a store clerk is $9.00 per hour.

QUESTIONS

1. What kind of customer might be attracted to the money order service? Would you expect these customers to be typical of a convenience store such as Store 24?
2. What is contribution margin per unit (money order)?
3. Using both the equation method and contribution margin method, how many money orders would each Store 24 location have to sell each month in order to break even on the service?
4. How many money orders would each Store 24 location need to sell to earn an operating income of $100 per month?
5. Studies have found that convenience store customers don’t like to wait in line for service. What effect might be offering of money orders have if there’s only one clerk staffed at the cash register each shift?



- An inescapable problem in every organization.

1. How should the costs of service departments be allocated among production departments?
2. How should the manufacturing overhead be allocated to individual products in a multiproduct company?

The answers are seldom clearly right or clearly wrong.

PURPOSES OF COST ALLOCATION

1. To provide information for economic decision:
- Pricing decisions.
- Make or buy decisions.
2. To motivate managers and employees:
- to push high margin products or services
- to show how costs in different functions are related to each other
3. To justify costs or compute reimbursement:
- Reimbursement for a consulting firm that is paid a percentage of the cost savings 4. To measure incomes and assets for external reporting: 1. To remind profit-center managers that indirect costs exist and that profit-center earnings must be adequate to cover some share of those costs.
2. To encourage use of central services that would otherwise be underutilized.
3. To stimulate profit-center managers to control service costs U. K.

1. To acknowledge that divisions would incur such costs if they were not provided centrally.
2. To make division managers aware that central costs exist.

3. To stimulate divisional managers to put pressure on central support managers to control costs.

4. To stimulate divisional managers to economize in usage of central services.

CRITERIA TO GUIDE COST ALLOCATION DECISION

1. CAUSE AND EFFECT: Identify the variable and allocate costs on that basis. 2. BENEFITS RECEIVED: costs are allocated among the beneficiaries in proportion to the benefits each receives. 3. FAIRNESS OR EQUITY: often cited in government contracting

4. ABILITY TO BEAR: Costs are allocated in proportion to the cost centers ability to bear them.
Allocation of 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; recruitment
Personal Department No. of employees; payroll
Rupees; recruitment · Classification
· Codification
· Collection
· Allocation and apportionment to cost centers
· Absorption in costs of products, services etc.
CLASSIFICATION

1. FUNCTIONS: Manufacturing OH 2. BEHAVIOUR: Fixed: office expenses, salaries of staff 3. ELEMENTS: Indirect material
4. NATURE: Salaries
WHY TO CLASSIFY?
1. Effective cost control: Flexible Budgets
Absorption of cost 2. Decision Making: CVP Analysis 3. Numeral method: Numbers
4. Mnemonic Method: Symbols/Letters
5. Mixed COLLECTION OF MANUFACTURING OH.

1. Material issue Analysis sheet/Material Abstract
2. Wages Analysis sheet
3. cash Book
4. Subsidiary Records 1. Primary distribution: Departmentalization of overhead 3. Final distribution: Overhead costs of production departments are distributed among the units produced. It is called as absorption of overhead.

CASE
P-I P-II P-III S-I S-II S-III
Area(Sq. m.) 1500 1000 900 800 600 500
No. of employees 30 25 20 15 10 10
Value of stock 20 30 10 - - -
(Rs. In lakhs)
Light points 50 40 30 20 10 10

Apportion the costs by the most equitable method.

ACTIVITY BASED COSTING
(For refining costing system)


A SIMPLE COSTING SYSTEM:
· A single indirect cost rate to allocate cost to products · Weak cause-and-effect relationship

· Cost smoothing leads to under casting & overcastting

· Product cost cross-subsidization
· Intense competition
· Advances in IT ABC systems calculate the costs of individual activities and assign costs to cost objects such as products and services on the basis of the activities needed to produce each product or service.



ABC : BENEFITS

· Obtaining true product cost
· Cost Management
· Better decision making

PROCESS

1. Direct cost tracing
2. Indirect-cost pool
3. Cost-allocation bases

IMPLEMENTING ABC: Steps

1. Identify the products that are the chosen cost objects
2. Identify direct cost of the products
3. Select the cost allocation bases to use for allocating indirect costs to the products
4. Identify the indirect costs associated with each cost-allocation base.
5. Compute the rate per unit of each cost- allocation base used to allocate indirect costs to the products
6. Compute the indirect costs allocated to the products
7. Compute the total costs of the products by 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 law marketing costs
· It has minimal customer-service costs
· Business environment is very competitive with respect to S3

Process

· Design products and processes
· Manufacturing operations
· Shipping and distribution

G. Motor’s purchasing manager indicated that a new competitor, who makes only simple lenses was offering to supply the S3 lens at a price of $53.

Plastim’s management is worried.

Options for plastim:

- lower its selling price
- Give up G. Motor’s business
- Reduce cost Mgt needs to first understand the costs to make and sell the S3 and CL5 lenses.


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
CL% : Uses 9,750 labour hours = $585,000

Thus, Plastims unit cost of the S3 lens will above the selling price of the competitor.

Possible Reasons :

· Plastims technology and process are inefficient in manufacturing and distributing S3 lens · Ineffective cost management

· Is costing system overcostting the S3 lens?

SEVEN ACTIVITIES OF PLASTIM

a. Design products and processes : $ 450,000
b. Set up of molding machines : $ 300,000
c. Manufacturing operations : $ 637,500
d. Cleaning and Maintenance : $ 270,000
e. Shipment set up : $ 81,000
f. Distribution : $ 391,500
g. Administration : $ 255,000
Guidelines for refining the costing system :

1. Direct cost tracing : To identify some costs or cost pools that can be reclassified as direct costs instead of indirect costs (improves cost accuracy)
2. Indirect cost pools : To create smaller cost pools linked to the different activities:
3. Cost allocation bases : A measure of activity performed serves as the cost allocation base for each activity-cost pool


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

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 Materials 1125,000 18.75 675,000 45.00
Direct Labour 600,000 10.00 195,000 13.00
Direct Mold Cleaning 120,000 2.00 150,000 10.00

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

Indirect Costs :

Design activity costs:

S3, 30 parts-sq.ft.*$4,500 135,000 2.25
CL5, 70 parts-sq.ft.*$4,500 315,000 21.00


Setup activity costs:

S3, 500 setup-hours*$150 75,000 1.25
CL5, 1,500 setuphours*$150 225,000 15.00


Manufacturing operations:

Activity costs
S3,9,000 moulding
Machine hours*$50 450,000 7.50
CL5,3,750 moulding
Machine hours* $50 187,500 12.50



Shipping setup activity:

S3, 100 shipments*$405 40,500 0.67
CL5, 100 shipments*$405 40,500 2.70



Distribution activity:

S3,45,000 cubic feet
Shipped*$5.80 261,000 4.35
CL5, 22,500 cubic
Feet shipped*$5.80 130,500 8.70



Administration activity:

S3,30,000 dir. Manuf.
Labour-hours*$6.4151 192,453 3.21
CL5,9,750 Dir. Manu.
Labor-hours*$6.4151 62,547 4.17


Total indirect costs: 1,153,953 19.23 961,04 64.07


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


CASE : DELL COMPUTER

Implementing Activity- Based Costing

When Dell embarked on its ABC change initiative in 1994, few managers knew what to expect. The Austin, Texas-based maker of made to order personal computers had “hit a wall”, according to Ken Hashman, director of service logistics. Net revenues for 1994 were $2.9 billion, but the year ended with a $36 million loss. The company was poised for tremendous growth, yet managers were not sure which products and markets were going to produce the profitability. Managers needed to know which product lines were driving profits and which were not.
So, when management chose to implement an ABC system, few people resisted. Dell managers recognized the value of better product-cost information and wanted to work out the details of implementing ABC in dozens of areas. In reflecting on this enthusiasm, Ken Hasman noted that the company actually had to pull back at first to get managers to focus on “the critical few” areas that held the greatest promise for big gains. When it came time to estimate total indirect costs of the activities, the Dell teams went to work gathering data. Cost driver identification followed indirect –cost estimation. Some of the cost drivers required rethinking by managers. For example, the purchasing function supports all product lines and acquires hundreds of parts for the computer assembly process. The cost of acquiring a part, whether the part costs $1 or $100, is pretty much the same. So the number of part numbers for each line of business became relevant. Before ABC, the cost of the purchasing function was simply part of overhead and was not identified with individual product lines.
Total cost-driver quantities were collected through Dell’s internal computer information system. Initially, spreadsheets were used to create the ABC models and to analyze the collected about the cost drivers. The spreadsheets made it easy to create the formulas to calculate the estimated indirect costs for each activity. The spreadsheets were also used to allocate the cost of activities to cost objects, such as different computer lines, based on the actual quantities used.
Five years later, the effort paid off big time! Net revenues for fiscal year1998 were $12.3 billion, an increase of 329% from 1994. net income for 1998 topped $944 million. Even more significant, managers now say they have a much better understanding of where the company makes money and where it doesn’t. john Jones, vice president and controller of Dell American Operations, says it best. “Activity-based costing has really allowed Dell to go to the next level of understanding the profitability of each product it sells.” Through the efforts of Dell’s teams, managers can use the resulting ABC information to perform activity-based management to truly affect profitability and decision making.

QUESTIONS

1. Why did Dell use cross-functional employee teams to identify company activities?
2. Prior to implementing activity-based costing and activity-based management, Dell used a simple job-costing system. How does job costing differ from activity-based costing, and why was it important for Dell to make this change? What would Dell have risked by not making the change?


COST ACCOUNTING SYSTEM

· Determines per unit cost
· Helps management in planning and controlling costs
· Provides information for decision making. - consists of techniques, forms and accounting records
- used to develop timely information about: o cost of producing specific products
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”.
- A TV set, An OHP
- Number of tons, gallons, pounds
- ‘Passenger-miles’ flown

Why to find unit cost?

- Provides the basis for inventory valuation - Basis for measurement of cost of goods sold

- Useful in setting selling prices

- Deciding what products to manufacture

- Evaluating the efficiency of operations

- Controlling costs Two basic types of CA system:
(Two extremes of product costing)

· JOB ORDER COST SYSTEM
· PROCESS COST SYSTEM
· produce “one-of-a-kind” products
· Tailor products to the specifications of individual customers

Examples: JOB - a method of ascertaining cost
- also known as “specific order costing”

Features:

1. Production is always against customers orders and not for stock.
2. Each job has its own characteristics and needs special treatment.
3. Each job undertaken is a cost unit.
4. A separate job cost sheet is prepared for each job to ascertain profit or loss.
5. There is no uniformity in the flow of production from one department to another in respect of jobs.

JOB COST SHEET

Job Number ---------- Product --------------
Date Started ------------- Date Completed --------------
Number of units Completed -----------------

DIRECT LABOUR
Date Time card
Number		HoursRateCost
MANUFACTURING OVERHEAD
DateActivity BaseApplication RateCost
COST SUMMARY
Cost ItemTotal CostUnit Cost
Total direct material used
Total direct Labour
Manufacturing overhead applied
Cost of Finished Goods manufactured
(To record all direct labour costs charged to the job)

ACCOUNTING FOR ‘OH’ COSTS
End of each week or month:
WIP Inventory- Rs. 10,000
Manufacturing overhead- Rs. 10,000
(To charge the WIP with OH costs applied to the Job)

ACCOUNTING FOR COMPLETED JOB
CASE – 1
The following information is available for job 321, which is being produced at the request of a customer:

Dept. A Dept. B Dept. C
Material consumed (Rs.) 4,000 1,000 1,500
Direct labour :
Wage rate per hour (Rs.) 3 4 5
Direct labour hours 300 200 400

In accordance with company policy, the following are chargeable to jobs:

Fixed production overhead – Rs. 5 per direct labour hour
Fixed administration overhead – 80% of works cost
Profit margin – 20% on selling price
Calculate:
a. calculate the total cost and selling price of job 321.
b. Assume that shortly after the job is completed, the original customer goes bankrupt and the job is not delivered. The only other possible customer is prepared to pay Rs. 10,500. Briefly indicate, with reasons, whether you would accept this offer.

CASE – 2
Winners Ltd. Produces different products. It has received an order for a new product which it is considering to manufacture. The following data are available regarding this product.
i. Number of units : 5,000
ii. Selling price : Rs. 22 per unit
iii. Raw material cost per unit : Rs. 12
iv. Labour cost per unit : Rs. 6
v. Depreciation Rs. 6000 on account of machinery which currently has enough capacity to manufacture these units.
vi. Special packaging : Rs. 3000
vii. Allocation of factory fixed overheads to the product Rs. 5,000 coupled with reduced allocation to other products.
What is the profit contributed by the new product?
- One type of specific order costing
- Used in civil engineering works
- Each contract: a separate accounts for each contract
COSTS
1. Materials
2. Labour
3. Direct Expenses
4. Indirect Expenses
5. Plant and machinery: Depreciation

WIP can be presented in the Balance Sheet as follows:
Balance Sheet as on…..

Assets Amount

Work in progress:
Value of work certified
Cost of work uncertified
Less reserve for unrealized profit
Less Amt. Received from contractile Profit on Incomplete Contracts:
1. Work Completed: Less than 1/4th : No profit 2. Work Certified: More than 1/4th but less than half: 3. Work Certified: Half or more than half: CASE - 1

The contract which has been commenced on 1st February, 2005 was of Rs. 3,00,000 and the amount certified by the architect after deduction of 20% retention money was Rs. 1,20,000 representing 80% of work certified up to 30th June 2005. The material on site at that date was valued at Rs. 9,800.

A contract plant ledger was also kept in which depreciation was dealt with monthly, the debited in respect of plant on contract No. 777 to 30th June 2005 was Rs. 1,130.


You are required to prepare an account showing the profit on the contract to 30th June, 2005. - Refers to costing of process involved in converting materials into finished products.
- The cost of operating each process or operation is found out.

CHARACTERISTICS
· Production is continuous and the products are processed in one or more processes.
· Products are homogeneous, identical and standardized.
· The finished product of one process is the raw material of the next process.
· Costs are collected process-wise.
· Unavoidable wastage generally arises at different stages.
· Different products with or without by-products are simultaneously produced.

APPLICATION
· Manufacturing Industries: iron and steel, cement, textiles, soap making, biscuits, food products
· Mining Industries: oil, coal
· Chemical Industries: drugs and medicines
· Public Utility Services: electricity, water supply

JOB COSTING VS. PROCESS COSTING
1. Job costing: Production is by specific orders. 2. Costs are determined by jobs or batches. 3. Each job is separate and independent. 4. There may or may not be any WIP 5. There is normally no transfers from one job to another. 6. Control is difficult. More managerial attention is required. 7. Unit cost of a job is calculated. - Cost of the normal loss is absorbed by good units produced.

Abnormal Loss: Caused by unexpected or abnormal conditions viz., careless, accident, bad plant design

Abnormal Gain: Arises when actual loss is less than expected

- Calculation is 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

By- product
- recovered from materials discarded in a main process or from the production of some major product.


CASE - 1 CASE - 2
Rs. Rs. Rs.
Materials consumed 6,000 4,000 2,000
Direct labour 8,000 6,000 2,000
Manufacturing Exp. 1,000 1,000 1,500

20,000 units have been issued to process A at a cost of Rs. 10,000. The output of each process has been as under:
Process A 19,500; Process B 18,800; Process C 16,000.
There is no WIP in any process.
Prepare process Accounts. Calculations should be made to the nearest rupee.

CASE – 3 (Inter- process profit)
Raman and Co. produces a product that passes through three process, before it is transferred to finished stock. Following information is available for the month of September.
Process-I Process –II Process-III Finished Rs Rs. Rs. Rs.

Opening Stock 80,000 48,000 32,000 1,20,000
Direct material 40,000 85,000 1,24,000 -
Direct wages 60,000 65,000 67,000 -
Production Overhead 65,000 26,000 1,30,000 -
Closing stock 20,000 24,000 18,000 -
Profit on cost of
each process 33 1/3% 25% 25% -
Inter process profit
for opening stock - 8,000 8,000 44,000



Stock in process are valued at prime cost and finished stock has been valued at price at which it is received from process-III. Sales during the period were Rs. 14,00,000.

Prepare:
b. Process cost accounts showing profit element at each stage.
c. Statement showing actually realized profit.
d. Stock valuation for Balance Sheet purposes. - Out put of one process is transferred to a subsequent process at a price showing a profit to the transferer process.

WHY INTER PROCESS PROFIT?

1. To show cost of production in relation to the market price. 2. To make each process stand on its own efficiency and economies.

3. To induce competition in different processes which ultimately leads to cost control.

BALANCE SHEET: ADJUSTMENTS
- The closing balance of inventories have to be adjusted- as it includes unearned profit. - A provision is created to reduce the stock to actual cost price.


Assumption:
Producing 1000 units that are 25% complete is viewed as equivalent to 250 full units of production

Work done by a Manufacturing Dept.

1. Completing opening WIP units
2. Working on units started and completed
3. working on closing WIP units


Example:

STATEMENT OF EQUIVALENT PRODUCTION

Units Portion Equiv. 1. Opening WIP 2. Units started & 3. Closing WIP 1. Estimate: The percentage of completion of opening WIP
2. State: Opening WIP in eqivalent completed units( apply the % work required to complete)
3. Units completed during the period:
- Units representing opening WIP
- Units introduced and completed

4. Closing WIP: State in equivalent completed units (apply the % work done)
5. Normal Loss: Not taken for calculation of EP
6. Abnormal loss and abnormal gain: These units are treated like “units finished and transferred to next process”.
CASE ON EQIVALENT PRODUCTION

Following information is available regarding process ‘A’ for the month of January, 2002.

PRODUCTION RECORD

Units in process as produced on 31st December, 2004(All materials used, 25% complete for labour and overhead): 8000.
New units started in process: 32,000
Production report shows the following results
Units completed: 28,000
Units in process on Jan. 31, 2005: 12,000 (All materials used,331/3%complete for labour & overhead)
Loss in production: Nil

Cost for January, 2005:

Material Rs. 10,240
Labour Rs. 6,000
Overhead Rs. 6,000

Assuming that FIFO method of inventory costing is used, prepare:
1. Statement of Equivalent production.
2. Statement showing cost for each element.

SEGMENT PERFORMANCE ANALYSIS

AS- 17 : SEGMENT
- Business Segment
- Geographical Segment


Segment is 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 within a business organization headed by a man fully responsible for its operation.
- A Responsibility Center/A Decision Unit HMT : 5 Divisions

Machine Tools; Tractors; Industrial Machinery; Engineering and Components; Consumer Products

WHY DIVISIONALIZATION?
1. Decentralization
2. Measurement of performance
3. Training ground for top mgt. Personnel
NEED FOR INFORMATION ABOUT SEGMENT PERFORMANCE
1. planning and allocation resources
2. Controlling operations
3. Evaluating performance

RESPONSIBILITY ACCOUNTING
Control Device

1. Responsibility centers (decision units) are identified.
2. The extent of responsibility for each R. C. is defined.
3. Controllable and uncontrollable activities at various levels of responsibility are specified.
4. Accounting system to accumulate information of R. C. is specified.
5. Performance reports are prepared. 1. To determine the contribution of a R. C.
2. To provide a basis for evaluation.
3. To motivate the managers.
Requirements of effective R. A.

1. A sound organization structure.
2. Dividing the organization into R. C.
3. Accurate and acceptable budgets.
4. Top management support
5. Healthy organizational environment.
Advantages of R.A.

1. Provides a system of closer control.
2. Helps “Management by exception”.
3. Facilitate decentralization.
4. Sets realistic plans and budgets.
5. Defines the corporate objectives and individual goals.
6. Creates a sense of cost consciousness among managers and subordinates. - Manager is held accountable only for costs incurred.
- Out put of cost center is not measured in monetary terms.
- Evaluation: Actual cost vs. Budgeted cost
- Employed in: Legal Dept, Accounting Dept, Public Relation Dept, HR Dept.
- Manager is held accountable for revenues only.
- Evaluation : Actual Revenue Vs. Budgeted Revenue
- Employed in : Sales Dept., Product Centre.

PROFIT CENTRE
- Manager is held responsible for both costs(inputs) and revenues(outputs), i.e., profits
- Inputs and out puts are capable of financial measurement.
- Measures effectiveness and efficiency and motivates managers.
- Employed in: Production Dept., production centers.

INVESTMENT CENTRE

- Manager is responsible for costs, revenues as well as investment in assets used.
- Evaluation by profit and ROI
- A measure of overall performance, and facilitates comparison.

CASE
Burnham Mfg. Co. operates two plants that produce and sell a single product. Shown below are the operating results of both plants during the current year, the company’s first year of operations.


Sales (40,000 units at $50 )….. $2,000,000 $2,000,000

Per unit costs :
Variable manufacturing cost…. $ 15 $ 18
Variable selling and
Administrative……………….. 3 4

Traceable fixed costs:
Manufacturing overhead……. $ 600,000 $ 400,000
Selling and administrative…… 150,000 150,000

During the current year, both plants produced 50,000 units, of which 40,000 were sold.
Common fixed costs relating to both plants amount to $500,000.



Instructions :

a. determine the variable cost of goods sold at each plant, using variable costing.
b. Prepare a partial income statement for Vurnham Mfg. Co., segmented by plant and using the contribution margin approach. Conclude this income statement with the company’s income from operations.
c. Compute the cost of goods sold at each plant using full costing.
d. Prepare a partial income statement for the entire company determining income from operations using the full costing approach. (show the cost of goods sold as a single figure.)
e. Explain the difference in the amounts of income operations reported in parts b and d. Inputs and outputs are capable of financial measurement


1. Dell focused its initial ABC efforts on about 10 key activities. Was this a good decision? Why or Why not?

STANDARD COSTING AND VARIANCE ANALYSIS

Objective: Cost Control

Accounting system: Historical Costing
Standard Costing
- A measure of desired performance.
- A predetermined criterion for evaluating the actual performance


WHY STANDARDS?
1. Cost control
2. pricing decision
3. performance Appraisal
4. Cost awareness
5. Management by objective TYPES OF STANDARDS
1. Ideal standards
2. Expected standards
3. Current standards
4. Basic standards

PROCESS OF DEVELOPING STANDARDS
1. The standard committee
2. Technical input
3. Past experience
4. Other input

Standard costing:
- A control device
- Not a separate method of product costing
- Used with any method of product costing : job or process
- 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

· Favourable Variance & Unfavorable Variance
· Controllable Variance & Uncontrollable Variance

Variances: - Sales variances
- Cost variances

Cost Variances:
- Direct material cost variances
- Direct labour cost variances
- Overhead cost variances
1. Material Cost variance = Standard cost for actual output - Actual cost of material used
2. Mat. Price var. = Qa(Ps – Pa) 3. Mat. Quantity var. = Ps(Qs – Qa) = Usage 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
1. Labour cost var. = Standard cost of labour for actual out put – Actual cost of labour 2. Labour rate of pay var. = Ha(Rs – Ra)

3. L. Gross 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)Rs 1. Variable overhead cost variance 1. Fixed overhead Cost variance 2. Fixed overhead Expenditure Variance
= Budgeted Cost – Actual Cost
= BO . SR – AO . AR
3. Fixed overhead Volume Variance 1. Sales Value Var. = Actual Value of Sales – Budgeted Value of Sales
2. Sales Price Var. = Act. Quantity sold(AP – SP)
3. Sales Volume Var. = SP(AQ – BQ)
4. Sales Mix Var. = SP(AQ- Smqa)
1.Mat. Price Variance Purchasing Agent or Purchasing Manager
2. Mat. Quantity Variance Plant Supt. , Dept. Supervisors, Machine Operators, Quantity Control Dept.
3.Labour Rate of Pay Variance Personnel Manager, Dept. Supervisors, Plant Superintendent
4. Labour Efficiency Variance Plant Superintendent
5. OH Expenditure Variance Variable portion : Foremen or Supervisor; Fixed portion : Top Mgt.
6. OH Volume Variance Top Mgt.

POSSIBLE CAUSES OF COST VARIANCES

1. Mat. Price Var. : Changes in actual price, Failure to 2. Mat. Quantity Var. : Poor material handling, inefficient machine operator, pilferage, waste, Labour turnover.
3. Lab. Efficiency Var. : Defective machine and equipment, poor supervision, inexperienced employee, insufficient training, poor working condition
4. OH Volume Var. : Failure to use normal capacity, Lack of sales order, Machine break down, Defective materials, Labour troubles power failure
5. OH Expenditure/Efficiency Var. = Same cause as Labour Efficiency Variance. STANDARD COSTING & VARIANCE ANALYSIS
CASE-3
Analyze labour variances:
Labour No. of person Rate Hours worked
Grade-1 100 3 100
Grade-2 50 5 100
Grade-3 40 10 100
Standard production: 200 units
Labour No. of persons Rate Hours worked
Grade-1 80 2.50 120
Grade-2 60 5 120
Grade-3 50 8 120
Actual production: 190 units STRATEGY 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.

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?
- Ensures economy in workings
- Establishes co-ordination
- Management by exception
- Optimum utilization of resources
- Continuous review of performance
1. Obtaining estimates of sales, production levels, expected costs and availability of resources from each sub- unit or division or department.
2. Co-coordinating estimates.
3. Communicating the budget to responsible managers and the concerned departments.
4. Implementing the budget plan
5. Reporting interim progress: Performance report · A part of the organization for which budget is prepared
· May be in the form of division or department or section or process or any other form

ORGANISATION CHART
- shows the position of each member in the organizational hierarchy and his relationship with other members
- Shows the flow of authority and responsibility
- No overlapping of authority
- Helps to work as a team


BUDGET COMMITTEE
- responsible for budget direction and execution
- Receive and review budget estimates
- Comprising of all executives in charge of major functioning
- Suggest changes and modifications
- Approve budgets
- Receive and analyze performance reports
- Suggest corrective action - defines the responsibility of persons engaged in budget preparation and execution
- Sets out the routine, the forms and records required for budgeting
- Sets out procedure for budgeting and forecasting
- Gives budget timetable
- Specifies performance report timetable
-

BUDGET PERIOD

Short range budget: weekly, monthly, quarterly, half-yearly, yearly: for operations

Long range budget: beyond one year
- normally prepared for capital expenditures

PRINCIPAL BUDGET FACTOR - Key factor, limiting factor or governing factor
- Its influence must first be assessed
Examples:
Non-availability of raw materials
Demand for the product
Production capacity
Availability of skilled labour
- Designed to remain unchanged irrespective of level of activity actually obtained.
- Prepared for a particular level of activity
- Acts as a target for the forthcoming period
- Not adjusted with actual activity
- Rarely used in practice


FLEXIBLE BUDGETS
- Designed to change in relation to the level of activity attained
- Prepared for a range of activities
- Recognizes the behavior of costs: - Facilitates performance measurement and control 1. Dysfunctional Behaviour
2. Implications of Participative Budgeting
3. Excessive Pressure Created by Budget
4. Budgetary Slack(Cushion)
5. Top Management Support
6. Inter-Departmental Conflict 1. Sales budget
2. Production budget
3. Production cost budget
a. Direct materials budget
b. Direct labour budget
c. Factory overhead budget

4. Cost of goods sold budget
5. Selling expense budget
6. Administrative expense budget
7. Budgeted income statement

FINANCIAL BUDGETS
1. Capital expenditure budget
2. R and D budget
3. Cash budget
4. Budgeted balance sheet

MASTER BUDGET

- A comprehensive budget that summarizes the planned activities of all subunits of an organization.
- Incorporate the summary of all functional budgets.
- Normally comprises of budgeted P.& L. A/C and budgeted Balance Sheet; budgeted Cash Flow statement, i. e., forecasted financial statements and operating schedules.
- A tool for coordinating all budgets.
- Reveals top management goals of incomes, expenditure, cash flows and financial position. - a method of budgeting
- all activities are evaluated each time a budget is formulated and every item of expenditure in the budget is fully justified
- involves starting from scratch or zero

STEPS OF ZBB
- Identify each separate activity of the organization called a decision package
- Each decision Package is determined
- Alternatives for each decision package is considered
- Managers rank their decision packages in order of priority for resource allocation
- Resources are allocated to the packages CASE – 1

Connors Rifle corporation uses departmental budgets and performance reports in planning and controlling its manufacturing operations. The annual performance report for the production department -for the year was presented to the president of the company.

BUDGETED COST FOR 5,000 UNITS

Per Unit Total Actual Costs Over or
Incurred Under Budget

Variable
Manufacturing Costs

Direct Materials $30.00 $150,000 171,000 $21,000
Direct labour…… 48.00 240,000 261,500 21,500
Indirect labour…… 15.00 75,000 95,500 20,500
Indirect materials,
Supplies, etc. …… 9.00 45.000 48.400 3,400
Total variable
Manufacturing costs $102.00 $510,000 $576,000 $66,400

Fixed manufacturing
Costs:
Lease rental………. $ 9.00 $ 45,000 $ 45,000 None
Salaries of foreman 24.00 120,000 125,000 $ 5,000
Depreciation
And other………… 15.00 75,000 78,600 3,600
Total fixed
Manufacturing costs $ 48.00 $240,000 248,000 $ 8,600
Total manufacturing
Costs……………… $150.00 $750,000 825,000 $ 75,000

Although a production volume of 5,000 guns was originally budgeted for the year, the actual volume of production achieved for the year was 6,000 guns. The company does not use standard costs; direct materials and direct labor are charged to production at actual cost. Factory overhead is applied to production at the predetermined rate of 150% of the actual direct labour cost.

After a quick glance at the performance report showing an unfavorable manufacturing cost variance of $75,000, the president said to the accountant : “Fix this thing so it makes sense. It looks as though our production people really blew the budget. Remember that we exceeded our budgeted production schedule by a significant margin. I want this performance report to show a better picture of our ability to control costs.”

a. prepare a revised performance report for the year on a flexible budget basis. Use the same format as the production report above, but revise the budgeted cost figures to reflect the actual production level of 6,000guns.
b. In a few sentences compare the original performance report with the revised report.
c. What is the amount of over or under applied manufacturing overhead for the year?

CASE – 2
Jake Marley. Owner of Marley wholesale, is negotiating with the bank for a $200,000, 12%. 90-day loan effective July 1 of the current year. If the bank grants the loan, the proceeds will be $194,000, which Marley intends to use on July 1 as follows: pay accounts payable, $150,000; purchase equipment, $16,000; add to bank balance, $28,000.

The current working capital position of Marley wholesale, according to financial statements as of June 30, is as follows:
Cash in bank …………………………………………………… $ 20,000
Receivables(net of allowance for doubtful accounts) 160,000
Merchandise inventory ………………………………………… 90,000

Total current assets ……………………………………………. $270,000
Accounts payable (including accrued operating expenses ) 150,000

Working capital ……………………………………………….. $120,000

The bank loan officer asked Marley to prepare a forecast of his cash receipts and cash payments for the next three months to demonstrate that the loan can be repaid at the end of September.

Marley has made the following estimates, which are to be used in preparing a three month cash budget: Sales ( all on open account ) for july, $300,000; august, $360,000; September, $270,000; and October, $200,000. past experience indicates that 80% of the receivables generated in any month will be collected in the month following the sale, 19% in the second month following the sale, and 1% will prove uncollectible. Marley expects to collect $120,000 of the June 30 receivables in July, and the remaining $40,000 in August.

Cost of goods sold has averaged consistently about 65% of sales. Operating expenses are budgeted at $36,000 per month plus 8% of sales. With the exception of $4,400 per month depreciation expenses, all operating expenses and purchase are on open account and are paid in the month following their incurrence.

Merchandise inventory at the end of each month should be sufficient of cover the following month’s sales.

Instructions :
a. prepare a monthly cash budget showing estimated cash receipts and cash payments for July, august, and September and the cash balance at the end of cash month. Supporting schedule should be prepared for estimated collections on receivables, estimated merchandise purchases, and estimated payments for operating expenses and of accounts payable for merchandise purchases.
b. On the basis of this cash forecast, write a brief report to Marley explaining whether he will be able to pay the $200,000 loan at the bank at the end of September.

CASE – 3
A single product firm prepares quarterly budgets. Budgeted variable costs per unit are as under:
Direct Materials Rs. 24
Direct labour 8 hours Rs. 48
(Rs. 6 per hrs.)
Factory Overheads Rs. 16
Selling price Rs.180

Administration overhead is Rs. 1,00,000 per month and fixed factory overhead is Rs. 90,000 per month including Rs.20,000 depreciation. The normal capacity of the factory is 3,000 units per month. Finished goods stocks are valued at full factory cost of production and the budgeted opening stock on 1st July 2005 is estimated at 2,400 units valued at Rs. 2,66,000. It is the policy of the company to keep the opening finished stock of each month at a constant ratio to the budgeted unit sales of that month. Extra production in excess of the capacity of 3,00 units per month can be achieved by working over time at double the labor hour rate.
Estimated sales are as under:
Months Units
June 2005 2,600
July 2005 2,000
August 2005 2,800
September 2005 3,200
October 2005 3,600
The direct material cost relating to the production of each month are paid for in the succeeding month. The pattern of collection of sales are as under:

30% in the same month; 70% in the next month

All other costs are paid in the month in which they are incurred. An installment of deferred payment of Rs. 14,000 in respect of the purchase of machinery is due for payment in July 2005. The company has to pay dividend amounting to Rs. 15,000 in September 2005. The projected cash balance on 1st July, 2005 is Rs. 1,00,000.
1. Prepare a combined budgeted profit and loss statement for the quarter ended 30th September, 2005. .
2. Prepare a cash budget for each of the three months of the quarter ended 30th September, 2005, viz., July, August and September 2005.










BALANCED SCORECARD

Concept v It is called the balanced scorecard because it balances the use of financial and non-financial performance measures to evaluate short-run and long-run performance in a single report. v The balanced scorecard translates an organization’s mission and strategy into a set of performance measures that provides the framework for implementing the strategy.

v The BSC measures an organization’s performance from four perspectives:
(i) Financial
(ii) Customer
(iii) Internal Business Processes
(iv) Learning and growth v Origin of BSC can be traced to the research study of KPMG on “Measuring Performance in the Organization of the Future”, which revealed that over reliance on summary financial performance measures (VIZ.,ROI) was hindering an organization’s abilities to create future economic value. v The balanced scorecard concept was recently selected by Harvard Business Review as one of the most influential management ideas of the past 75 years

v BSC puts vision and strategy at the center of management’s focus.

v BSC links strategy with action plan by the help of both financial and non-financial measures.

v It ensures commitment at all levels and motivates employees.

v The BSC enables an organization to answer the following questions:
Ø How should it appear to its shareholder?
Ø How should it appear to its customers?
Ø What business processes must it excel at
Ø How will it sustain its ability to change and improve?
FINANCIAL
CUSTOMER
v Revenue/Income Growth
v Cost Management
v Asset Utilization
v ROI		v Customer Retention
v Customer Acquisition
v Customer Satisfaction
v Market Share
INTERNAL PROCESS
LEARNING & GROWTH
v Value Chain
      (R & D => Design => Production =>
      Marketing => Service)
v Process Innovation
Ø Improve Quality
Ø Redesign Products		v Improve working environment
v Enhance Employee Capabilities
v Develop Information System
v Motivate & Empower


SAIL

v SAIL is the leader in Indian steel market.
v The potential for growth in SAIL is very high because the per capital consumption of steel in India is 30kg as compared to world average consumption of 144kg.
v SAIL should use BSC for the following reasons to achieve its corporate plan of 2012:
Ø Attract and retain skilled employees.
Ø Develop core competencies and skill.
Ø Facilitates functional excellence.
Ø Develop a culture of accountability and appreciation.

CONCLUSION

v As SAIL marches towards 2012 to achieve its corporate plan, there is need for implementing BSC in SAIL.
v There is need for making investments in acquiring newer capabilities and resources in SAIL.
v We should remember that BSC is not the end by it self, it is the means an end. i. Labour time is the limiting factor.
iii. Machine time is the limiting factor.


During the coming year, it has been estimated that the cost of direct material, as compared to the current year, will increase by 10%. If the new order for 10,000 units is accepted, fixed overheads will increase further by Rs.60,000 due to increased administrative charges.
You are required to analyze whether the concern should accept this order or instead of that try to secure orders for the balance unused capacity, as available now, through some sales promotion expenses which will be Rs.50,000 per annum. Ignore financial charges for the new investment.

Alternative II
To increase the installed capacity of the factory to 12,000 units by adding plant and machinery in department at a capital cost of Rs.4crore. Any balance surplus capacity in other departments, after meeting the increased volume, to be hired out as per alternative I. the additional units would fetch an incremental revenue of Rs.1,600 per unit.
You are required to evaluate the two proposals and suggest to the management, which of the two proposals are to be accepted.