Cost PDF

SARANSHLast Mile Referencer for
COST MANAGEMENT
AND STRATEGIC
DECISION MAKING
The Institute of Chartered

Accountants of India
(Setup by an Act of Parliament)
Board of Studies (Academic)
www.icai.org | www.boslive.icai.org
Saransh - Last Mile Referencer for Cost Management and
Strategic Decision Making
While due care has been taken in preparing this booklet, if any errors or omissions are noticed, the
same may be brought to the notice of the Director, BoS. The Council of the Institute is not
responsible in any way for the correctness or otherwise of the matter published herein.
© 2023. The Institute of Chartered Accountants of India (Also referred to as ICAI)
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or
transmitted, in any form, or by any means, electronic, mechanical, photocopying, recording, or
otherwise, without prior permission, in writing, from the publisher.
Published in January 2023 by:

The Institute of Chartered Accountants of India
‘ICAI Bhawan” A-29, Sector-62,
Noida 201 309
Board of Studies (Academic), the student wing of the Institute, does not leave any
stone unturned in providing best-in-class services to its students. It imparts quality
academic education through its value-added study materials, wherein concepts are
explained in lucid language. Illustrations and Test Your Knowledge Questions
contained therein facilitate enhanced understanding and application of concepts
learnt. Booklet on MCQs & Case Scenarios contain a rich bank of MCQs and Case
Scenarios to hone the analytical skills of students, by applying the concepts learnt in
problem solving. Revision Test Papers contain updates and Q & A to help students
update themselves with the latest developments before each examination and revise
the concepts and provisions by solving questions contained therein. Suggested
PREFACE
Answers containing the ideal manner of answering questions set at examination also
helps students revise for the forthcoming examination. Mock Test Papers help
students assess their level of preparedness before each examination. BoS (Academic)
also conducts live virtual classes through eminent faculty for its students across the
length and breadth of the country.
To reach out to its students, the BoS (Academic) has also been publishing
subject-specific capsules in its monthly Students’ Journal “The Chartered
Accountant Student” since the year 2017 for facilitating effective revision of concepts
dealt with in different topics of each subject at the Foundation, Intermediate and
Final levels of the chartered accountancy course. Each issue of the journal includes a
capsule relating to specific topic(s) in one subject at each of the three levels. In these
capsules, the concepts and provisions are presented in attractive colours in the form
of tables, diagrams and flow charts for facilitating easy retention and quick revision
of topics.
In today’s business world, Chartered Accountants are very much part of the
decision-making team of any Organisation. They are rigorously involved in decision
making process with the help of Cost Accounting and Strategic Management tools.
The capsule on ‘Cost Accounting & Strategic Cost Management’ covers diagrams,
flow charts tables and formulas. In addition, it encompasses case studies and skill
assessment-based questions so that students can critically analyse business problems
and strengthen their analytical skills through interpreting and evaluating.” This
capsule, though, facilitates the students in undergoing quick revision, under no
circumstances, such revisions can substitute the detailed study of the materials
provided by BoS such as Study Material and Practice Manual.
Happy Reading!
© ICAI BOS(A)
SARANSH
Message of Key ICAI Office Bearers
CA. (Dr.) Debashis Mitra

President, ICAI
The Board of Studies (Academic) of ICAI has always been at the forefront of providing
quality education to aspiring CA students and handholding them in preparing for their
exams. Saransh — Last Mile Referencer is a step in that direction. This pack of 3 booklets
on Accounting, Auditing & Cost Management and Strategic Decision Making covers
significant concepts of each chapter in precise form. This will not only help students for
their reference for examinations but also Members can use it for their practice reference.
CA. Aniket S. Talati

Vice-President, ICAI
It has always been the endeavour of ICAI to provide updated information to its student to
keep them abreast about the latest happenings in the accounting and related fields. The
Board of Studies (Academic), the academic wing of ICAI, has come up with a series of
booklets ‘Saransh – Last Mile Referencer’ with key points of different subjects. This will help
facilitate effective revision of concepts in each subject.
CA. Dayaniwas Sharma

Chairman, Board of Studies (Academic)
Saransh — Last Mile Referencer is a compilation of capsules on different subjects of

Foundation, Intermediate and Final levels of the chartered accountancy course. This
series of booklets consolidates all significant topics of Accounting including Accounting
Standards & Ind AS, Auditing with Auditing Standards and Cost Management and
Strategic Decision Making at one place by capturing the key points. The concepts and
provisions presented in attractive colours in the form of tables, diagrams and flow charts
will facilitate quick revision of topics and easy retention.
CA. Vishal Doshi

Vice-Chairman, Board of Studies (Academic)
Among the many best-in-class services that the Board of Studies (Academic) provides to
its students, Saransh — Last Mile Referencer is another initiative in that direction. These
booklets on different subjects have been provided in a concise and precise form. It will
facilitate understanding of the concepts better to students and grasp the essence of the
subject. These capsules will enhance of level of preparedness before the examinations.
© ICAI BOS(A)
SARANSH

INDEX
Topic Pg No.
PART I: COST AND MANAGEMENT ACCOUNTING
Introduction To Cost and Management Accounting I. 2
Material Cost I. 7
Overheads I. 10
Process And Operation Costing I. 12
Standard Costing I. 14
Marginal Costing I. 17
Budget & Budgetary Control I. 19
Employee (Labour) Cost I. 22
Cost Sheet I. 26
Unit & Batch Costing I. 30
Job & Contract Costing I. 32
Activity Based Costing (ABC) I. 36
Joint Products & By-products I. 39
Service Costing I. 43
© ICAI BOS(A)
SARANSH
Topic Pg No.
PART II: STRATEGIC COST MANAGEMENT

AND PERFORMANCE EVALUATION
Skill Assessment Grid II. 2
Subject Structure II. 3
Introduction to Strategic Cost Management II. 4
Modern Business Environment II. 6
Lean System and Innovation II. 10
Cost Management Techniques II. 13
Pricing Decision II. 15
Performance Measurement and Evaluation II. 17
Division Transfer Pricing II. 20
Budgetary Control II. 23
Case Study II. 25
Standard Costing II. 26
Decision Making II. 38
Framework for Reporting to External Stakeholders II. 44
Triple Bottom Line Reporting II. 45
Global Reporting Initiative II. 46
Integrated Reporting Framework II. 48
Case Study - Triple Bottom Line II. 52
Case Scenario – Six Sigma II. 54
Case Scenario – Performance Measurement II. 55
Skill Assessment Based Questions II. 56
Strategic Role of Management Accounting- An Overview II. 60
Case Study – Pricing Strategy II. 61
Case Scenario – Profitability Analysis II. 62
Case Study- KAIZEN (with integration to 5S and PDCA) II. 73
Case Study- 5S II. 75
Case Study – Business Process Reengineering II. 77
© ICAI BOS(A)
SARANSH Part I: Cost and Management Accounting
Part I
COST AND MANAGEMENT
ACCOUNTING
© ICAI BOS(A) I. 1
Cost and Management Accounting

In contemporary business environment, existence of an entity depends on the way it tackles the challenges
posed by the competitive market conditions. Cost leadership being one of the competitive strategies, gives
an added advantage to the entity. Cost being an important aspect for survival and growth in business,
requires a mandatory awareness about the cost control and cost reduction. Fourth industrial revolution,
also known as Industry 4.0, puts more emphasis on the digitization of information for effective decision-
making, which enables an entity in keeping ahead in competition. Cost and Management accounting, a
discipline of accounting, capacitates an entity in taking timely decisions by provisions of cost, profitability
and other relevant information.
Chartered Accountants, as a global business solution provider, play an important role in business, have
an onus by helping an entity to achieve its long-term objectives. In this direction, Cost and Management
Accounting helps Chartered Accountants in taking timely and informed business decisions.
Introduction to Cost and Management Accounting

Chapter Overview
Objectives of Cost Scope of Cost Role & Functions of Users of Cost

and Management and Management Cost and Management and Management
Accounting Accounting Accounting Accounting
Cost Relationship of Cost and

Cost Responsibility Cost
Accounting Management Accounting with
Classification Centres Object
using IT other accounting disciplines
Meaning of Terms used in Cost and Management Accounting

First of all, let us discuss the meaning of various terminologies used in Cost and Management Accounting to have
a clear understanding about the subject.
Cost Cost Management Cost

Cost Costing Accounting Accountancy Accounting Management
Cost It is an
The amount Costing is Accountancy has Management application of
of expenditure defined as the been defined as accounting is management
It is the the application accounting
incurred on or technique and the application
process of of costing and concepts,
attributable to a process of of the principles
accounting for cost accounting methods of
specified article, ascertaining of accounting
cost. principles, collections,
product or costs. and financial
activity. methods and management. analysis and
techniques. presentation of
data.
© ICAI BOS(A) I. 2
Objectives of Cost Accounting
There are many objectives of cost accounting. The main objectives are explained as below. We also need to keep
our focus on understanding the difference between Cost Control and Cost Reduction.
Ascertainment of Cost: The main objective of cost and management accounting is accumulation
and ascertainment of cost. Costs are accumulated, assigned and ascertained for each cost object.
Objectives of Cost Accounting
Determination of Selling Price and Profitability: The cost and management accounting system
helps in determination of selling price and thus profitability of a cost object.
Cost Control: Maintaining discipline in expenditure is one of the main objectives of a good cost and
management accounting system. It ensures that expenditures are in consonance with predetermined
set standard and any variation from these set standards is noted and reported on continuous basis.
Cost Reduction: It may be defined “as the achievement of real and permanent reduction in the
unit cost of goods manufactured or services rendered without impairing their suitability for the use
intended or diminution in the quality of the product.”
Assisting management in decision making: Cost and Management accounting by providing

relevant information, assist management in planning, implementing, measuring, controlling and
evaluation of various activities.
Scope of Cost Accounting Role and Functions of Cost and

We also need to know various scopes of cost accounting. Management Accounting
Cost ascertainment and the process of cost accounting
are the major scopes. The other scopes are presented. Role of a Cost and Functions of Cost and
Management Accounting Management Accounting
system System
Provide relevant Collection and

information to management accumulation of cost for
for decision making each element of cost
Cost Analysis
Assigning costs to cost
Assist management for objects to ascertain cost.
planning, measurement,
Sets budget and standards
evaluation and controlling of
for a particular period
business activities or activity beforehand
Statutory and these are compared
Cost
Compliances Scope with the assigned and
Comparisons
of Cost Help in allocation of cost ascertained cost.
Accounting
to products and inventories
for both external and Provision of relevant
internal users. information to the
management for decision
making.
Cost Cost
Control To gather data like time
Reports taken, wastages, process
idleness etc., analyse the
data, prepare reports and
take necessary actions
© ICAI BOS(A) I. 3
Users of Cost and Management Accounting Relationship of Cost Accounting,

Cost and Management Accounting information
Management Accounting, Financial
which are generated or collected are used by various
Accounting and Financial Management
stakeholders. The users of the information can be There is a close relationship between various disciplines
broadly categorized as below: like Cost Accounting, Management Accounting,
Financial Accounting and Financial Management.
Sometimes these disciplines are interrelated and
Internal External dependent on each other also.
Users Users
Managers Regulatory
Management Cost
Authorities
Accounting Accounting
Operational Auditors
level staffs
Financial
Accounting
Employees Shareholders
Creditors and Financial Management

Lenders
Essentials of a good Cost Accounting System

The essential features which a cost accounting system should possess are depicted as below:
Informative and Accurate and Uniformity and Integrated and Flexible and Trust on the
simple authentic consistency inclusive adaptive system
Cost Accounting using Information Cost Objects

Technology It is very important to understand the meaning of
With the use of information technology, the cost cost object, cost unit and cost driver. Their meaning
accounting system gets integrated and automated. The alongwith examples are illustrated below.
basic features are depicted as below:
Cost Object: Cost object is anything for which
a separate measurement of cost is required. Cost
object may be a product (book), a service (airline),
a project, a customer, a brand category etc.
Enterprise Resource Internet (including intranet
Planning (ERP) and extranet)
Cost Accounting
using IT Cost Units: It is a unit of Cost Drivers: A Cost driver
product, service or time (or is a factor or variable which
combination of these) in effect level of cost. Example
relation to which costs may for a purchase department is
Paperless Environment Just-in-Time (JIT)
be ascertained or expressed. number of purchase orders.
Example for power industry is
kilo Watt hour (kWh).
© ICAI BOS(A) I. 4
Responsibility Centres
To have a better control over the organisation, management delegates its responsibilities and authorities to various
departments or persons, which are known as responsibility centres. There are four types of responsibility centres
as discussed below:
Responsibility Centres
Cost Centres: Revenue Centres: Profit Centres: Investment Centres:

The responsibility centre Which are accountable for Which have both Which are not only
which is held accountable generation of revenue for responsibility of generation responsible for profitability
for incurrence of costs the entity. Example- Sales of revenue and incurrence but also has the authority
which are under its control. Department. of expenditures. Example- to make capital investment
Decentralised branches of decisions. Example-
an organisation. Maharatna, Navratna and
Miniratna.
Standard Cost Centre: Discretionary Cost

Cost Centre where output Centre:
is measurable and input The cost centre whose
required for the output can output cannot be measured
be specified. in financial terms.
&ODVVLÀFDWLRQRI&RVW
Classification of cost basically means grouping of cost according to their common features. The important ways of
classification of cost are illustrated as below:
Classification of Cost
By Nature By Variability By By Costs for

or Element By Functions By Normality Managerial
or Behaviour Controllability
Decision Making
(i) By Nature or Element

ELEMENTS OF COST
Material Cost Labour Cost Other Expenses
Direct Indirect Direct Indirect Direct Indirect

Material Cost Material Cost Labour Cost Labour Cost Expenses Expenses
Overheads
Production Administration Selling and Distribution

Overheads Overheads Overheads
© ICAI BOS(A) I. 5
(ii) By Functions (iv) By Controllability

Direct Materials
Direct Employees Controllable Costs: Cost that can be controlled
Prime Cost
(Labours)
Direct Expenses Uncontrollable Costs: Costs which cannot be influenced
Indirect Factory Overheads or controlled
Material Factory Cost or Works Cost
Administration
Indirect Overheads Cost of Goods Sold
Labour (v) By Normality
Selling and Distribution
Indirect Overheads
Expenses Cost of Sales
Normal Cost - It is the cost which is normally incurred
(iii) By Variability or Behaviour

Abnormal Cost - It is the cost which is not normally incurred
Fixed Cost Variable Cost Semi-variable Cost
(vi) By Cost for Managerial Decision Making
(j) Out-of- It is that portion of total cost, which involves

(a) Pre A cost which is computed in advance before pocket Cost cash outflow
determined production or operations start
Cost
Those costs, which continue to be incurred

(k) Shut down even when a plant is temporarily shut-down
A pre-determined cost, which is calculated
(b) Standard Costs e.g. rent, rates, depreciation, etc
from managements ‘expected standard of
Cost efficient operation’ and the relevant necessary
expenditure
Historical costs incurred in the past are
(l) Sunk Costs known as sunk costs. They play no role in
The amount at any given volume of output decision making in the current period.
(c) Marginal by which aggregate costs are changed if the
Cost volume of output is increased or decreased by
one unit
(m) Absolute These costs refer to the cost of any product,
Cost process or unit in its totality.
The expected cost of manufacture, or
(d) Estimated acquisition, often in terms of a unit of product
Cost computed on the basis of information
available in advance of actual production or Such costs are not tied to a clear cause
purchase (n) Discretionary
and effect relationship between inputs and
Costs
outputs.
It represents the change (increase or decrease)
(e) Differential
in total cost (variable as well as fixed) due to
Cost
change in activity level, technology, process or
method of production, etc. These are the costs, which are not assigned
(o) Period Costs to the products but are charged as expenses
against the revenue of the period in which
they are incurred.
(f) Imputed These costs are notional costs which do not
Costs involve any cash outlay
These are costs that result specifically from
(p) Engineered a clear cause and effect relationship between
Costs inputs and outputs.
(g) Capitalised These are costs which are initially recorded as
Costs assets and subsequently treated as expenses.
These costs are also known as out of pocket
(q) Explicit costs and refer to costs involving immediate
These are the costs which are associated with payment of cash. Salaries, wages, postage and
(h) Product the purchase and sale of goods (in the case of Costs
Costs telegram, printing and stationery, interest on
merchandise inventory). loan etc.
This cost refers to the value of sacrifice (r) Implicit

(i) Opportunity made or benefit of opportunity foregone in These costs do not involve any immediate
Cost Costs cash payment.
accepting an alternative course of action
© ICAI BOS(A) I. 6
Material Cost
Chapter Overview How Material is Procured?
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Valuation of Material
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How Inventory is Controlled?
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© ICAI BOS(A) I. 7
(a) Inventory Control- By Setting Quantitative

Levels
Re-order Stock Level When to Order

(v) Average Inventory Level:
Average Stock Level = Minimum Stock Level
+ 1/2 Re-order Quantity
Re-order Quantiy/ EOQ How Much to Order Or
Average Stock Level =
Maximum Stock Level Upto How much to stock Maximum Stock Level + Minimum Stock Level
2
Minimum Stock Level Atleast How much to keep (b) On the basis of Relative Classification
Average Stock Level Stock normally kept ABC Analysis On the basis of value and
frequency of inventory
Danger Stock Level Kept for emergency requirement

Fast, Slow and Non On the basis of inventory
Moving (FSN) turnover
Buffer Stock To meet sudden demand
Vital, Essential and On the basis of importance of

Desirable (VED) inventory
(i) Re-order Stock Level (ROL): Maximum
Consumption × Maximum Re-order Period
Or, ROL = Minimum Stock Level + (Average Rate of High, Medium and Low On the basis of price of an item
Consumption × Average Re-order period) (HML) of inventory
(ii) Re-Order Quantity/ Economic Order Quantity

(EOQ): (c) Using Ratio Analysis
(i) Input Output Ratio: Input-output ratio is the ratio
of the quantity of input of material to production and
2x Annual Requirement (A) x Cost per order (O) the standard material content of the actual output.
EOQ =
Carrying Cost per unit per annum (C)
(ii) Inventory Turnover Ratio:
Inventory Turnover Ratio =
Just in Time (JIT) Inventory Management Cost of materials consumed during the period
JIT is a system of inventory management with
Cost of average stock held during the period
an approach to have a zero inventories in stores.
According to this approach material should only be (d) Physical Control
purchased when it is actually required for production. (i) Two Bin System: Two Bin System is supplemental
Production Material Order Supplier
to the record of respective quantities on the bin
Demand starts to Requirement for raw sent the card and the stores ledger card.
for final process the is sent to materials material
product for
demad for
product
Purchase
department
sent to
supplier production
(ii) Establishment of system of budgets: Based on this,
inventories requirement budget can be prepared.
Such a budget will discourage the unnecessary
investment in inventories.
(iii) Minimum Stock Level:
Minimum Stock Level = Re-order Stock Level - (iii) Perpetual inventory records and continuous
(Average Consumption Rate × Average Re-order stock verification :
Period) Perpetual inventory represents a system of records
maintained by the stores department in the form of
(iv) Maximum Stock Level: Bin cards and Stores ledger.
Maximum Stock Level = Re-order Level + Re-
order Quantity - (Minimum Consumption Rate × (iv) Continuous Stock Verification:
Minimum Re-order Period) The system of continuous stock-taking consists of
physical verification of items of inventory.
© ICAI BOS(A) I. 8
Valuation of Material Issue
Cost Price Methods Average Price Methods Market Price Methods Notional Price Methods
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Normal and Abnormal Loss of Materials PVUPGDBVTFTOPUJOIFSFOUJONBOVGBDUVSJOHQSPDFTT
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DIBSHFEUPUIF$PTUJOH1SPmUBOE-PTT"DDPVOU
QSPDFTTJOHIBWJOHOPSFDPWFSBCMFWBMVF
(iv) Treatment of Defectives:
Scrap:ͳFJODJEFOUBMNBUFSJBMSFTJEVFDPNJOH Normal- ͳF DPTU MFTT SFBMJTBCMF WBMVF PO TBMF PG
PVU PG DFSUBJO NBOVGBDUVSJOH PQFSBUJPOT EFGFDUJWFT BSF DIBSHFE UP NBUFSJBM DPTU PG HPPE
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Loss of Material
Spoilage: (PPET EBNBHFE CFZPOE Abnormal- ͳF NBUFSJBM DPTU PG BCOPSNBM MPTT JT
SFDUJmDBUJPO UP CF TPME XJUIPVU GVSUIFS USBOTGFSSFEUPDPTUJOHQSPmUBOEMPTTBDDPVOU
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(v) Treatment of Obsolescence:

Defectives:(PPETXIJDIDBOCFSFDUJmFEBOE ͳFWBMVFPGUIFPCTPMFUFNBUFSJBMIFMEJOTUPDLJTBUPUBM
UVSOFEPVUBTHPPEVOJUTCZUIFBQQMJDBUJPOPG
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Pĉ BU UIF CFTU BWBJMBCMF QSJDF ͳF MPTT BSJTJOH PVU PG
PCTPMFUFNBUFSJBMTPOBCOPSNBMMPTTEPFTOPUGPSNQBSU
Obsolescence: *U JT UIF MPTT JO UIF JOUSJOTJD
WBMVFPGBOBTTFUEVFUPJUTTVQFSTFTTJPO PGUIFDPTUPGNBOVGBDUVSF
© ICAI BOS(A) I. 9
Overheads
Chapter Overview Steps for Distribution of Overheads
OVERHEADS Estimation of Overheads
Selling and Allocation of Overheads: Apportionment of

Production Administrative Distribution Overheads: Allotment
Overheads Overheads Direct assignment of cost
Overheads to a cost object which can of proportions of items
be traced directly of cost to cost centres or
departments on some basis.
Accounting and Control of Overheads

Production Production Service Service
Department-I Department-II Department-I Department-II
Concepts
Distribution of Overhead related with
Overheads Rates Capacity Re-apportionment of Overheads: The process of assigning
service department overheads to production departments
is called reassignment or re-apportionment. Methods of re-
apportionment are:
&ODVVLÀFDWLRQRI2YHUKHDGV (i) Direct re-distribution method
Overheads are the expenditure which can not be (ii) Step method of secondary distribution or non-reciprocal
identified with a particular cost unit. Overheads can be method
classified as under. (iii) Reciprocal Service method.
By Function By Nature By Element By Control
t'BDUPSZPS t'JYFE t*OEJSFDU t$POUSPMMBCMF Total Overheads: The sum of allocated, apportioned and re-
Manufacturing Overhead materials costs apportioned overhead is called total overheads for a cost object.
or Production t7BSJBCMF t*OEJSFDU t6ODPOUSPMMBCMF
Overhead Overhead employee cost costs
t0ĊDFBOE t4FNJ7BSJBCMF t*OEJSFDU Absorption of Overheads: Total overheads calculated as above
Administrative Overheads expenses is distributed over the actual quantity of goods produced. The
Overheads distribution of total estimated overheads to units of production
t4FMMJOHBOE is called absorption of overheads.
Distribution
Overheads
Methods for Re-apportionment of
Overheads
)XQFWLRQDO&ODVVLÀFDWLRQRI2YHUKHDGV
One of the most important ways of classifying overheads The re-apportionment of service department expenses
is as per their function. As per this classification over the production departments may be carried out by
overheads are classified as under. using any one of the following methods:
Indirect cost incurred for manufacturing or Methods for
Factory or production activity in a factory. Manufacturing
Manufacturing Re-apportionment
overhead includes all expenditures incurred
or Production from the procurement of materials to the
Overhead completion of finished product.
Expenditures incurred on all activities relating

to general management and administration Direct Step method or Reciprocal
of an organisation. It includes formulating re-distribution non-reciprocal Service
Office and the policy, directing the organisation and method method. method.
Administrative controlling the operations of an undertaking
Overheads which is not related directly to production,
selling, distribution, research or development
activity or function.
(i) Selling overhead: expenses related to sale of

Simultaneous Trial and Repeated
Selling and products and include all indirect expenses in
Equation error distribution
Distribution sales management for the organisation.
method method method
Overheads (ii) Distribution overhead: cost incurred on
making product available for sale in the market.
© ICAI BOS(A) I. 10
Methods of Absorbing Overheads to various Products or Jobs

Several methods are commonly employed either individually or jointly for computing the appropriate overhead
rate. The more common of these are:
Percentage of Percentage of Percentage of direct Labour hour Machine hour Rate per unit of
direct materials prime cost labour cost rate rate Output
Machine hour rate Treatment of Under-absorption and Over-

absorption of overheads in Cost Accounting
Machine hour rate implies, cost of running a machine
for an hour to produce goods.
Is there any under/
The steps involved in determining of Machine hour over absorption of
rate is as follows: overheads?
Step1: Calculate total of overheads apportioned to a production

department. Yes
Step 2: Apportion further these overheads to machines or group

of machines in the department. Amount of under/ Yes
over absorption is
small
Step 3: Allocate machine specific costs (directly identifiable with
the machine)
No
Costing
P&L A/c
Step 4: Estimate total productive hours for the machine
Due to wrong
estimation Yes
Step 5: Aggregate overheads as apportioned in step-2 and and abnormal
allocated in step-3 and divide it by Estimated total productive reasons
hours
No
The resultant figure is machine hour rate
Calculate Supplementary Rate and Charge to Cost of Sales
A/c, Finished Goods A/c and W-I-P A/c
Types of Overhead Rates Concepts related with Capacity

Installed/ The maximum capacity of producing goods
Normal Rate: This rate is calculated by dividing Rated or providing services. It is also known as
the actual overheads by actual base. It is also capacity theoretical capacity.
known as actual rate.
Practical It is defined as actually utilised capacity of a

Pre-determined Overhead Rate: This rate capacity plant. It is also known as operating capacity.
is determined in advance by estimating the
amount of the overhead for the period in
which it is to be used.
The volume of production or services
Normal achieved or achievable on an average over a
capacity period under normal circumstances taking
Blanket Overhead Rate: Blanket overhead into account the reduction in capacity
rate refers to the computation of one single resulting from planned maintenance.
overhead rate for the whole factory.
Actual Capacity actually achieved during a given
capacity period.
Departmental Overhead Rate: It refers to the
computation of one single overhead rate for a
particular production unit or department. Idle It is that part of the capacity of a plant,
capacity machine or equipment which cannot be
effectively utilised in production.
Treatment of Certain Items in Cost Accounting
Interest and financing It includes any payment in nature of interest for use of non- equity funds and incidental cost that an entity
charges incurs in arranging those funds. Interest and financing charges shall be presented in the cost statement as a
separate item of cost of sales.
Cost of primary packing necessary for protecting the product or for convenient handling, should become a
Packing expenses part of cost of production. The cost of packing to facilitate the transportation of the product from the factory
to the customer should become a part of the distribution cost.
These indirect benefits stand to improve the morale, loyalty and stability of employees towards the
Fringe benefits organisation. If the amount of fringe benefit is considerably large, it may be recovered as direct charge by
means of a supplementary wage or labour rate; otherwise these may be collected as part of production
overheads.
If research is conducted in the methods of production, the research expenses should be charged to the
production overhead; while the expenditure becomes a part of the administration overhead if research relates
Research and to administration. Similarly, market research expenses are charged to the selling and distribution overhead.
Development
Expenses Development costs incurred in connection with a particular product should be charged directly to that
product. Such expenses are usually treated as “deferred revenue expenses,” and recovered as a cost per unit of
the product when production is fully established.
Process and Operation Costing

Chapter Overview Meaning of Process Costing
Process Costing is a method of costing used in
industries where the material has to pass through two
or more processes for being converted into a final
Meaning
product. It is defined as “a method of Cost Accounting
whereby costs are charged to processes or operations
and averaged over units produced”.
Costing
Procedure
Normal
This can be understood with the help of the following
diagram:
Process & Operation Costing
Treatment of
Process loss/ gain Raw Process Process Process Finished
Abnormal Material -I -II -III Goods
Costing Procedure in Process Costing

Process Costing
Methods Materials: Each process for which the materials are used, are
debited with the cost of materials consumed on the basis of the
information received from the Cost Accounting department.
Valuation of WIP
Equivalent Units
Employee Cost (Labour) - Each process account should
Inter-process be debited with the labour cost or wages paid to labour for
Profit carrying out the processing activities. Sometimes the wages
paid are apportioned over the different processes after selecting
appropriate basis.
Operation Costing
Direct expenses - Each process account should be debited with
direct expenses like depreciation, repairs, maintenance, insur-
ance etc. associated with it.
Production Overheads- These expenses cannot be allocated to a

process. The suitable way out to recover them is to apportion them
over different processes by using suitable basis.
Steps in Process Costing Treatment of Normal, Abnormal Loss and

Abnormal Gain
Step-1: Analyse the Physical Flow of Production Units Normal Process Abnormal Abnormal Process
Loss Process Loss Gain/ Yield
Step-2: Calculate Equivalent Units for each Cost Elements t ͳF DPTU PG tͳF DPTU PG tͳFQSPDFTTBDDPVOU
normal process an abnormal under which
loss in practice process loss unit
is equal to the abnormal gain
is absorbed
cost of a good arises is debited
Step-3: Determine Total Cost for each Cost Element by good units VOJU ͳF UPUBM
produced under with the abnormal
cost of abnormal
UIFQSPDFTTͳF process loss is gain and credited
amount realised credited to the to abnormal gain
Step-4: Compute Cost Per Equivalent Unit for each Cost Element by the sale of process account
from which it account which
normal process
loss units should arises. will be closed by
be credited to t5PUBM DPTU transferring to the
of abnormal
Step-5: Assign Total Costs to Units Completed and Ending WIP the process Costing Profit and
process loss
account. is debited to Loss account.
costing profit
and loss account.
Valuation of Work-in-process
ͳFWBMVBUJPOPGXPSLJOQSPDFTTQSFTFOUTBHPPEEFBMPGEJĊDVMUZCFDBVTFJUIBTVOJUTVOEFSEJĉFSFOUTUBHFTPG
completion from those in which work has just begun to those which are only a step short of completion.
(i) Equivalent Units
Equivalent units or equivalent production units, means converting the incomplete production units into
their equivalent completed units. Under each process, an estimate is made of the percentage completion of
XPSLJOQSPDFTTXJUISFHBSEUPEJĉFSFOUFMFNFOUTPGDPTUT WJ[ NBUFSJBM MBCPVSBOEPWFSIFBET
ͳFGPSNVMBGPSDPNQVUJOHFRVJWBMFOUDPNQMFUFEVOJUTJT
Equivalent completed units = Actual number of units in Percentage of

X
the process of manufacture Work completed
Input Details Units Output Units Equivalent Units

Particulars
Material Labour Overhead
% Units % Units % Units
a b c= a×b d e=a×d f g=a×f
Opening xxx Opening W-I-P* xxx xxx xxx xxx xxx xxx xxx
W-I-P
Unit xxx Finished xxx xxx xxx xxx xxx xxx xxx
Introduced output**
Normal loss*** xxx - - - - - -
Abnormal loss/ xxx xxx xxx xxx xxx xxx xxx

Gain****
Total Closing W-I-P xxx xxx xxx xxx xxx xxx xxx
xxx Total xxx xxx xxx xxx
* Equivalent units for Opening W-I-P is calculated only under FIFO method. Under the Average method, it is not shown separately.
**Under the FIFO method, Finished Output = Units completed and transferred to next process less Opening WIP. Under Average
method, Finished Output = Units completed and transferred.
***For normal loss, no equivalent unit is calculated.
****Abnormal Gain/ Yield is treated as 100% complete in respect of all cost elements irrespective of percentage of completion.
(ii) Methods for valuation of work-in-process

First-in-first-out (FIFO) method Weighted Average (Average) Method
Under this method the units completed and transferred include Under this method, the cost of opening work-in-process and cost
completed units of opening work-in-process and subsequently of the current period are aggregated and the aggregate cost is
introduced units. Proportionate cost to complete the opening divided by output in terms of completed units.
work-in-process and that to process the completely processed
units during the period are derived separately.
,QWHU3URFHVV3URÀW Operation Costing

In some process industries the output of one process is This product costing system is used when an entity produces
transferred to the next process not at cost but at market more than one variant of final product using different
value or cost plus a percentage of profit. The difference materials but with similar conversion activities. Which
between cost and the transfer price is known as inter- means conversion activities are similar for all the product
process profits. variants but materials differ significantly. Operation
Costing method is also known as Hybrid product costing
system as materials costs are accumulated by job order or
batch wise but conversion costs i.e. labour and overheads
costs are accumulated by department, and process costing
methods are used to assign these costs to products.
Standard Costing
Chapter Overview Types of standards
There are various types of standard which are illustrated
Meaning of below:
Advantages Standard cost
and Standard
and Criticism
Costing Types of Ideal Standards: The
of Standard Standards level of performance
Costing
attainable when
prices for material
and labour are most
favourable, when Normal Standards:
Computation Standard
The Process the highest output These are standards
of Standard is achieved with the that may be achieved
of Variance Costing Costing
best equipment and under normal
layout and when the operating conditions.
maximum efficiency
in utilisation of
Setting-up of resources results in
Classification of
Standard Cost maximum output
Variances
Types of with minimum cost.
Standards
Basic or Bogey Current Standards:

Standards: These These standards reflect
What is a Standard or Standard Cost? standards are used the management’s
Standard cost is defined in the CIMA Official Terminology only when they are anticipation of what
as “‘the planned unit cost of the product, component likely to remain actual costs will be for
or service produced in a period. The standard cost may constant or unaltered the current period.
be determined on a number of bases. The main use of over a long period.
standard costs is in performance measurement, control,
stock valuation and in the establishment of selling prices.”
Process followed in Standard Costing
Setting of Ascertainment of Comparison of Investigate the Disposition of

Standards actual costs actual cost with reasons for variances
standard cost variances
Variances at a Glance
Total Cost Variance
Material Cost Variance Labour Cost Variance Overhead Cost Variance
Usage Idle Time Efficiency Variable Overheads Fixed Overhead

Price Variance Variance Rate Variance Variance Variance Variance Variance
Expenditure
Mix Variance Mix Variance Expenditure Volume
Variance Variance Variance
Efficiency Efficiency
Yield Variance Yield Variance Variance Variance
Capacity
Variance
Calendar
Variance
Variance Analysis
(i) Material Cost Variance
Material Cost Variance
[Standard Cost – Actual Cost]
(The difference between the Standard Material Cost of the actual production volume and the Actual Cost of Material)
[(SQ × SP) – (AQ × AP)]
Material Price Variance Material Usage Variance

[Standard Cost of Actual Quantity – Actual Cost] [Standard Cost of Standard Quantity for Actual Production –
Standard Cost of Actual Quantity]
(The difference between the Standard Price and Actual Price for
the Actual Quantity Purchased) (The difference between the Standard Quantity specified for actual
production and the Actual Quantity used, at Standard Price)
[(SP – AP) × AQ] [(SQ – AQ) × SP]
Or Or
[(SP × AQ) – (AP × AQ)] [(SQ × SP) – (AQ × SP)]
Material Mix Variance Material Yield Variance

[Standard Cost of Actual Quantity in Standard Proportion – [Standard Cost of Standard Quantity for Actual Production –
Standard Cost of Actual Quantity] Standard Cost of Actual Quantity in Standard Proportion]
(The difference between the Actual Quantity in standard (The difference between the Standard Quantity specified for
proportion and Actual Quantity in actual proportion, at Standard actual production and Actual Quantity in standard proportion, at
Price) Standard Purchase Price)
[(RSQ – AQ) × SP] [(SQ – RSQ) × SP]
Or Or
[(RSQ × SP) – (AQ × SP)] [(SQ × SP) – (RSQ × SP)]
(ii) Labour Cost Variances

Labour Cost Variance
[Standard Cost – Actual Cost]
(The difference between the Standard Labour Cost and the Actual Labour Cost incurred for the production achieved)
[(SH × SR) – (AH* × AR)]
Labour Rate Variance Labour Idle Time Variance Labour Efficiency Variance
[Standard Cost of Actual Time – Actual Cost] [Standard Rate per Hour x Actual Idle Hours] [Standard Cost of Standard Time for Actual
(The difference between the Standard Rate (The difference between the Actual Production – Standard Cost of Actual Time]
per hour and Actual Rate per hour for the Hours paid and Actual Hours worked at (The difference between the Standard Hours
Actual Hours paid) Standard Rate) specified for actual production and Actual
Hours worked at Standard Rate)
[(SR – AR) × AH*] Or [(AH* – AH#) × SR] Or [(SH – AH#) × SR] Or
[(SR × AH*) – (AR × AH*)] [(AH* × SR) – (AH# × SR)] [(SH × SR) – (AH# × SR)]
Labour Mix Variance Or Gang Variance Labour Yield Variance Or Sub-Efficiency Variance
[Standard Cost of Actual Time Worked in Standard [Standard Cost of Standard Time for Actual Production
Proportion – Standard Cost of Actual Time Worked] – Standard Cost of Actual Time Worked in Standard
(The difference between the Actual Hours worked in Proportion]
standard proportion and Actual Hours worked in actual (The difference between the Standard Hours specified
proportion, at Standard Rate) for actual production and Actual Hours worked in
standard proportion, at Standard Rate)
[(RSH – AH#) × SR] Or (SH – RSH) × SR Or
[(RSH × SR) – (AH# × SR)] (SH × SR) – (RSH × SR)
(iii) Variable Overhead Variances

Variable Overhead Cost Variance
(Standard Variable Overheads for Production – Actual Variable Overheads)
Variable Overhead Expenditure Variable Overhead Efficiency Variance

(Spending) Variance
(Standard Variable Overheads for Actual Hours#) (Standard Variable Overheads for Production)
Less Less
(Actual Variable Overheads) (Standard Variable Overheads for Actual Hours#)
[(SR – AR) × AH#] [(SH – AH#) × SR]
Or Or
[(SR × AH#) – (AR × AH#)] [(SH × SR) – (AH# × SR)]
(iv) Fixed Overhead Variances

Fixed Overhead Cost Variance
(Absorbed Fixed Overheads) Less (Actual Fixed Overheads)
Fixed Overhead Expenditure Variance Fixed Overhead Volume Variance

(Budgeted Fixed Overheads) (Absorbed Fixed Overheads)
Less Less
(Actual Fixed Overheads) (Budgeted Fixed Overheads)
Or Or
(BH × SR) – (AH × AR) (SH × SR) – (BH × SR)
Fixed Overhead Capacity Variance Fixed Overhead Calendar Variance Fixed Overhead Efficiency Variance
SR (AH – BH) Std. Fixed Overhead rate per day (Actual no. SR (AH – SH)
Or of Working days – Budgeted Working days) Or
(AH × SR) – (BH × SR) (AH × SR) – (SH × SR)
AH* - Actual Hours paid
AH# - Actual Hours worked
Marginal Costing
Chapter Overview Characteristics of Marginal Costing
Meaning of All elements of cost are classified into fixed and variable
Marginal Cost components. Semi-variable costs are also analyzed into fixed
and Marginal and variable elements.
Costing
The marginal or variable costs (as direct material, direct

Characteristics Break-even labour and variable factory overheads) are treated as the cost
Characteristics of Marginal Costing

of Marginal Analysis of product
Marginal Costing
Costing
Under marginal costing, the value of finished goods and
Cost-Volume- Margin of Safety work–in–progress is also comprised only of marginal costs.
Profit (CVP) Variable selling and distribution overheads are excluded for
Analysis valuing these inventories.
Angle
of Incidence Fixed costs are treated as period costs and are charged to profit
Short-term
and loss account for the period for which they are incurred
Decision making
Contribution
Prices are determined with reference to marginal costs and
Ratio
contribution margin
Profitability of departments and products is determined with

reference to their contribution margin
Meaning of Terms
In order to understand the concept of marginal costing,
let us first define various terminology associated with &RPSXWDWLRQRI&RQWULEXWLRQDQG3URÀW
marginal costing. under Marginal Costing
For the determination of cost of a product/ service under
marginal costing, costs are classified under variable and
Marginal Differential fixed. All the variable costs are part of product and fixed
Marginal Cost Direct Costing
Costing Cost costs are charged against contribution margin.
Cost and Profit Statement under Marginal Costing

Marginal It is a costing Direct costing Differential
cost as system where and Marginal cost is Amount Amount
understood products or Costing difference (Rs) (Rs)
in economics services and is used between the Revenue xxx
is the inventories synonymously costs of two Product Cost:
incremental are valued at at various different - Direct Materials xxx
cost of variable costs places and it production - Direct employee (labour) xxx
production only. is so also. levels. - Direct expenses xxx
which arises - Variable manufacturing overheads xxx
due to
Product (Inventoriable) Costs xxx (xxx)
one-unit
Product Contribution Margin xxx
increase
- Variable Administration overheads xxx
in the
- Variable Selling & Distribution overheads xxx (xxx)
production
Contribution Margin xxx
quantity.
Period Cost:
Fixed Manufacturing expenses xxx
Fixed non-manufacturing expenses xxx (xxx)
Profit/ (loss) xxx
Advantages of Marginal Costing %UHDN(YHQ$QDO\VLV

There are many advantages of marginal costing, some Break-even analysis is a generally used method to study
of them are discussed below. the CVP analysis. This technique can be explained in
two ways.
(i) In narrow sense it is concerned with computing the
Simplified break-even point.
Pricing
Policy
(ii) In broad sense this technique is used to determine
Short term
profit
Proper the possible profit/loss at any given level of
recovery of
planning production or sales.
Overheads
= Fixed Cost /
Break-even Point Contribution per unit
Advantages
Helps in of Marginal Shows
Decision Costing Realistic
Making Profit
Break even
Cash Break-even = Cash Fixed Cost /
point Contribution per unit
More How
control over much to
expenditure produce
The contribution is
Multi-Product calculated by taking
Break-even Analysis weights (sales quantity/
value) for the products
&RVW9ROXPH3URÀW&93$QDO\VLV Angle of Incidence

It is a managerial tool showing the relationship between This angle is formed by the intersection of sales line and
various ingredients of profit planning viz., cost, selling total cost line at the break-even point. This angle shows
price and volume of activity. the rate at which profit is earned once the break-even
point is reached. The wider the angle the greater is the rate
Marginal Cost Equation of earning profits. A large angle of incidence with a high
Marginal Cost Equation = S -V = C = F ± P margin of safety indicates extremely favourable position
Marginal Cost Statement 0DUJLQRI6DIHW\

This is the difference between the expected level of sales
(r) and break even sales (no profit, no loss). The larger is
Sales (S) xxxx the margin of safety higher is the profit and vice versa.
Less: Variable Cost (V) xxxx
Variations of Basic Marginal Cost Equation and
Contribution (C) xxxx other formulae
Less: Fixed Cost (F) xxxx
Profit/ Loss (P) xxxx i. Sales – Variable cost = Fixed cost + Profit / Loss
By multiplying and dividing L.H.S. by S

3URÀW9ROXPH5DWLRRU39UDWLR ii. S (S – V)
=F+P
This ratio shows the proportion of sales required to S
cover fixed cost and profit. P/V ratio is calculated as S- V
below: iii. S x P/V Ratio = F + P or Contribution (P / V Ratio = X 100)
S
Contribution ( ... at BEP Profit is zero )
(a) P/V Ratio= ×100 iv. BES x P/V Ratio = F
Sales v.
Fixed cost
BES =
(b) When two years’ data is given, P/V Ratio P/V Ratio
vi.
Fixed cost
Change in contribution/ Profit P/V Ratio =
×100 BES
Change in sales vii S × P/V Ratio = Contribution (Refer to iii)
viii. xiv.
Contribution Contribution
P/V Ratio = X 100
Sale Profitability =
Key factor
ix. (BES + MS) × P/V Ratio = Contribution (Total sales = BES + MS)
xv. Profit
Margin of Safety = Total Sales – BES or
x. (BES × P/V Ratio) + (MS × P/V Ratio) = F + P P/V Ratio
By deducting (BES × P/V Ratio) from L.H.S. and F from R.H.S. xvi. BES = Total Sales – MS
in (x) above, we get:
xvii.
xi. M.S. × P/V Ratio = P Margin of Safety Ratio = Total sales – BES
Total Sales
xii.
Change in profit
P/V Ratio = X 100
Change in sales
xiii.
Change in contribution
P/V Ratio = X 100
Change in sales
Budget & Budgetary Control

Chapter Overview 'HÀQLWLRQDQG7HUPLQRORJ\
Let us first define various important terminologies
Essentials of used in budget and budgetary control.
Budget
Budget Budgeting Budgetary control

Objectives of Capacity-wise
Budgeting
Budget & Budgetary Control
Quantitative Coordinating The establishment

expression of a the combined of budgets
Types of plan for a defined intelligence of an relating to the
Budgets Functions-wise period of time entire organisation responsibilities
into a plan of of executives
action based on of a policy and
past performance the continuous
Zero-based
Budgeting (ZBB) comparison of the
Period-wise
actual with the
budgeted results,
either to secure by
Performance individual action
Budgeting
Master Budget the objective of
the policy or to
provide a basis for
Budget Ratio its revision
Essentials of Budget
Essential elements of budget are illustrated below:
Essential elements of a budget
Organisational Setting of clear Budgets are Budgets are Budgets should be Budgetary
structure must objectives and prepared for updated for the quantifiable and master performance
be clearly reasonable the future events that were budget should be broken needs to be linked
defined targets periods based on not kept into down into various effectively to the
expected course the mind while functional budgets. reward system
of actions establishing Budgets should be
budgets monitored periodically
Characteristics of Budget Objectives of Budgeting

Main characteristics of budget are as below: The objective of budgeting begins with planning and
ends with controlling. Once the planning is done, they
can be used for directing and controlling operations so
It is concerned that the stated targets in planning are achieved.
for a definite
future period
Budget is usually
prepared in the light It is a written Planning
of past experiences document
Characteristics
of Budget
Budget helps
in planning, It is a detailed
plan of all Dir
coordination and
the economic Co ectin
control ord g a
activities of a ing ina nd
Budget is a business troll tin
g
means to achieve C on
business and it
is not an end in
itself
Advantages of Budgetary Control System

There are many advantages of budgetary control system, and some of the them are illustrated below:
Control on Finding Effective Revision of Implementation Cost

Efficiency utilisation of of Standard Credit Rating
expenditure deviations plans Consciousness
resources Costing system
&ODVVLÀFDWLRQRI%XGJHW
BUDGET
Capacity wise Functions wise Master Budget Period wise
Sales budget Long-term

Fixed Budget Production budget Budgets
Plant utilisation budget
Direct-material usage budget
Flexible Direct-material purchase budget Short-term
Budget Direct-labour (personnel) budget Budgets
Factory overhead budget
Production cost budget
Current
Ending-inventory budget Budgets
Cost of goods-sold budget
Selling and distribution cost budget
Administration expenses budget
Research and development cost budget
Capital expenditure budget
Cash budget
'HÀQLWLRQRIGLIIHUHQWW\SHVRI%XGJHW
Functional Budgets Budgets which relate to the individual functions in an organisation are known as Functional Budgets. For
example, purchase budget; sales budget; production budget; plant-utilisation budget and cash budget.
Master Budget It is a consolidated summary of the various functional budgets. It serves as the basis upon which budgeted
P & L A/c and forecasted Balance Sheet are built up.
Long-term Budgets The budgets which are prepared for periods longer than a year are called long-term budgets. Such budgets
are helpful in business forecasting and forward planning. Capital expenditure budget and Research and
Development budget are examples of long-term budgets.
Short-term Budgets Budgets which are prepared for periods less than a year are known as short-term budgets. Cash budget is
an example of short-term budget. Such types of budgets are prepared in cases where a specific action has
to be immediately taken to bring any variation under control, as in cash budgets.
Basic Budgets A budget which remains unaltered over a long period of time is called basic budget.
Current Budgets A budget which is established for use over a short period of time and is related to the current conditions
is called current budget.
Fixed Budget According to CIMA official terminology, “a fixed budget, is a budget designed to remain unchanged
irrespective of the level of activity actually attained”.
Flexible Budget According to CIMA official terminology, “a flexible budget is defined as a budget which, by recognizing
the difference between fixed, semi-variable and variable costs is designed to change in relation to the level
of activity attained.”
'LIIHUHQFHVEHWZHHQ)L[HG%XGJHWDQG)OH[LEOH%XGJHW
Sl. no. Fixed Budget Flexible Budget
1. It does not change with actual volume of activity achieved. Thus it is It can be re-casted on the basis of activity level to be
known as rigid or inflexible budget achieved. Thus it is not rigid.
2. It operates on one level of activity and under one set of conditions. It It consists of various budgets for different levels of
assumes that there will be no change in the prevailing conditions, which activity.
is unrealistic.
3. Here as all costs like - fixed, variable and semi-variable are related to only Here, analysis of variance provides useful information
one level of activity, so variance analysis does not give useful information. as each cost is analysed according to its behaviour.
4. If the budgeted and actual activity levels differ significantly, then the Flexible budgeting at different levels of activity
aspects like cost ascertainment and price fixation do not give a correct facilitates the ascertainment of cost, fixation of
picture. selling price and tendering of quotations.
5. Comparison of actual performance with budgeted targets will be It provides a meaningful basis of comparison of the
meaningless specially when there is a difference between the two actual performance with the budgeted targets.
activity levels.
=HUR%DVHG%XGJHWLQJ=%% 3HUIRUPDQFH%XGJHWLQJ

It is defined as ‘a method of budgeting which requires A performance budget is one which presents the
each cost element to be specifically justified, although purposes and objectives for which funds are required,
the activities to which the budget relates are being the costs of the programmes proposed for achieving
undertaken for the first time, without approval, the those objectives, and quantitative data measuring the
budget allowance is zero’. accomplishments and work performed under each
programme.
Stages in Zero-based budgeting
Steps in Performance Budgeting
Identification and description of Decision packages
Establishing Evolving suitable

Bring the norms, yardsticks,
a meaningful system of
Evaluation of Decision packages functional work units of
accounting performance
programme and financial
and activity and units costs,
management wherever possible
classification in accord
Ranking (Prioritisation) of the Decision packages of under each
with this programme and
government classification
operations activity for their
reporting and
Allocation of resources evaluation
EMPLOYEE (LABOUR) COST

Points of Discussion Classification of Employee cost:
Meaning of Wage and

Absorption of Direct
Employee Incentives employee cost
Wages Indirect
(Labour) Cost Payment System employee cost
Efficiency
Control of
Employee Cost
Overtime Rating Direct employee cost Indirect employee cost
Procedures
1. Cost of employees, directly $PTU PG FNQMPZFFT XIP BSF
engaged in the production not directly engaged JO UIF
process. QSPEVDUJPO QSPDFTT
Attendance Employee
& Payroll Idle Time (Labour) 2. Easily identifiable and Apportioned on some
Procedures Turnover allocable to cost unit. appropriate basis
3. Varies with the volume .BZ not vary with the
of production and has volume PG QSPEVDUJPO
Meaning of Employee (Labour) Cost positive relationship with
the volume.
t #FOFmUT QBJE PS QBZBCMF UP UIF FNQMPZFFT

EMPLOYEE PG BO FOUJUZ XIFUIFS QFSNBOFOU Employee Cost Control
(LABOUR) PS UFNQPSBSZ GPS UIF TFSWJDFT SFOEFSFE
COST CZ UIFN
t *ODMVEFT QBZNFOUT NBEF JO DBTI PS LJOE - To control over the cost incurred on
employees.
EMPLOYEE - To keep the wages per unit of output
(LABOUR) as low as possible.
COST
CONTROL - To give the employees an appropriate
compensation and encourage
Wages and
efficiency.
salary
Factors for the Control of Employee Cost:

0UIFS CFOFmUT
MFBWF XJUI QBZ Control over time-
Allowances and Assessment of
free or subsidised keeping and time-
incentives manpower requirements.
food, leave travel booking.
DPODFTTJPO FUD
Employee cost
includes Control over idle time
Time and Motion Study.
and overtime.
Control over employee Wage and Incentive

Employer’s turnover. systems.
contribution to PF Payment for
BOE PUIFS XFMGBSF overtimes
funds;
Job Evaluation and
Employee productivity.
Merit Rating.
Time-keeping: A record of total time spent by t"UUFOEBODFBOE5JNFEFUBJMT

UIF FNQMPZFFT JO B GBDUPSZ
Detailed sheet of number of days or hours worked
Step-1 by each employee as reflected by the time keeping
methods are sent to the payroll department.
(i) For the preparation of payrolls.
(ii) For calculating overtime.
(iii) For ascertaining employee cost.
Objectives of
Time Keeping: (iv) For controlling employee cost. t-JTUPGFNQMPZFFTBOEPUIFSEFUBJMT
(v) For ascertaining idle time. List of employees on roll and the rate at which
(vi) For disciplinary purposes. Step-2 they will be paid is sent by the personnel/ HR
(vii) For overhead distribution. department.
Methods of Time-keeping
t$PNQVUBUJPOPGXBHFTBOEPUIFSJODFOUJWFT
Methods of Time-keeping Payroll department prepares pay slip and forward
Step-3 the same to the cost/ accounting department.
Mechanical/ Automated
Manual Methods Methods
t1BZNFOUUPUIFFNQMPZFFT
Attendance 1VODI $BSE After all deductions (like PF, ESI, TDS), wages/
Step-4 salary is paid to the employees.
3FHJTUFS NFUIPE Attendance
.FUBM %JTD 5PLFO #JPNFUSJD

NFUIPE Attendance system
t%FQPTJUPGBMMTUBUVUPSZMJBCJMJUJFT
All statutory deduction are paid to the respective
Time-Booking: " NFUIPE XIFSFJO FBDI BDUJWJUZ PG Step-5
BO FNQMPZFF JT SFDPSEFE statutory bodies & funds.
(i) To compute the cost of the job

or activity. Idle Time
Objectives of (ii) To measure efficiency.
5JNF #PPLJOH (iii) To analyse the variance in The time during which no production is carried-out because
time with respect to the the worker remains idle but are paid.
standard time.
For the collection of all such data, a separate record, Normal idle
generally known as Time (or Job) card, is kept. time Abnormal
idle time
Payroll Procedures of Employees

5JNF LFFQJOH Personnel/ HR Normal Idle Time: Time which cannot be avoided or
Department Department reduced in the normal course of business.
t 5JNF MPTU CFUXFFO GBDUPSZ HBUF BOE UIF QMBDF PG

5JNF BOE
Attendance
&NQMPZFF
Payroll work,
Details
Department t *OUFSWBM CFUXFFO POF KPC BOE BOPUIFS

Causes:
t 4FUUJOH VQ UJNF GPS UIF NBDIJOF
8BHF BOE t /PSNBM SFTU UJNF CSFBL GPS MVODI FUD
4BMBSZ TIFFU
t 5SFBUFE BT B part of cost of production

%FQPTJU PG EFEVDUJPOT
and contributions Treatment t *O UIF DBTF PG direct workers an allowance for
Cost/ Accounting OPSNBM JEMF UJNF JT DPOTJEFSFE XIJMF setting of
of Normal
Department standard hours PS TUBOEBSE SBUF
Idle Time
t In case of indirect workers, normal idle time is
1BZNFOU BGUFS EFEVDUJPOT DPOTJEFSFE GPS UIF computation of overhead rate.
and contributions
Abnormal Idle Time: Apart from normal idle time, there

Employees 4UBUVUPSZ #PEJFT may be factors which give rise to abnormal idle time.
t -BDL PG DPPSEJOBUJPO Systems of Wage Payment and Incentives

t 1PXFS GBJMVSF #SFBLEPXO PG NBDIJOFT
Causes: t /POBWBJMBCJMJUZ PG SBX NBUFSJBMT System of Wages Payment
t 4USJLFT MPDLPVUT QPPS TVQFSWJTJPO mSF nPPE
etc.
Time Output Combination Premium Group Incentives
based based of time and Bonus bonus for indirect
output based method scheme workers
Causes further
analysed into
Time based (Time Rate System):

Workers are paid on time basis i.e. hour, day, week, or month.
Controllable Uncontrollable
abnormal idle time abnormal idle time
Wages = Time Worked (Hours/ Days/ Months) × Rate for the time
Time which could have Time lost which

been put to productive management does not Output Based (Piece Rate System):
use had the management have any control e.g.,
been more alert and breakdown of machines, Each operation, job or unit of production is termed a piece.
efficient. flood etc. A rate of payment, is fixed for each piece.
The wages of the worker depend upon his output and rate of
each unit of output.
t Not included in production cost.
t 4IPXO BT B separate item JO UIF Costing Profit Wages = Number of units produced × Rate per unit
and Loss "DDPVOU
Treatment
of Abnormal t 'PS FBDI DBUFHPSZ JF controllable and
uncontrollable JEMF UJNF UIF break-up of cost due
Idle time
UP WBSJPVT GBDUPST TIPVME CF separately shown
t Management TIPVME BJN BU eliminating
Premium Bonus Method:
controllable idle time
The worker is guaranteed his daily wages, if output is below
and up to standard.
In case the task is completed in less than the standard time,
Overtime the saved time is shared between the employees and the
employer.
Overtime: Work done beyond normal working hours.
Overtime Payment = Wages paid for overtime at normal rate +

1SFNJVN FYUSB
QBZNFOU GPSPWFSUJNF XPSL t "TUBOEBSEUJNFJTmYFEGPSFBDIKPCPS
process
t 8PSLFS HFUT IJT UJNF SBUF FWFO JG IF
HALSEY exceeds the standard time limit, since
Overtime PREMIUM his day rate is guaranteed.
Extra amount so paid over the normal rate PLAN
premium: t *G KPC EPOF JO MFTT UIBO UIF TUBOEBSE
time, bonus equal to 50 percent of the
wages of time saved is paid.
CAUSES TREATMENT
Urgency of work. Charged to job directly. Wages = Time taken × Time rate + 50% of time saved × Time rate
To make up shortfall in Treated as overhead cost of

production due to some the particular cost centre
unexpected development. which works overtime. ADVANTAGES of DISADVANTAGES of
HALSEY PREMIUM PLAN HALSEY PREMIUM PLAN
If overtime is worked in a t Time rate is guaranteed t Incentive is not so strong
To make up shortfall in department due to the fault t 0QQPSUVOJUZ GPS increasing BT XJUI QJFDF SBUF TZTUFN
production due to some of another department, then
fault of management. premium should be charged earnings by increasing t Harder the worker works,
to the latter department. QSPEVDUJPO UIF lesser IF gets QFS QJFDF
t System is equitable in as t 4IBSJOH QSJODJQMF NBZ not
NVDI BT UIF FNQMPZFS HFUT B be liked by employees
Overtime worked on account direct return GPS IJT FĉPSUT
To take advantage of an of abnormal conditions
expanding market or of such as flood, etc., should in improving production
rising demand. be charged to Costing P/L NFUIPET
Account.
Factors for increasing Employee productivity:

t 4UBOEBSE UJNF BMMPXBODF JT mYFE GPS
performance of a job.
ROWAN Employing XIP QPTTFTT right type of skill.
t #POVTJTQBJEJGUJNFJTTBWFE
PREMIUM t #POVT JT UIBU QSPQPSUJPO PG UIF UJNF
PLAN wages as time saved bears to the 1MBDJOH UIF right type of person UP UIF right job
standard time.
Training ZPVOH BOE PME XPSLFST CZ QSPWJEJOH

Time Saved SJHIU UZQFT PG PQQPSUVOJUJFT
Time taken × Rate per hour + × Time taken × Rate per hour
Time Allowed
5BLJOH BQQSPQSJBUF NFBTVSFT UP avoid UIF TJUVBUJPO PG

excess or shortage of employees.
ADVANTAGES of DISADVANTAGES of
ROWAN PREMIUM PLAN ROWAN PREMIUM PLAN
Carrying out work study for fixation of wages.
t " XPSLFS DBO never double t 4ZTUFN JT B bit complicated
his earnings even if there t *ODFOUJWF JT weak at a high
is bad rate setting production level where the
t 4VJUBCMF GPS encouraging time saved is more than
moderately efficient 50% of the time allowed
workers
Employee (Labour) Turnover
t 4IBSJOH QSJODJQMF JT not
t 4IBSJOH QSJODJQMF appeals generally welcomed by
to the employer as being employees Rate of change in the composition of employee
EMPLOYEE
FRVJUBCMF force during a specified period measured
TURNOVER
against a suitable index.
Absorption of Wages
Methods to calculate Employee Turnover
ELEMENTS OF WAGES
Monetary payment Non-monetary benefits Replacement Method Separation Flux Method

t #BTJDXBHFT t .FEJDBMGBDJMJUJFT This considers actual Method This considers
t %FBSOFTTBMMPXBODF t &EVDBUJPOBMBOEUSBJOJOH replacement of This considers CPUI UIF OVNCFS
facilities; employees irrespective total number of replacements
t 0WFSUJNFXBHFT of number of of employees BT XFMM BT UIF
t 1SPEVDUJPOCPOVT t 3FDSFBUJPOBMBOETQPSUT QFSTPOT MFBWJOH UIF separated number of
t &NQMPZFSTDPOUSJCVUJPOUP facilities; organisation separations
PF, ESI and other funds, t )PVTJOHBOETPDJBM
t -FBWFQBZ FUD welfare; and Number of employees Replaced
t $PTUPGTVCTJEJTFEDBOUFFO Replacement method =
EVSJOH UIF QFSJPE
× 100
and co-operative societies, "WFSBHF OVNCFS PG FNQMPZFFT EVSJOH UIF
period on roll
etc.
/VNCFS PG FNQMPZFFT 4FQFSBUFE EVSJOH UIF QFSJPE

Separation method = "WFSBHF OVNCFS PG FNQMPZFFT EVSJOH UIF QFSJPE on roll
× 100
(IÀFLHQF\5DWLQJ3URFHGXUHV
Number of employees Seperated +

If the time taken by a worker on a job ≤ the standard time, /VNCFS PG FNQMPZFFT 3FQMBDFE EVSJOH UIF QFSJPE
then he is rated efficient. Flux method = "WFSBHF OVNCFS 0G FNQMPZFFT EVSJOH UIF QFSJPE PO SPMM
× 100
Or
/P PG 4FQBSBUJPOT/PPG "DDFTTJPOT JF/PPG 3FQMBDFNFOUT
/PPG /FX +PJOJOHT
Time allowed as per standard × 100

Efficiency in % = × 100 "WFSBHF OPPG FNQMPZFFT EVSJOH UIF QFSJPE PO SPMM
Time Taken
Need for Efficiency rating: Newly recruited employees are also responsible for changes
in the composition or work force, some management
accountants feel to take new recruitment for calculating
employee turnover. The total number of workers joining,
Payment including replacements, is called accessions.
Firm IBT B Helps
following management
system of direct
relationship for preparing
payment by manpower
results XJUI UIF requirements
output
Causes of Employee Turnover: COST SHEET

$IBOHF PG KPCT GPS CFUUFSNFOU
Points of Discussion
Premature retirement
Personal
Causes Domestic problems/ Family
responsibilities Head of
Functional
%JTDPOUFOU PWFS UIF KPCT BOE Costs in Cost
Classification
XPSLJOH FOWJSPONFOU Sheet
4FBTPOBM OBUVSF PG UIF CVTJOFTT

Causes of Employee Turnover
4IPSUBHF PG SBX NBUFSJBM QPXFS Advantages

Format of
TMBDL NBSLFU GPS UIF QSPEVDU FUD of
Cost Sheet
Unavoidable Cost Sheet
$IBOHF JO QMBOU MPDBUJPO
Causes
Disability
Disciplinary measures
)XQFWLRQDO&ODVVLÀFDWLRQRI(OHPHQWVRI&RVW
%JTTBUJTGBDUJPO XJUI KPC
SFNVOFSBUJPO IPVST PG XPSL
Direct Material Cost
XPSLJOH DPOEJUJPOT FUD
4USBJOFE SFMBUJPOTIJQ XJUI
management
Direct Employee (labour) Cost
Avoidable -BDL PG USBJOJOH GBDJMJUJFT BOE
Causes promotional avenues
-BDL PG SFDSFBUJPOBM BOE Direct Expenses
medical facilities
Low wages and allowances

Production/ Manufacturing Overheads
Effects of Employee Turnover:

Even flow of production is disturbed Administration Overheads
Efficiency of new workers is low
Increased cost of training Selling Overheads
New workers cause increased breakage of tools
Cost of recruitment Distribution Overheads
Cost of Employees Turnover:

Research and Development costs etc.
Cost of Employees Turnover
Preventive Costs
Costs incurred to prevent Replacement Costs Cost Heads in a Cost Sheet
$PTUT XIJDI BSJTF EVF UP
FNQMPZFF UVSOPWFS PS LFFQ employee turnover
it as lowest as possible Prime Cost
Cost of medical Cost of

CFOFmU recruitment
Cost of Production
Cost on employees’ Training and
XFMGBSF MJLF induction
QFOTJPO FUD
Abnormal Cost of Goods Sold
$PTU PO PUIFS CSFBLBHF BOE TDSBQ
CFOFmUT XJUI BO
objective to retain Extra wages and
employees PWFSIFBET EVF UP
UIF JOFĊDJFODZ PG Cost of Sales
OFX XPSLFST
Prime Cost:
Direct Direct Direct Prime

material costs employee costs expenses Cost
Prime Cost xxxx

Add: Factory Overheads #
xxx
Gross Works Costs xxxx
Cost of material
Direct Material Cost
Add: Opening stock of Work-in-process xxx

'SFJHIU JOXBSET Less: Closing stock of Work-in-process (xxx)
Cost of direct
material Insurance
Factory or Works Costs xxxx
consumed* FH Add: Quality Control Cost xxx
Trade discounts or rebates
Add: Research & Development cost (Process related) xxx
(to be deducted)
Add: Administrative Overheads related with xxx
Duties & Taxes (if ITC is not production
BWBJMBCMF BWBJMFE

Less: Credit for recoveries (miscellaneous income) (xxx)
Wages and salary Add: Packing Cost (Primary packing) xxx
Direct Employee Cost
Cost of Production xxxx

Payments to Allowances and incentives
the employees
engaged in the Payment for overtime
#
Factory Overheads (Works / production / manufacturing
overheads) includes-
production
of goods and #POVT FYHSBUJB
provision of
services FH Employer’s contribution to
Consumable Lease rent of
PF, ESI & funds Depreciation
stores and spares production assets
0UIFS CFOFmUT NFEJDBM MFBWF
XJUI QBZ -5$

Power & fuel Repair and Indirect

maintenance employees cost Drawing and
Expenses other Royalty paid of plant and related with Designing
Direct Expenses
than direct machinery, production department cost

material cost )JSF DIBSHFT factory building activities
and direct
employee cost 'FF GPS UFDIOJDBM BTTJTUBODF
FH Insurance of plant Service
Amortised cost of moulds, and machinery, Amortised cost department cost
patterns, patents factory building, of jigs, fixtures, such as Tool Room,
stock of raw tooling Engineering &
0UIFS FYQFOTFT EJSFDUMZ SFMBUFE material & WIP Maintenance,
XJUI UIF QSPEVDUJPO PG HPPET Pollution Control
*
Cost of Goods Sold:
Opening Closing Direct Cost of Cost of

Addition/ Opening Closing
Stock of stock of materials Cost of Cost of
Purchases stock of stock of
Material Material consumed Production Goods Sold
finished finished
goods goods
Cost of Production: Cost of Sales:

Cost of Goods Sold xxxx
Factory Add: Administrative Overheads (General) xxx
Prime related Cost of Add: Selling Overheads xxx
cost costs and Production
overheads Add: Packing Cost (secondary) xxx
Add: Distribution Overheads xxx
Cost of Sales xxxx
Examples:
Administrative Selling Packing Cost Distribution
Overheads (General) Overheads (secondary) Overheads
Depreciation and Salary and wages 1BDLJOH NBUFSJBM Salary and wages of
maintenance of, office SFMBUFE XJUI TBMFT UIBU FOBCMFT UP employees engaged in
CVJMEJOH GVSOJUVSF FUD department store, transport, and distribution of goods
NBLF UIF QSPEVDU
NBSLFUBCMF
Salary of administrative Rent, depreciation, Transportation and
employees, maintenance related insurance costs related
BDDPVOUBOUT FUD XJUI TBMFT EFQBSUNFOU XJUI EJTUSJCVUJPO
Rent, rates & taxes Advertisement, %FQSFDJBUJPO IJSF

maintenance of website DIBSHFT NBJOUFOBODF
GPS POMJOF TBMFT NBSLFU BOE PUIFS PQFSBUJOH DPTUT
SFTFBSDI FUD SFMBUFE XJUI EJTUSJCVUJPO
*OTVSBODF MJHIUJOH
office expenses
Indirect materials-
printing and stationery,
PĊDF TVQQMJFT FUD
-FHBM DIBSHFT BVEJU GFFT

NFFUJOH FYQFOTFT FUD
Cost Sheet- Specimen Format

Particulars Total Cost (R) Cost per unit (R)
1. %JSFDU NBUFSJBMT DPOTVNFE
0QFOJOH 4UPDL PG 3BX .BUFSJBM xxx
Add: "EEJUJPOT 1VSDIBTFT xxx
Less: $MPTJOH TUPDL PG 3BX .BUFSJBM (xxx)
xxx xxx
2. Direct employee (labour) cost xxx
3. Direct expenses xxx
4. Prime Cost (1+2+3) xxx xxx
5. Add: 8PSLT 'BDUPSZ 0WFSIFBET xxx
6. (SPTT 8PSLT $PTU
xxx
7. Add: 0QFOJOH 8PSL JO 1SPDFTT xxx
8. Less: $MPTJOH 8PSL JO 1SPDFTT (xxx)
9. Works/ Factory Cost (6+7-8) xxx xxx
10. Add: Quality Control Cost xxx
11. Add: 3FTFBSDI BOE %FWFMPQNFOU $PTU xxx
12. Add: "ENJOJTUSBUJWF 0WFSIFBET SFMBUJOH UP QSPEVDUJPO BDUJWJUZ
xxx
13. Less: $SFEJU GPS 3FDPWFSJFT4DSBQ#Z1SPEVDUT NJTD JODPNF (xxx)
14. Add: 1BDLJOH DPTU QSJNBSZ
xxx
15. Cost of Production (9+10+11+12-13+14) xxx xxx
16. Add: 0QFOJOH TUPDL PG mOJTIFE HPPET xxx
17. Less: $MPTJOH TUPDL PG mOJTIFE HPPET (xxx)
18. Cost of Goods Sold (15+16-17) xxx xxx
19. Add: "ENJOJTUSBUJWF 0WFSIFBET (FOFSBM
xxx
20. Add: .BSLFUJOH 0WFSIFBET
4FMMJOH 0WFSIFBET xxx
%JTUSJCVUJPO 0WFSIFBET xxx
21. Cost of Sales (18+19+20) xxx xxx
Treatment of various items of cost in Cost Sheet:

Advantages of Cost Sheet
t "OZ BCOPSNBM DPTU XIFSF JU JT NBUFSJBM BOE
Abnormal RVBOUJmBCMF TIBMM OPU GPSN QBSU PG DPTU PG Provides the total cost figure as well as cost per
costs production or acquisition or supply of goods unit of production.
PS QSPWJTJPO PG TFSWJDF
Subsidy/ Helps in cost comparison.

t 3FEVDFE GSPN UIF DPTU PCKFDUT UP XIJDI TVDI
Grant/
Incentives BNPVOU QFSUBJOT
Facilitates preparation of cost estimates
Penalty, fine, required for submitting tenders.
damages, and t %PFT OPU GPSN QBSU PG DPTU
demurrage
Provides sufficient help in arriving at the
figure of selling price.
Interest and t /PU JODMVEFE JO DPTU PG QSPEVDUJPO
other finance t 4IBMM CF QSFTFOUFE JO UIF DPTU TUBUFNFOU BT B
costs TFQBSBUF JUFN PG DPTU PG TBMFT Facilitates cost control by disclosing
operational efficiency.
UNIT & BATCH COSTING

Points of Discussion COST COLLECTION PROCEDURE IN UNIT
COSTING
Meaning
Unit Collection of
Costing Process of Cost Accumulation Collection of Employees Collection of
and Calculation Materials Cost (labour) Cost Overheads
Methods of Costing
Meaning
It is collected Direct employee These are
Process of Cost Accumulation from Material cost: It is collected collected under
and Calculation Requisition notes. from job time suitable standing
Batch cards or sheets. orders numbers,
Costing Determination of Economic and selling and
Batch Quantity (EBQ) distribution
Accumulated overheads against
material cost is The time booked/ cost accounts
Difference between Job and then posted in cost recorded is valued
Batch Costing numbers.
accounting system. at appropriate rates
and entered in the
cost accounting
UNIT COSTING system. Total expenses
so collected are
Meaning of Unit Costing apportioned
to service and
Indirect employee production depart-
costs: These are ments on some
- where the output produced is identical collected from
and each unit of output requires identical suitable basis.
the payrolls books
cost. and posted against
UNIT - also known as single or output costing.
COSTING standing order
- applied in industries like PAPER, or expenses code The expenses
CEMENT, STEEL WORKS, MINING, numbers in the of service
BREWERIES ETC. overhead expenses departments are
ledger. finally transferred
to production
departments.
Here, costs are collected and analysed element wise and
then total cost per unit is ascertained as follows:
The total overhead

of production
Total cost of production departments is
Cost per unit =
No. of units produced then applied to
products on some
realistic basis, e.g.
machine hour;
labour hour etc.
Image source: https://metry.io/en/cost-collection-from-invoices/
TREATMENT OF SPOILED AND DEFECTIVE ECONOMIC BATCH QUANTITY (EBQ)

WORK
Primarily, the total production cost under batch production
comprises of two main costs, namely,
Loss due to Loss due to
normal reasons abnormal reasons
Inventory
Machine
holding
Set Up Costs
costs
Actual number Number of Cost of
of defectives defective units rectification and
is within the substantially loss is treated
exceeds the as abnormal Balancing Machine set up cost and Inventory holding cost
normal limit
normal limits cost and is
written off as
loss in Costing
Profit and Loss - Set up cost may - Lower inventory
Lower lot size

Account. decline due to lesser holding costs.
Higher lot size

Cost of Cost of rectification
rectification or loss beyond normal number of set ups.
- But higher set up
or loss will be limits are written off - But units in costs due to high
charged to the in Costing Profit and inventory will go up number of set ups.
entire output Loss Account leading to higher
holding costs
BATCH COSTING
ECONOMIC
Meaning of Batch Costing BATCH
It is the size of a batch where total
cost of set-up and holding costs are at
QUANTITY
(EBQ) minimum.
is a type of specific order costing
where articles are manufactured in
predetermined lots, known as batch.
BATCH the cost object for cost determination is Cost/unit
COSTING
a batch for production. Total cost
example PEN MANUFACTURING Inventory
INDUSTRY carrying
cost
A batch consists of certain number of units which are

PROCESSED SIMULTANEOUSLY. Under this method of
manufacturing, the inputs are accumulated in the assembly
line till it reaches minimum batch size. Soon after a batch
size is reached, all inputs in a batch is processed for further Set-up cost
operations.
Batch Size
COSTING PROCEDURE IN BATCH COSTING
Material On the basis of material Determination of EBQ

cost requisitions for the batch.
By calculating the total cost for a series of possible batch
Multiplying the time spent on sizes and checking which batch size gives the minimum cost.
the batch by direct workers as
Labour cost ascertained from time cards or
job tickets.
Mathematical formula:
Absorbed on some suitable
Overheads basis like machine hours, direct
labour hours etc.
Where, D = Annual demand for the product

S = Setting up cost per batch
C = Carrying cost per unit of production
DIFFERENCE BETWEEN JOB AND BATCH PROCESS OF JOB COSTING

COSTING
Prepare a separate cost sheet for each job
Sr. Job Costing Batch Costing
No
Disclose cost of materials issued for the job
1 Used for non- standard and Homogeneous products
non- repetitive products produced in a continuous
produced as per customer production flow in lots. Employee costs incurred (on the basis of bill of
specifications and against material and time cards respectively)
specific orders.
2 Cost determined for each Cost determined in When job is completed, overhead charges are
Job. aggregate for the entire added for ascertaining total expenditure
Batch and then arrived at on
per unit basis.
3 Jobs are different from each Products produced in a
SUITABILITY OF JOB COSTING
other and independent of batch are homogeneous and
each other. Each Job is lack of individuality. When jobs are executed for different customers
unique. according to their specifications.
When no two orders are alike and each order/

job needs special treatment.
JOB AND CONTRACT COSTING
POINTS OF DISCUSSION Where the work-in-progress differs from period to
period on the basis of the number of jobs in hand.
Methods of Costing
JOB COST CARD/ SHEET
Specific Order Costing
A cost sheet where,
quantity of materials issued,
Job Costing Contract Costing JOB COST hours spent by different class of
CARD/ employees,
SHEET amount of other expenses and share of
overheads
are recorded.
JOB COSTING
MEANING OF JOB COSTING Format of Job Cost Sheet:
JOB COST SHEET

It is applicable where the work consists
of separate contracts, jobs or batches, Description: ______________ Job No.: _____________________
each of which is authorised by specific Blue Print No.: ____________ Quantity: ____________________
JOB
COSTING order or contract. Material No.: ______________ Date of delivery: _______________
Industry example: PRINTING; Reference No.: ____________ Date commenced: _____________
FURNITURE; HARDWARE; SHIP- Date finished: _________________
BUILDING; HEAVY MACHINERY;
INTERIOR DECORATION. Date Reference Details Material Labour Overhead
Total
PRINCIPLES OF JOB COSTING Summary of costs Estimated Actual
(R) (R) For the job __________
Analysis and ascertainment of cost of each unit of Direct material cost Units produced______
production Direct wages Cost/unit __________
Production overhead Remarks ___________
PRODUCTION COST Prepared by:________
Administration and Checked by: ________
Control and regulate cost Selling & Distribution
Overheads
TOTAL COST
Determine the profitability PROFIT/LOSS
SELLING PRICE
COLLECTION OF COSTS FOR A JOB
Materials cost Labour cost Overheads
Traced to and Booked against Manufacturing overheads are

identified with specific specific jobs in the job collected under suitable standing
job or work order time cards or sheets order numbers
Selling and distribution overheads

Posted to individual Posted to the are collected against cost
job cost sheets or appropriate job cost accounts numbers
cards in the work-in- card or sheet in work-
progress ledger in-progress ledger
Total overhead expenses are
apportioned to service and production
departments on some suitable basis.
If the surplus material
is utilised on some
other job, instead of
being returned to the The expenses of service
stores first, a material departments are finally transferred
transfer note is to production departments.
prepared.
Image source: https://www.dreamstime.com/ The total production overhead is

job-costing-text-paper-sheet-chart-dice-spectacles-
pen-laptop-blue-yellow-push-pin-wooden-table- then applied to products on
business-banking-image197323655 some realistic basis.
SPOILED AND DEFECTIVE WORK ACCOUNTING OF COSTS FOR A JOB

Meaning 1. For purchase of materials
It is the quantity of production that has been Stores Ledger Control A/c Dr.
Spoiled work
totally rejected and cannot be rectified.
To Cost Ledger Control A/c
It refers to production that is not as perfect 2. For the value of direct materials issued to jobs
Defective work as the saleable product but is capable of
being rectified Work-in-Process Control A/c Dr.
To Stores Ledger Control A/c
Treatment 3. For return of direct materials from jobs
Where a percentage Stores Ledger Control A/c Dr.

of defective work The cost of rectification will be
is ALLOWED in a charged to the whole job and To Work-in-Process Control A/c
particular batch spread over the entire output of 4. For return of materials to suppliers
AS IT CANNOT BE the batch
AVOIDED. Cost Ledger Control A/c Dr.
Where defect is The cost of rectification shall
DUE TO BAD be written off as a loss being an 5. For indirect materials
WORKMANSHIP. abnormal cost
Factory Overhead Control A/c Dr.
Where defect is due
to the inspection 6. For wages paid
department Cost of rectification will be
WRONGLY charged to the department and Wages Control A/c Dr.
ACCEPTING will not be considered as cost of
INCOMING MATERIAL manufacture of the batch To Cost Ledger Control A/c
OF POOR QUALITY.
7. For direct wages incurred on jobs DIFFERENCE BETWEEN JOB COSTING AND
PROCESS COSTING
Work-in-Process Control A/c Dr.
To Wages Control A/c Job Costing Process Costing
8. For indirect wages
A Job is carried out by Process of producing the product
Factory Overhead Control A/c Dr. specific orders. has a continuous flow and the
product produced is homogeneous.
To Wages Control A/c Costs determined for each job.
Costs are compiled on time
9. For any indirect expense paid basis i.e., for each process or
Each job is separate and department.
Factory Overhead Control A/c Dr. independent.
To Cost Ledger Control A/c Products lose their individual
Each job has a number and identity.
10. For charging overhead to jobs costs are collected against the
same job number. The unit cost of process is an
Work-in-Process Control A/c Dr. average cost for the period.
To Factory Overhead Control A/c Costs are computed when a Costs are calculated at the end
job is completed. of the cost period.
11. For the total cost of jobs completed
More managerial attention is Control here is comparatively
Cost of Sales A/c Dr. required for effective control. easier.
To Work-in-Progress Control A/c
12. The balance of Cost of Sales A/c is transferred to
Costing Profit and Loss A/c; For such transfer
CONTRACT COSTING
Costing Profit and Loss A/c Dr. MEANING OF CONTRACT COSTING
To Cost of Sales A/c
13. For the sales value of jobs completed It is a form of specific order costing
where job undertaken is relatively large
Cost Ledger Control A/c Dr. and normally takes period longer than a
CONTRACT year to complete.
To Costing Profit and Loss A/c COSTING Adopted by the contractors engaged
in contracts like CONSTRUCTION
OF BUILDING, ROAD, BRIDGE,
ERECTION OF TOWER ETC.
ADVANTAGES AND DISADVANTAGES OF JOB
COSTING FEATURES OF CONTRACT COSTING
Details of Cost of material, labour and Work in contract
Separate account Bulk of the
overhead for all job is available to control. is ordinarily
is usually expenses incurred
carried out at
maintained for are considered as
Profitability of each job can be derived. the site of the
each contract. direct.
contract.
Facilitates production planning.
Advantages
Budgetary control and Standard Costing Number of
Indirect expenses
can be applied in job costing. contracts Cost unit in
mostly consist of
undertaken by a contract costing is
Spoilage and detective can be identified office expenses,
contractor at a the contract itself.
and responsibilities can be fixed stores and works.
time is usually few.
accordingly.
TERMS USED IN CONTRACT COSTING

It is costly and laborious method.
(i) Work-in-Progress
Chances of error is more as lot of
clerical process is involved. Work-in-Progress
Dis-
advantages
This method not suitable in inflationary The contract which is not complete at the reporting date.
condition. It includes:
Previous records of costs will be
meaningless if there is any change in
market condition. Cost of work Amount of
completed
Cost of work not estimated/
(certified and
yet completed notional profit
uncertified)
(ii) Cost of Work Certified or Value of Work Certified (viii) Estimated Profit
Expert, based on his assessment, certifies the work completion

in terms of percentage of total work. Estimated Contract Estimated
Cost or value of certified portion is calculated and is known as Profit price total cost
Cost of work certified or Value of work certified respectively.
(a) Value of Work Certified = Value of Contract × Work

certified (%)
SPECIMEN OF CONTRACT ACCOUNT (with few items)
(b) Cost of Work Certified = Cost of work to date – (Cost of
work uncertified + Material in hand + Plant at site) The cost of Work Uncertified may be ascertained as follows:
Particulars (R) Particulars (R)

(iii) Cost of Work Uncertified
To Materials xxx By Plant at site c/d xxx
Cost of the work ” Wages xxx ” Work-in-progress xxx

carried out but Always shown c/d:
not certified by at cost price.
the expert. ” Direct expenses xxx - Work certified xxx
” Indirect expenses xxx - Work xxx
The cost of Work Uncertified may be ascertained as follows: uncertified
(R) (R) ” Plant and xxx ” Costing P&L A/c xxx
Machinery (b/f ) (If Loss)
Total cost to date xxx
Less: Cost of work certified xxx ” Cost of Sub- xxx
Contract
Material in hand xxx
Plant at site xxx xxx ” Costing P&L A/c xxx
(b/f ) (If Profit)
Cost of work uncertified xxx
XXX XXX
(iv) Progress Payment
Progress Value Retention Payment COST PLUS CONTRACT

payment of work to date
certified money
Cost- Plus When the value of the contract is

Contract determined by adding an agreed
(v) Retention Money percentage of profit to the total cost.
Value Payment
Retention
of work actually
Money
certified made
ADVANTAGES AND DISADVANTAGES OF
COST PLUS CONTRACT
(vi) Cash Received ADVANTAGES DISADVANTAGES

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Cash Retention
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received money
certified done is not definitely to reduce cost.
fixed at the time of
making the estimate.
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(vii) Notional Profit himself about ‘the cost
of the contract’, as he is
empowered to examine
Cost of the books and docu-
Value work to date ments of the contractor.
Notional of work –
profit certified Cost of
work not yet
certified
ESCALATION CLAUSE FACTORS PROMPTING DEVELOPMENT OF ABC
Growing overhead
Empowers costs
the contractor
to recover the Increasing market
increased competition
prices.
Increasing product
diversity
Protect the
contractor from
Contractor may Decreasing costs
adverse financial
increase the of information
impacts. processing
contract price if the
cost of materials,
employees and other
expenses increases
beyond a certain USEFULNESS/SUITABILITY OF ABC
limit.
ABC is particularly needed in the following situations:
High amount Wide range Presence of Stiff
of overhead of products non-volume competition
related
activities
ACTIVITY BASED COSTING
POINTS OF DISCUSSION ADVANTAGES AND DISADVANTAGES OF ABC
Usefullness ADVANTAGES DISADVANTAGES

Concept of ABC
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added activities. difficult or complicated.
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with multiple products.
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MEANING OF ACTIVITY BASED COSTING which require attention of
the management.
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costs to activities rather than products TERMS USED
or services.
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(ii) Cost Object
required
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activity-
t Resource cost driver: Measure of the
(iii) Cost Driver
quantity of resources.
t Activity cost driver: Measure of the
frequency and intensity of demand.
Examples of Cost Driver business function wise:
Design of
Research and products, Customer Marketing Distribution
Development services and Service
procedures
Number of Number of Number of Number of Number

research products in service calls advertisements of units
projects design distributed
Personnel Number of Number of Number Number of

hours on a parts per products of sales customers
project product serviced personnel
Number of Hours spent Sales

engineering on servicing revenue
hours products
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(iv) Cost Pool
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COST ALLOCATION
Linked through Linked through

Overhead Cost
Activities
Costs Objects
Resource Cost Activity Cost
Drivers Drivers
REQUIREMENTS IN ABC IMPLEMENTATION TRADITIONAL ABSORPTION COSTING VS

ABC
Traditional Based on Machine

Costing hours, labour
Hours, Volume etc.
Staff Training Cost
Allocation
Activity based Based on Cost
Costing Driver
Process
Assigning Cost Specification
Activity Based Traditional Absorption
Costing Costing
Requirments
Related to activities Related to cost centers
More realistic Not realistic
Activity Driver Activity

Selection Definition Activity–wise cost drivers Time (hours) - only cost
driver
Cost are assigned to

cost objects Costs are assigned to cost units
Aids cost control Not suitable for cost control.
LEVEL OF ACTIVITIES UNDER ABC METHOD- EXAMPLES OF COST DRIVERS

OLOGY/COST HIERARCHY
ACTIVITY COST
Unit level activities COST POOL DRIVERS
Activities which can be - Indirect materials/
identified with the number of consumables
units produced. - Inspection or testing of Ordering and Receiving Number of purchase
every item produced Materials cost orders
Setting up machines Number of set-ups

costs
Batch level activities
Activities which are performed - Material ordering Machining costs Machine hours
each time a batch of goods is - Machine set-up costs
produced.
Assembling costs Number of parts
Overhead Costs
Product level activities Inspecting and testing Number of tests
costs
Activities which are performed - Designing the product
to support different products in - Producing parts
product line. specifications Painting costs Number of parts
Supervising Costs Direct labour hours

Facilities level activities
Activities which are common - Maintenance of buildings
and joint to all products - Plant security Delivery cost Number of deliveries
manufactured.
Shelf-stocking cost Shelf-stocking hours
STAGES IN ACTIVITY BASED COSTING (ABC)

Customer Support Number of items sold
Identify different activities within the organisation
Break the Relate the overheads to the activities

organisation
down This Support activities are then spread HOW TO CALCULATE COST PER PRODUCT
creates across the primary activities USING ABC?
into many
very small ‘cost pools’
Where Determine the activity If it is given that,
activities. or ‘cost cost drivers
buckets’. base is the
cost driver Activity Cost (R) Particulars Product Product
To relate Calculate
measuring, activity cost Ordering 64,000 1 2
the
how the
overheads driver rates Delivery 1,40,000 No. of Purchase 30 50
support Orders
collected Calculate Shelf stocking
activities activity 80,000
in cost No. of Deliveries 110 90
are used. cost driver
pools to Shelf Stocking 220 180
the cost rates
for each Hours
objects.
activity
Total cost of activity

Activity cost driver rate =
Activity driver
Image source: https://www.dreamstime.com/photos-images/activity-based-

costing.html
Then, cost per product as per ABC
Activity Total Cost (R) Cost Driver Cost Driver Level Cost Driver Rate Product 1 (R) Product 2 (R)
(R)
(a) (b) (c) (d) (e) = (b)/(d) (f) (g)
Ordering 64,000 No. of Purchase 80 800 24,000 40,000
Orders (30+50) (800 x 30) (800 x 50)
Delivery 1,40,000 No. of Deliveries 200 700 77,000 63,000
(110 + 90) (700 x 110) (700 x 90)
Shelf stocking 80,000 Shelf Stocking 400 200 44,000 36,000
Hours (220 +180) (200 x 220) (200 x 180)
PRACTICAL APPLICATIONS OF ACTIVITY Key Elements Benefits

BASED COSTING
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profitability or vendor expansion rework
Helps in Decision
JOINT PRODUCTS AND BY PRODUCTS
determining support
price based POINTS OF DISCUSSION
for human
on cost plus resources
markup basis
Joint Products &
By-Products
As Activity Based Management
Cost Driver
Analysis Meaning of Joint Treatment of By-
Value-Added Apportionment of Product Cost in
Products and By-
Activities (VA) Joint Costs Cost Accounting
Products
Activity Analysis
Non-Value-
Added Activities
(NVA)
Activity Based
Cost Management MEANING OF JOINT PRODUCTS AND BY-
(ABM): Using ABC PRODUCTS
to manage costs at Cost Reduction
activity level. Two or more products separated in the
Joint Products*
course of same processing operation.
Business Process
Re-engineering
Performance Products recovered from-
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Benchmarking
*OIL INDUSTRY PRODUCING JOINT PRODUCTS using crude
Performance petroleum like gasoline, fuel oil, lubricants, paraffin, asphalt,
Measurement kerosene etc.
Facilitate Activity Based Budgeting (ABB)
It analyses the resource input or cost for each activity.

It is the reversing of the ABC process to produce financial
plans and budgets.
CO-PRODUCTS
CO-PRODUCTS
Joint products and co-products are used synonymously, but a

distinction is there.
Co-products are the two or more products which are

contemporary but do not emerge necessarily from the same
material in the same process.
For instance,
wheat and gram produced

Timber boards made from
in two separate farms with
different trees are
separate processing of
co-products.
cultivation are co-products.
METHODS OF APPORTIONMENT OF JOINT

Petroleum Refining Processes1
COST TO JOINT PRODUCTS
# MOLASSES IS PRODUCED AS A BY-PRODUCT in the Methods for

process of sugar manufacturing apportioning joint cost
Physical Net Realisable Using Other

Units Value at Technical methods
Method split-off point Estimates
Market Market Average Contribution

value at the value after unit cost margin
point of further method method
Sugar Manufacturing Process2 separation processing
Physical Units Method:

Point at which products are separated from the main product is
known as SPLIT-OFF POINT.
Joint costs here are apportioned on the basis of some
physical base, such as weight, numbers etc.
DISTINCTION BETWEEN JOINT PRODUCTS

AND BY-PRODUCTS Net Realisable Value at Split-off Point Method:
Joint costs here are apportioned on the basis of
JOINT PRODUCTS BY-PRODUCTS Net Realisable Value at Split-off Point.
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simultaneously. product.
sales value of joint products after processing
Estimated profit margins
Selling and distribution expenses

1
Image source: https://www.cmegroup.com/education/courses/introduction-to-refined-
products/a-look-into-the-refining-process.html
2
Image source: http://www.sustainablesugar.eu/molasses Post split- off costs
Using Technical Estimates: Variable costs
Apportioned on the In case products are further

This method is used WHEN- basis of units produced processed after point of separation,
(average method or then all variable cost incurred
physical quantities) be added to the variable costs
determined earlier.
Result obtained by above methods does not match
with the resources consumed by joint products, or;
Total variable cost is arrived which is deducted from their

Realisable value of the joint products are respective sales values to ascertain their contribution.
not readily available.
Fixed costs
Other Methods: Thereafter, fixed costs are apportioned over the joint
products on the basis of the contribution ratios.
(i) Market value at the point of separation
Useful method where further processing costs are

incurred disproportionately.
METHODS OF APPORTIONMENT OF JOINT
To determine the apportionment of joint costs over joint COST TO BY-PRODUCTS
products, a multiplying factor is determined as follows:
Methods for
apportioning joint cost
Alternatively, joint cost may be apportioned in the ratio of sales

values of different joint products. Net Standard Comparative Re-use
Realisable cost in price basis
Value Technical
(ii) Market value after further processing method Estimates
Basis of apportionment of joint cost is the total

sales value of finished products.
Net Realisable Value method:
Use of this METHOD IS UNFAIR WHERE-
No further Further processing

processing required required
Further processing costs after the point of
separation are disproportionate, or;
Realisation on the Additional expenses so

disposal of the by-product incurred be deducted from
All the joint products are not subjected
deducted from the total the total value realised from
to further processing.
cost of production. the sale of the by-product.
(iii) Average Unit Cost Method Only the net realisations be

deducted from the total cost of
production to arrive at the cost of
production of the main product.
Physical unit method also follows the same steps of calculation
as followed under Average unit cost method, ultimately giving the Standard cost in Technical Estimates:
same outcome.
This method may be adopted where by-product is not saleable.
(iv) Contribution Margin Method
It may be valued at standard costs.
Variable
Joint costs segregated Standard cost may be determined by averaging costs recorded
into two parts in the past and making technical estimates of the number of
Fixed units of original raw material going into the main product
and the number forming the by-product; or by adopting some
other consistent basis.
Comparative price: TREATMENT OF BY-PRODUCT COST IN

COST-ACCOUNTING
Value of by-product is ascertained with reference to the price of -
Similar material, or; Alternative material Treatment of by-product

cost in cost-accounting
Re-use basis:
Small total Considerable Require
value total value further
Sometimes, by-product may be of such a nature that it can processing
be reprocessed in the same process as part of the input of
the process.
In that case, value put on However, if the by-product Deducted May be
Sales value Net realisable
by-product should be same can be put into an earlier credited to from total regarded as value of the
as that of the materials process only, the value Costing costs joint products by-product at
introduced into the process. should be the same as for the P&L rather than as the split-off
materials introduced into Account by-products point may be
the process. arrived
SERVICE COSTING
POINTS OF DISCUSSION SERVICE COSTING VS. PRODUCT COSTING
Unlike products, Composite cost

Application of units are used,
Service Costing
sevices are intangible. for cost measurement.
sevices cannot be stored. to express the volume of
there are no inventory for outputs.
Service Costing vs
the services.
Product Costing
employee (labour) cost
constitutes a major cost
Composite element than material cost.
Unit Indirect costs like
Methods of Ascertaining administration overheads
Service Costing
Service cost unit Equivalent have significant proportion

in total cost.
Unit
service sector heavily depends
on support services.
Service Cost Statement

WHAT is service cost UNIT?
All the costs incurred during a period are-
Costing of Services: collected

(i) Transport
(ii) Hotels & Lodges
(iii) Hospitals analyzed
(iv) Information Technology
Enabled Services
expressed in terms of a cost per unit of service.
(v) Toll Roads
(vi) Educational Institutes
LIST of typical cost unit
(vii) Insurance
(viii) Financial Institutes Service industry Unit of cost (examples)
(ix) Others
Transport Passenger- km., (In public
Services transportation)
WHEN is service costing APPLIED? Quintal- km., or Ton- km. (In
goods carriage)
Internal application External application Electricity Kilowatt- hour (kWh)
Supply service
When service provided by When services are offered
service cost centre to other to outside customers as a Hospital Patient per day, room per day or
responsibility centre profit centre per bed, per operation, etc.
Example- Example- Canteen Per item, per meal, etc.

Use of canteen services by Hospitality services provided
hospital staff, operation of by a hotel,
fleet of trucks for transport provision of services by Cinema Per ticket
of raw material to factory financial institutions
Hotels Guest Days or Room Days Equivalent Cost Unit/ Equivalent Service Unit
Each grade of service is assigned a weight and converted

Bank or Financial Per transaction, per services into equivalent units
Institutions (e.g. per letter of credit, per
application, per project, etc.) Example- hotel having three types of suites for its
customers, viz., Standard, Deluxe and Luxurious and tariff
Educational Per course, per student, per
to be decided for one suite being double the rate of other
Institutes batch, per lecture, etc.
suite.
Information Technology Cost per project, per module, etc. Example: A hotel may decide tariff to their different
Enabled Services type of suites as follows-
Insurance Per policy, per claim, per TPA,
etc.
What are the METHODS for ascertaining

Service Cost Unit?
Composite Cost Unit
Two measurement units combined together

Type of suite Number of rooms Room Tariff
Standard 100 Amount X
Example- transportation undertaking measuring
operating cost per passenger per kilometre. Deluxe 50 2.5 times of the
Other examples- Ton- km., Quintal- km., Passenger-km., Standard suites
Patient-day etc. Luxurious 30 Twice of the
Deluxe suites
Composite unit may be computed in TWO WAYS Since, all three types of suites use same amount of overheads
but to attach qualitative weight, these rooms are required to be
converted into equivalent units.
Absolute Commercial (i) If Standard suite is taken as base:
(Weighted Average) basis (Simple Average) basis
Nature of suite Occupancy Equivalent single
(Room-days) room suites
Summation of the products Product of average qualitative (Room-days)
of qualitative and quantitative and total quantitative factors
factors Standard 36,000 36,000
(100 rooms x 360 (36,000 x 1)
days)
∑Weight Carried (W) × ∑{Distance (D)1 + D2 +
Distance (D)1 + (W × D)2 …………...…+ Dn} × Deluxe 18,000 45,000
+…. [(Weight1 + W2 + .... + Wn)/n] (50 rooms x 360 days) (18,000 x 2.5)
+(W × D)n
Luxurious 10,800 54,000
(30 rooms x 360 days) (10,800 x 5)
Example: A Lorry starts with a load of 20 Metric Ton (MT) of
Goods from Station ‘A’. It unloads 8 MT in Station ‘B’ and balance 1,35,000
goods in Station ‘C’. On return trip, it reaches Station ‘A’ with a
load of 16 MT, loaded at Station ‘C’. The distance between A to B, Or
B to C and C to A are 80 Kms, 120 Kms and 160 Kms, respectively.
(ii) If Luxurious suite is taken as base:
B 20 Mt – 8 MT = 12 MT Nature of suite Occupancy Equivalent
20 MT (120 KM) (Room-days) luxurious suites
(80 KM) (Room-days)
16 MT
A C
(160 KM) Standard 36,000 7,200
(100 rooms x 360 (36,000 x 1/5)
Weighted Average or Absolute basis – MT – Kilometer would days)
be calculated as follows:
= (20 MT × 80 Kms) + (12 MT × 120 Kms) + (16 MT × 160 Deluxe 18,000 9,000
Kms) (50 rooms x 360 days) (18,000 x ½)
= 1,600 + 1,440 + 2,560 = 5,600 MT – Kilometer Luxurious 10,800 10,800
Simple Average or Commercial basis – MT – Kilometer would (30 rooms x 360 days) (10,800 x 1)
be calculated as follows:
= [{(20+12+16) / 3} MT × (80 +120 +160) Kms]
= 16 MT × 360 Kms = 5,760 MT – Kilometer 27,000
STATEMENT OF COSTS FOR SERVICE COSTING OF HOTELS AND LODGES

SECTORS
Cost sheet on the basis of variability is prepared classifying all
the costs into three different heads.
Fixed costs or Standing charges

HOTEL
Variable costs or Operating expenses
Semi-variable costs or Maintenance expenses

Guest-day
Cost unit or
COSTING OF TRANSPORT SERVICES Room-day
Types of transport COSTING OF HOSPITALS

services
Goods Passenger
transport transport
Cost unit: Cost unit:

Ton– Kilometer Passenger– Kilometer
A hospital may have different
departments such as Unit of Cost
t 0VU 1BUJFOU t 0VU 1BUJFOU o 1FS
Suggestive heads: t *O 1BUJFOU Out-patient
t .FEJDBM TFSWJDFT MJLF 93BZ t *O 1BUJFOU o 1FS
Standing Scanning, etc. Room Day
charges or t *OTVSBODF t (FOFSBM TFSWJDFT MJLF t 4DBOOJOH o 1FS $BTF
fixed costs t -JDFOTF GFFT Catering, Laundry, Power t -BVOESZ o 1FS
(costs that t 4BMBSZ UP %SJWFS $POEVDUPS $MFBOFST house, etc. items laundered
remain etc if paid on monthly basis t .JTDFMMBOFPVT TFSWJDFT MJLF
constant t (BSBHF DPTUT JODMVEJOH HBSBHF SFOU Transport, Dispensary, etc.
irrespective t %FQSFDJBUJPO JG SFMBUFE UP FñVY PG UJNF
of distance t 5BYFT
travelled) t "ENJOJTUSBUJPO FYQFOTFT FUD
COSTING OF INFORMATION TECHNOLOGY
ENABLED SERVICES
Variable costs
or Running t 1FUSPM BOE %JFTFM
costs t -VCSJDBOU PJMT
(costs t 8BHFT UP %SJWFS $POEVDUPS $MFBOFST
associated etc. if it is related to operations
with distance t %FQSFDJBUJPO JG SFMBUFE UP BDUJWJUZ
travelled) t "OZ PUIFS WBSJBCMF DPTUT JEFOUJîFE
Semi-variable t 3FQBJST BOE NBJOUFOBODF EMPLOYEE COST constitutes SIGNIFICANT portion

costs or t 5ZSFT of total operating costs.
Maintenance t 4QBSFT FUD
costs
DIRECT EMPLOYEE COST is TRACEABLE to
SERVICES RENDERED.
Typical MANPOWER DIRECTLY ENGAGED on a project: SUPPORT MANPOWER ENGAGED on a project:

tSoftware Engineers / Functional Consultants / Business t Quality Assurance Team,
Analysts, t Testing team,
t Project Leaders, t Version Control team,
t Project Manager, t Staffing Manager, etc.
t Program Manager, etc. If time is NOT TRACEABLE with a single project, then it may
The COSTS are TRACEABLE with a project and hence forming either be allocated or apportioned to various projects on some
part of DIRECT COSTS of the project. SUITABLE BASIS.
COSTING OF TOLL ROADS
Entry after
toll tax
tPreliminary and pre-operative expenses,
tLand Acquisition,
Capital Costs
tMaterials, Labour, Overheads incurred in the course of
(incurred during
actual construction,
construction period)
tContingency allowance,
Cost Involved tInterest during construction period.
cost of operating tollbooths,
administrative expenses,
Annual
operating
cost emergency services,
Operating and
Maintenance Costs
communications and security services.
(incurred once the
road is operational)
Patching of potholes, sealing of cracks,
edge repair,
Routine
maintenance Surface renewal,
Periodic maintenance.
Total Cost + Profit

To compute the toll rate, following formula may be used: =
Number of Vehicles
COSTING OF EDUCATIONAL INSTITUTIONS EXPENDITURE of Insurance companies
Direct costs like Indirect costs like

commission paid to agents, actuarial fees,
claim settlement, market and product
cost of valuation, development costs,
premium for re-insurance, administration cost,
legal and other costs, etc. asset management cost, etc.
Method
of Costing
INCOME of the Educational Institutions

Activity Based
Costing
One-time fees like Admission fee, Development fee, Annual fee etc
Pre-product development Post product development

Recurring fees like tuition fee, laboratory, computer and activities activities
internet fee, library fee, training fee, amenities fee, sports fee,
extracurricular activities fee, etc.
Market research,
product Selling of Processing
Other incomes like transport, hostel, mess and canteen. development policy of claims
like specification
of coverage,
conditions, Appointment Claim
amount of of distribution inception,
EXPENDITURE of the Educational Institutions premium, etc. of sales claim
channel, estimation,
soliciting claim
Operational Cost like teachers' salary, Building maintenance, for policy, settlement
Computer maintenance and internet charges. processing of and legal
applications, actions.
etc.
Research and Development Cost like academic research on

COSTING OF FINANCIAL INSTITUTIONS
various fields of specialisations.
COSTING OF INSURANCE COMPANIES
COSTS TO BE IDENTIFIED with appropriate activities that

have caused its occurrence.
Then costs must be REASSIGNED FROM ACTIVITIES TO

INCOME of Insurance companies COST OBJECTS based on identified cost drivers.
Premium on Fund administration

Commission on fee and return on The concepts on ACTIVITY BASED COSTING under Costing of
policy (periodic re-insurance investment of funds, etc. Insurance Companies is also applicable to financial institutions.
or onetime)
Integrated Accounting System

COSTING OF POWER HOUSES
COST AND FINANCIAL ACCOUNTS are kept in the
SAME SET of books.
PROVIDES RELEVANT INFORMATION necessary for

preparing profit and loss account and the balance sheet.
Cost unit Cost per kilowatt- NON-INTEGRATED ACCOUNTING SYSTEM

hour (kWh) MAIN ACCOUNTS usually prepared when a separate Cost
Ledger is maintained
Manufacturing/
Cost Ledger Stores Ledger Wages
Production/Works/
Suggestive heads: Control
Account
Control
Account
Control
Account
Factory Overhead
Control Account
Work-in- Administrative Finished Selling and

Goods Distribution Cost of
Standing Progress Overhead
Variable Control Overhead Sales
charges or Control Control Control
costs or Accounts Account
Fixed costs Account Account Account
Running costs Semi-variable
(costs that costs or
remain constant (costs associated Maintenance Costing Overhead
irrespective of with power costs Profit & Loss Adjustment
or stream Account Account
power or stream tMeters
generated) generated)
tFuel Charges tFurnaces
tRent, Rates & FLOWCHART
Taxes tWater Charges tService
materials
t Insurance tWages /
Labour tTools, etc.
t Depreciation Materials
charges, if paid
tSalaries, if on the basis of Control A/c Production
Wages
paid on time production Overhead
Control A/c
(Monthly Control A/c
basis) tAny other
variable costs
t Administration identified. Work in Progress
expenses, etc. Control A/c
Administration Finished Goods

Overhead Control A/c
POINTS OF DISCUSSION Control A/c
Cost Accounting System Cost of Goods

Sold Control A/c
Non-Integral accounting system Integral accounting system
Reconciliation of Cost and Financial Accounts Cost of Sales Selling & Distribution
Control A/c Overhead Control A/c
Non-integrated Accounting System
SEPARATE LEDGERS are maintained for both cost and
financial accounts.
INTEGRATED ACCOUNTING SYSTEM
ADVANTAGES
This system is also known as COST LEDGER
ACCOUNTING SYSTEM.
tNo need for reconciliation
tLess efforts
This system contain limited ACCOUNTS due to the tLess time consuming
exclusion of purchases, expenses and also Balance Sheet
items like fixed assets, debtors and creditors. tEconomical process
In integrated system, all accounts necessary for showing classification

ITEMS OF ACCOUNTS excluded are REPRESENTED BY
COST LEDGER CONTROL ACCOUNT. of cost will be used but the cost ledger control account of non-
integrated accounting is replaced by use of following accounts:
RECONCILIATION OF COST AND FINANCIAL

Receivables Payables
Bank
(Debtors) (Creditors)
ACCOUNTS
account
account account
Reconciliation is done when cost and financial accounts are kept
separately
Provision for Reconciliation of the balances of two sets of accounts is

Fixed assets Share capital possible by preparing a MEMORANDUM RECONCILIATION
depreciation
account account ACCOUNT
account
Causes of differences in Financial and Cost Accounts

Interest on loans
Expenses and discounts on issue of shares
Purely Financial Expenses Loss by fire not covered by insurance
Losses on the sales of fixed assets
Income tax, donations

Items included in
Financial Accounts only Interest received on bank deposits
Purely Financial Income Dividends received

Profits on the sale of fixed assets
Charges in lieu of rent where
premises are owned Rent receivables
Interest on capital at notional figure

Items included in Cost though not incurred
Accounts only (notional
expenses) Salary for the proprietor at notional figure
Notional Depreciation on the assets fully

depreciated
LIFO may be adopted for cost accounts

Items whose treatment is
different in the two sets Different method of depreciation may be
of accounts followed
Varying basis of valuation Valuation of stock (at cost in cost accounting)
Procedure for Reconciliation Now, reconciliation between Financial and Cost Accounts can be
done by preparing RECONCILIATION STATEMENT as follows:
(Rs.) (Rs.)
3. Reconciliation of
both the profits Profit as per Cost Accounts 3,00,000
2. Ascertainment Add: Factory overheads over-absorbed
of profit as per (`5,00,000 – `4,50,000) 50,000
1. Ascertainment cost accounts
of profit as per
financial accounts Selling & Dist. Overhead over-absorbed
(`2,00,000 – `1,80,000) 20,000
Example: Difference in the valuation of closing stock

Profit as per Cost Accounts after following adjustment `3,00,000 of finished goods (`1,50,000 – `1,23,000) 27,000 97,000
Factory overheads absorbed `5,00,000
Selling & Distribution Overhead absorbed `2,00,000 3,97,000
Valuation of closing stock of finished goods `1,23,000
Administrative Overhead absorbed `1,93,000 Less: Admn. overhead under-absorbed
(`2,60,000 – `1,93,000) 67,000
Profit as per financial accounts after following adjustment `1,10,000
Factory overheads charged `4,50,000
Selling & Distribution Overhead charged `1,80,000 Interest on loan 2,20,000 2,87,000
Valuation of closing stock of finished goods `1,50,000
Administrative Overhead charged `2,60,000 Profit as per financial accounts
Interest on loan `2,20,000
1,10,000
SARANSH Part II: Strategic Cost Management and Performance Evaluation
Part II
STRATEGIC COST
MANAGEMENT AND
PERFORMANCE EVALUATION
© ICAI BOS(A)
SKILL ASSESSMENT
The questions/ cases are based on Skill Assessment. An illustrative list of the verbs that appear in the requirements for each question/
case is given below. It is important that students answer according to the definition of the verb:
Evaluation & Synthesis

Important
Analysis & Application
Comprehension & Knowledge
Level Learning Objective Illustrative Verbs Definition/ Explanations1
III EVALUATION Recommend i To recommend you must:
How are you i Identify and explain any reasonable options o evaluate each o conclude o recommend.
expected to use your Evaluate i ‘Evaluate’ means balanced assessment including both the positive and negative aspects of an
learning to evaluate, issue.
make decisions or i It might mean computations, but it might not.
recommendations? i It is important to emphasise something is in qualitative terms, as well as monetary.
Advise i ‘Advise’ requires to build up a good, comprehensive, argument that leads to one or more choices
for the owners or managers to consider.
II ANALYSIS Produce i Begin with very little or nothing to make something or bring something into existence.
How are you Prioritise i To decide which of a group of things are the most important so that you can deal with them first.
expected to analyse Here, you’ll also have to elucidate/ clarify, for each item, why you put it, where you did in the list
the detail of what you of ‘priorities’.
have learned? Interpret i Generally, ‘Interpret’ is translation of one form of words to another, where the latter is more
clear in its exact sense than the former.
i This is often the second stage of ‘analyse’.
Discuss i There needs to be an ‘argument’.
i You need two or more differing or conflicting viewpoints. Also, any discussion should, if
possible, end in an outcome.
i For example; advantages vs. disadvantages o outcome; Or reasons why vs. why not o outcome;
Or maybe this vs. maybe that o outcome.
Construct i As ‘prepare’, but maybe with an elucidation as to why you put things.
Compare and i An elucidation of the similarities and differences between two or more things.
contrast
Categorise i To put things into groups with the same features with an explanation after each item saying why
you put it in that particular group and not one of the others.
Analyse i Taking apart information or data to discover relationships, causes, patterns and connections.
i This is about a series of detailed explanations.
APPLICATION Tabulate i An arrangement of facts and numbers in rows or blocks.
How you are Solve i Generally, ‘Calculation’ is how to do something.
expected to apply i ‘Solve’ leave you to select the most suitable technique or process.
your knowledge? Reconcile i To find a way in which two situations (often the results of calculations) that are opposed to each
other can agree and exist together.
Prepare i ‘Prepare’ is used where there is a fair amount of numerical data given in the question.
i You have to consider the relevant data, process it by calculations or rearranging it, then provide
it in a specific form.
Demonstrate i ‘Demonstrate’ is consistent with situations where there is only one correct answer.
i You need to show something to be correct, apart from any doubt, by giving proof.
Calculate i Ascertain or reckon mathematically.
Apply i Applying the facts, rules, concepts, and ideas.
i This is not just talk about it in theory, do it for real i.e. new situations.
I COMPREHENSION Illustrate i Give an example.
What you are Identify i Recognise, establish or select after consideration.
expected to Explain i To make something clear or easy to understand by describing or giving information about it.
understand? i Write a sentence that makes point o Then write another to clarify why the sentence is so o If
point still isn’t clear, write another sentence that makes it clearer.
Distinguish i To recognize the difference between two things.
i List the features of each of the things that make them unlike from each other.
Describe i What it is?
i This is next step from list, state, define.
i You might need to give a short paragraph covering the issues.
KNOWLEDGE Define i Just give a textbook or dictionary definition, you may use your own words instead.
What you are i This is simply a test of memory.
expected to know? State i What is...?
i Convey what need to say in brief.
i No need to explain, unless it isn’t clear.
List i How many...?
i Just give a list.
i Each of the points on ‘list’ should be stated in terms of a full sentence, for clarity, but there’s no
requirement to go any further than that.
It may be presumed that the skills specified in Level I are inherent in Level II i.e., only when the student possesses Level I skills, he/ she would be able
to achieve Level II skills. Likewise, the skills specified in Levels I and II are inherent in Level III i.e., only when a student possesses Level I and II skills,
he/ she would be able to achieve Level III skills.
© ICAI BOS(A) II. 2

“Strategy is about setting yourself apart from the competition. It’s not a matter of being better at
what you do - it’s a matter of being different at what you do.”
– Michael Porter
Value Recoginition Value Chain Analysis/ Value Shop Model
Total Quality Management
Quality Management
Tools Cost of Quality
Environmental Mgt. EFQM

Accounting Business Excellence Model
Ethics & Non Financial Baldrige Criteria

Considerations Value Analysis/ Engineering
Business Process
Value Management Re-engineering
Strategic Cost
Management Process Innovation & Re-engineering
Process Innovation
Target Costing
Strategic Cost Management and Performance Evaluation
Cost Management Life Cycle Costing

Techniques
Throughput Accounting
Lean System JIT, Kaizen, 5S, TPM,

Cellular Mfg., Six Sigma
Product Service &
Delivery
Supply Chain Management Upstream and
Downstream Flow
Decision Making
Decision Making Internal Transfer Pricing

Pricing Decision
External
Linking of CSFs to KPIs
and Strategy
Financial ROI, RI, EVA
Performance Divisional Performance
Management Measures
Non Financial BSC; TBL; Performance-
Prism, Pyramid etc.
Benchmarking
Standard Costing
Cost Control & Beyond Budgeting
Analysis
Budgetary Control
Behavioural Aspects
Strategic Analysis;
Profitability Analysis Analysis Through ABC
Planning and
Forecasting Tools ABB & ABM

INTRODUCTION TO STRATEGIC COST MANAGEMENT

Chapter Overview Strategic Cost Management
Limitations of
Traditional Cost Strategic Cost Vision, Mission Strategic cost
Management and Objectives It also involves
Management management is integrating cost
the application of information with
cost management the decision-making
Components of Strategic techniques so that they
Cost Management framework to
improve the strategic support the overall
• Strategic Positioning position of a business as organisational strategy.
well as control costs.
• Cost Driver Analysis Value Shop
• Value Chain Analysis Model
The basic aim of
Strategic Cost
It is not limited to Management is to help
controlling costs but the organisation to
The Value Chain Approach using cost information achieve the sustainable
Strategic Frameworks for for Assessing Competitive for management competitive advantage
Value Chain Analysis Advantage decision making. through product
differentiation and cost
leadership.
Industry Core Segmentation Internal Internal Vertical

Structure Competencies Analysis Cost Differentiation Linkage
Analysis Analysis Analysis Analysis Analysis Components of Strategic Cost Management
Strategic Cost Management primary revolves around three business
Traditional Cost Management themes - Value Chain analysis, Cost driver analysis and Strategic
positioning analysis.
Traditional cost management system involves allocation of costs and
overheads to the production and focusses largely on cost control and
cost reduction.
Ignores Strategic
Competition, Positioning
Market Growth,
and Customer Analysis
Requirement
Excessive
Short-term Focus on Cost
Outlook Reduction
Cost
Limitations of Driver
Traditional Cost Analysis
Management
Ignores
Reactive Dynamics of Value
Approach Marketing and Chain
Economics Analysis
Limited Focus
on Review and
Improvisation
External
Enviroment
Strategic Positioning Analysis Organisation Internal

Strategic Positioning Analysis is a company’s relative position within Values, Culture Enviroment
its industry matters for performance. Strategic positioning reflects and Systems (Resources and
choices a company makes about the kind of value it will create and how Competencies)
that value will be created differently than rivals. The following factors
affect the strategic position of a company –
Strategic
Position

External environment can be analysed using models like PESTEL Factors which influence profitability are:
(Political, Economic, Social, Technological, Environmental and Legal Threat of new
factors) and Porter’s 5 forces. entrants
Cost Driver Analysis

Cost is caused or driven by various factors which are interrelated.
Cost is not a simple function of volume or output as considered by
traditional cost accounting systems. Cost driver concept is explained
in two broad ways in strategic cost management parlance - Structural Rivalry among
cost drivers and Executional cost drivers. Bargaining power existing Bargaining power
of suppliers competitors of buyers
Structural cost drivers are the organisational factors which affect the
costs of a firm’s product. These factors drive costs of an organisation
in varied ways. The scale and scope of operation of a company will
impact the costs.
Executional cost drivers are based on firm’s operational decision
on how the various resources are employed to achieve the goals
Threat of substitute
and objectives. These cost drivers are determined by management products or services
style and policy. The participation of workforce towards continuous
improvement, importance of total quality management, efficiency of
plant layout etc. are examples of executional cost drivers. The five forces analysis helps a firm to better understand the industry
A company must focus on those cost drivers which is of strategic value chain and its competitive environment.
importance.
Core Competencies Analysis
Value Chain Analysis Core Competency is a distinctive or unique skill or technological
knowhow that creates distinctive customer value. A core competency
“Value-chain analysis is a process by which a firm identifies & analyses is the primary source of an organisation’s competitive advantage. The
various activities that add value to the final product” competitive advantage could result from cost leadership or product
i The idea is to identify those activities which do not add value to the differentiation.
final product/service and eliminate such non-value adding activities.
There are three tests useful for identifying a core competence.
i The analysis of value chain helps a firm obtain cost leadership or
improve product differentiation.
i Resources must be deployed in those activities that are capable of
producing products valued by customers.
Access to a
wide variety
End-product
Firm Infrastructure of markets
(General Management, Accounting, Finance, Strategic Planning) benefits
Human Resource Management

Support Activities
(Recruiting, Training, Development)
Technology Development Difficult for

(R & D, Product and Process Improvement) competitors
Margin
to imitate
Procurement
(Purchasing of Raw Materials, Machines, Supplies)
Inbound Operations Outbound Marketing Service

Logistics (Machining, Logistics & (Installation,
(Raw Assembling, (Warehousing Sales Repair
Materials, Testing and (Advertising, Parts)
Handling and Products) Distribution of Promotion,
Warehousing) Finished Pricing, Core Competence
Products) Channel
Relations)
Primary Activities In order to attain superior performance and attain competitive

advantage, a firm must have distinctive competencies.
Primary activities are those which are directly involved in transforming Distinctive competencies can take any of the following two
of inputs (Raw Material) into outputs (Finished Products) or in forms:
provision of service. Secondary activities (also known as support i An offering or differentiation advantage. If customers perceive
activities) support the primary activities. a product or service as superior, they become more willing to
pay a premium price relative to the price they will have to pay
for competing offerings.
Strategic Frameworks For Value Chain Analysis i Relative low-cost advantage, under which customers gain when
The Value Chain analysis requires strategic framework for organizing a company’s total costs undercut those of its average competitor.
varied information. The following three are generally accepted strategic
framework for Value Chain analysis.
Segmentation Analysis
Industry Structure Analysis A single industry might be a collection of different market segments.
An industry might not yield high profits just because the industry is This analysis will reveal the competitive advantages or disadvantages
large or growing. The five forces suggested by Porter’s play an important of different segments. A firm may use this information to decide to exit
role in determining profit potential of the firms in an industry. the segment, to enter a segment, reconfigure one or more segments, or
embark on cost reduction/ differentiation programs.

The Value Chain Approach For Assessing Value Shop Model or Service Value Chain
Competitive Advantage This concept aims to serve companies from service sector. In value shop
The value chain model can be used by business to assess the principle, no value addition takes place. It only deals with the problem,
competitive advantage. Companies must not only focus on the end figure-out the main area requires its service and finally comes with
product/ service but also on the process/ activities involved in creation the solution. This approach is designed to solve customer problems
of these products/ services. The value chain approach can be used to rather than creating value by producing output from an input of raw
better understand the competitive advantage in the following areas: materials. The model has the same support activities as Porter’s
Value Chain but the primary activities are described differently. In
Internal Cost Analysis the value shop they are:
Organisations can use the value chain analysis to understand the cost i Problem finding and acquisition.
of processes and activities and identify the source of profitability. i Problem solving.
i Choosing among solutions.
i Execution and control/evaluation.
Internal Differentiation Analysis
Companies can also use value chain analysis to create and offer
superior differentiation to the customers. The focus is on improving Infrastructure
the value perceived by customers on the companies’ products and
service offering. The firms must identify and analyse the value creating Human-resource Management
process and carry out a differentiation analysis.
Technology Development
Vertical Linkage Analysis Procurement
A company generates competitive advantage not only through linkages
of internal processes within a firm but also through linkages between
a firm’s value chain and that of suppliers or users. A vertical linkage
analysis includes all upstream and downstream activities throughout Problem
Problem
the industry. Finding and
Solving
Acquisition
In the SCM frame work, effective cost management involves a

broad focus which Porter calls the value chain. It is a strategic tool
Choice
used to analyse internal firm activities. Its goal is to recognize,
which activities are the most valuable (i.e. are the source of cost
or differentiation advantage) to the firm and which ones could Control/
Execution
be improved to provide competitive advantage. Cost leadership Evaluation
can be achieved through techniques like target costing. Product
differentiation is directly proportional to market movements and The management in a value shop focuses on areas like problem and
changing business requirements. opportunity assessment, resource mobilization, project management,
solutions delivery, outcome measurement, and learning.
MODERN BUSINESS ENVIRONMENT

Chapter Overview
Modern Business Environment
Quality Management • Theory of Constraints Supply Chain Management • Gain Sharing Arrangement
• Throughput Accounting • Outsourcing
Cost of Quality Total Quality Management Business Excellence Model • Key Process
• Push/Pull Model
• Components • 6 Cs • EFQM
• Upstream-flow Management
• Optimal COQ • Deming’s 14 points • Baldrige Criteria
• Downstream-flow Management
• PDCA Cycle • Organisation Culture
• Service Level Agreements
• Criticism
• Prevention Costs
• Apprisal Costs • Concepts of Excellence • Relationship with Suppliers • Relationship Marketing
• Internal Failure Costs • Conceptual Framework • Use of Information • Customer Relationship
• External Failure Costs • Logic Assessment Framework Technology Management
• Use of Information Technology
• Brand Strategy

Modern Business Environment

Total Costs
Today’s business environment is that of a buyer’s market. This
Cost of
trend is the result of international transitions and macroeconomic, Non-conformance
technological, political, and social changes. The challenge for
businesses today is to satisfy their customers through the exceptional
performance of their processes.
Cost Of Quality (COQ)

Mr. Philip B. Crosby in his book ‘Quality is Free’ referred to the COQ
costs in two broad categories namely ‘Price of Conformance’ and
Cost of
‘Price of Non-conformance’. These two can be bifurcated further in Conformance
to prevention & appraisal costs and internal & external failure costs.
Hence, COQ is often referred as PAF (Prevention, appraisal & failure)
model. In other words, ‘Price of Conformance’ is known as ‘Cost of
Good quality’ and ‘Price of Non-conformance’ is often termed as ‘Cost 0 1 2 3 4 % Defects
of Poor Quality’.
Total Quality Management (TQM)
Cost of Quality Total Quality Management (TQM) is a management strategy aimed at
embedding awareness of quality in all organizational processes. TQM
requires that the company maintain this quality standard in all aspects
of its business. This requires ensuring that things are done right the first
time and that defects and waste are eliminated from operations. TQM
is a comprehensive management system which:
Cost of Poor Cost of Good
Quality i Focuses on meeting owner’s/ customer’s needs, by providing
Quality
quality services at a reasonable cost.
i Focuses on continuous improvement.
Internal External i Recognizes role of everyone in the organization.
Appraisal Prevention
Failure Failure Costs Costs i Views organization as an internal system with a common aim.
Costs Costs i Focuses on the way tasks are accomplished.
i Emphasizes teamwork.
Prevention Costs
i The costs incurred for preventing the poor quality of products and Six C’s of TQM
services may be termed as Prevention Cost. Commitment
i They are planned and incurred before actual operation and are
associated with the design, implementation, and maintenance of
the quality management system. Control Culture
Appraisal Costs
i The need of control in product and services to ensure high 6C’s
quality level in all stages, conformance to quality standards and
performance requirements is Appraisal Costs.
Continuous
i Appraisal Cost incurred to determine the degree of conformance Customer Focus Improvement
to quality requirements (measuring, evaluating or auditing).
Internal Failure Costs Co-operation
i These are costs that are caused by products or services not

conforming to requirements or customer/user needs and are found
before delivery of products and services to external customers.
The Plan–Do–Check–Act (PDCA) Cycle
i Deficiencies are caused both by errors in products and
inefficiencies in processes. Deming developed the Plan – Do – Check – Act cycle. PDCA Cycle
describes the activities a company needs to perform in order to
incorporate continuous improvement in its operation.
External Failure Costs
Plan
i These costs occur when products or services that fail to reach Establish obectives and
design quality standards are not detected until transfer to the develop action plans
customer.
Optimal COQ Act Do

Take corrective action Implement the process
It is generally accepted that an increased expenditure in prevention planned
and appraisal is likely to result in a substantial reduction in failure
costs. Because of the trade off, there may be an optimum operating
level in which the combined costs are at a minimum. Check
Measure the effectiveness
of new process

Deming outlined his philosophy on quality in his famous “14 Points.” Theory of Constraints
These points are principles that help guide companies in achieving
quality improvement. Operational Measures of Theory of Constraints
The theory of constraints focuses on revenue and cost management
Criticisms of Total Quality Management when faced with bottlenecks. It advocates the use of three key
measures. These are:
i the focus on documentation of process and ill-measurable
outcomes; Core Definition
i the emphasis on quality assurance rather than improvement; Measures
i an internal focus which is at odds with the alleged customer Throughput i Throughput as a TOC measure is the rate of
orientation; and (T) generating money in an organization through Sales.
i may not be appropriate for service based industries i Throughput = (Sales Revenue – Unit Level Variable
Expenses)/ Time
i Direct Labour Cost is viewed as a fixed unit level
The Business Excellence Model expenses and is not usually included.
Business Excellence (BE) is a philosophy for developing and
strengthening the management systems and processes of an Investment i This is money associated with turning materials
(I) into Throughput and do not have to be immediately
organization to improve performance and create value for stakeholders.
expensed.
The essence of this approach is to develop quality management i Includes assets such as facilities, equipment,
principles that increase the overall efficiency of the operation, fixtures and computers.
minimize waste in the production of goods and services, and help to
increase employee loyalty as a means of maintaining high standards Operating i Money spent in turning Investment into Throughput
throughout the business by achieving excellence in everything that Expense and therefore, represent all other money that an
an organization does (including leadership, strategy, customer focus, (OE) organisation spends.
information management, people and processes). i Includes direct labour and all operating and
Several business excellence models exist world-wide. While variations maintenance expenses.
exist, these models are all remarkably similar. The most common Based on these three measures, the objectives of management can
include; be expressed as increasing throughput, minimizing investment and
i EFQM Excellence Model decreasing operating expenses.
i Baldrige Criteria for Performance Excellence
Operational Measures
i Singapore BE Framework
i Japan Quality Award Model
i Australian Business Excellence Framework Operating Expenses
Throughput Investment
Business Excellence Model and Organizational

Culture Measures Measures
Incoming Money Tiedup Money Leaving
i Business Excellence approach focuses on strengthening the Money with in the the System
internal function and communication, looks towards the System
cultivation of strong ties with consumers and can be incorporated
into the culture.
i Excellence cannot be attained if the staffs are forced to conform to Increase Minimum Decrease
certain norms. They have to be critically managed and motivated.
Goldratt’s Five-Step Method for Improving

Performance
The key steps in managing bottleneck resources are as follows:
Identify the
Constraints
Repeat the Exploit the

Process Constraints
Elevate the Subordinate &

Performance Synchronize to the
of the Constraint Constraint

Throughput Accounting be achieved for both businesses, something that would be difficult to
achieve if operating independently.
Several ratios were defined by Galloway and Waldron based on the
definition of throughput.
Throughput Accounting Ratio:
Use of Information Technology
The main activities of upstream supply chain are procurement and
Throughput per Bottleneck Minute logistics. In modern business environment upstream supply chain
management use E-Procurement process. E-Procurement is the
Factory Cost per Bottleneck Minute electronic methods beginning from identification of the organization’s
requirements and end on payment. E-Procurement includes
If the TA ratio is greater than 1 the product in question is “profitable”
E-Sourcing, E-Purchasing and E-Payment.
because, if all capacities were devoted to that product, the throughput
generated would exceed the total factory cost. If there was a bottleneck,
products could be ranked by a variant of the TA ratio (although the Downstream Supply Chain Management
ranking is the same as that derived by the use of throughput per Management of transactions with consumers or customers are termed
bottleneck minute). as downstream supply chain management.
Other Performance Ratios suggested include:
Downstream supply
Throughput Throughput chain management
and
Labour Cost Material Cost
Relationship Customer’s Relationship Use of Information
Supply Chain Management Marketing Management Technology Brand Strategy
The Global Supply Chain Forum (GSCF) defines Supply chain

management as the “integration of key business processes from end Six Markets Analysis of Customers
user through original suppliers that provides products, services, and Model and their Behaviour
information that add value for customers and other stakeholders”.
Customers Account
Types of Supply Chain- Push and Pull Profitability (CAP)
Push Model
Customers Lifetime
Supplier Manufacturer Distributor Retailer Customer Value (CLV)
Supply to Production Inventory Stock Based Purchase

Forecast Based on Based on on Forecast What is Customer’s Selection,
Forecast Forecast Available Acquisition, Retention
and Extension
Pull Model
Supplier Manufacturer Distributor Retailer Customer Relationship Marketing

Marketing plays a vital role to successfully handle the downstream
Supply to Produce to Automatically Automatically Customer supply chain management. The Relationship marketing helps the
Order Order Replenish Replenish Orders organization to keep existing customer and to attract new customers
Warehouse Stock
through helpful staff, quality service / product, appropriate prices and
proper customer care etc.
Upstream and Downstream Flow
Six Markets Model identifies the six key “market domains” where
A supply chain begins right from the supplier and finally ends on end organizations may consider directing their marketing activities.
customer or consumer. In the total chain, there are flows of material,
information and capital or finance. When the flow relates to supplier, it
is termed as upstream flow. If the flow is with consumers or customers,
it is named as downstream flow. Internal
Markets
Management of Upstream Supplier Chain

Management of transactions with suppliers are termed as upstream
supply chain management.
Supplier Consumer Referral
Markets Markets Markets
Relationship with E-Sourcing
Suppliers
Upstream Supply
Chain Management
Use of Information E-Purchasing Recruitment Influence

Technology
Markets Markets
E-Payment The six markets model suggests that a firm must regulate its actions
towards developing appropriate relationships with each of the market
Relationship with Suppliers areas as the management of relationships in each of the six markets is
Supplier capabilities of innovation, quality, reliability and costs/ critical for the attainment of customer retention objective.
price reductions and agility to reduce risk factors all have witnessed The growing interest in relationship marketing suggests a shift in
significant changes when aligned with key suppliers. Greater value can the nature of marketplace transactions from discrete to relational

exchanges, from exchanges between parties with no past history and

Customer’s Selection, Acquisition, Retention and Extension
no future to interactions between parties with a history and plans for
future interaction.
Customers Relationship Management Customer Customer

To manage and analyse customer’s interaction and data throughout Selection – Acquisition –
the life cycle with the main motive of improving business relations Type of customer A relationship
the strategies and technologies used is Customer Relationship which the company needs to be
Management (CRM). Relation includes relations with customers, needs to target has developed with in
to be selected. new customers.
assisting in customer retention and driving sales growth. CRM is
knowing the needs of the customers and providing them with best
possible solution.
Customer Customer
Extension -
Analysis of Customers and their Behaviour Retention -
The products
Analysis of customers is necessary based on geographical location Keeping existing bought by the
customers. customers need to
or purchasing characteristics. For industrial customer expectation of be increased.
benefits - quality, discount, serviceability, size of the should be taken
into consideration. During such analysing process, management should
keep in mind the physiological need, safety need, social need, status/
ego need and self-fulfillment need of existing and future customers.
The use of Information Technology in Downstream
&XVWRPHUV$FFRXQW3URÀWDELOLW\&$3 Supply Chain Management
In managing downstream supply chain, organizations link their sales
Undertaking a customer account profitability improvement initiative
system to the purchasing system of its customer through Electronic
is a five-step process:
Data Change. Using E-Business, they sell products. Intelligence
gathering is used to monitor the online customer transactions.
E-mail is the way through which organization keeps in touch with
customers. Use of IT results in quick action, reduction in associated
cost and saving in time.
Analyse the Calculate

Calculate
customer the annual
the annual
Identify Re-engineer/
eliminate the
Brand Strategy
base and revenues and retain
earned costs of quality unprofitable Specially branding of product makes a huge difference in its appeal
split it serving the
into the from the customers segments to customers. Branding can be usage of logo or specific colour or any
customer segment
segments other means which makes the product or service distinctively visible
among others.
Gain Sharing Arrangements

Gain sharing is an approach to the review and adjustment of an existing
Customers Lifetime Value (CLV) contract, or series of contracts, where the adjustment provides benefits
to both parties.
Customer Life time value is the present value of net profit that we
derive from a customer over the entire lifetime of relationship with that
particular customer. It is the net present value of the projected future
Outsourcing
cash flows from a lifetime of customer relationship. It is an essential Outsourcing is a business practice used by companies to reduce costs
tool used in marketing to focus on more profitable customers and stop or improve efficiency by shifting tasks, operations, jobs or processes to
servicing non-profitable customers. another party for a span of time.
LEAN SYSTEM AND INNOVATION

Chapter Overview
Lean System and Innovation
Lean System Innovation and BPR
Just in Time Kaizen Costing 5 Ss Total Productive Cellular Process Business

Maintenance Manufacturing Six Sigma Innovation Process
• Concept • Concept • Concept Reengineering
• Pre-requisites • Principles • Application • Concept • Concept • Concept • Concept • Concept
• Impact • Phases • Implementation • Implementation
• Performance • Principles
• Pillars Process of Six Sigma • Main Stages
Measurement • Performance • Difficulties in • Quality
• Back-flushing • Measurement Creating Flow Management
in JIT • TQM & TPM • Benefits and Tools
Costs • Limitations
DMAIC & DMADV
Seven • Lean Six Sigma
• Phases • Similarities
Wastes • Applications • Differences

Lean System Essential Pre-requisites of a JIT system

“Lean System is an organized method for waste minimization i Low variety of goods
without sacrificing productivity within a manufacturing system. Lean i Vendor reliability
implementation emphasizes the importance of optimizing work flow i Good communication
through strategic operational procedures while minimizing waste and
being adaptable.” i Demand stability
There are generally 7 type of wastes: i TQM
i Defect-free materials
Transportation i Preventive maintenance
Impact of JIT System on

Inventory
i Waste Costs: When fully installed, a JIT system vastly reduce all
these types of waste. When this happens, there is a sharp drop in
Motion several aspects of a product’s costs.
i Overhead Costs: The costs of material handling, facilities, and
Seven Wastes
quality inspection decline when a JIT system is installed.
Waiting
i Product Prices: When a company achieves a higher level of
product quality, along with ability to deliver products on the dates
Over-Processing required, customers may be willing to pay a premium.
Over-production Performance Measurements in a JIT System

Many of the performance measurement measures used under a
traditional accounting system are not useful in a JIT environment, while
Defects new measures can be implemented that take advantage of the unique
characteristics of this system.
Most of lean system techniques are based on following principles: i Machine utilization measurements can be discarded under JIT
i Perfect first-time quality environment.
i Waste minimization i Another inappropriate measurement is any type of piece rate
i Continuous improvement tracking for each employee.
i Flexibility i Any type of direct labour efficiency tracking is highly
The characteristics of lean manufacturing: inappropriate in a JIT system.
i Zero waiting time i Installing a JIT system does not mean that there should be a
i Zero inventory complete elimination of operational measures.
i Pull processing
i Continuous flow of production
%DFNÁXVKLQJLQD-,76\VWHP
Back-flushing requires no data entry of any kind until a finished
i Continuous finding ways of reducing process time.
product is completed.
Just-In-Time (JIT) Kaizen Costing
CIMA defines:
This philosophy implies that small, incremental changes routinely
“System whose objective is to produce or to procure products or applied and sustained over a long period result in significant
components as they are required by a customer or for use, rather than improvements.
for stock. Just-in-time system Pull system, which responds to demand,
in contrast to a push system, in which stocks act as buffers between the
different elements of the system such as purchasing, production and Kaizen Costing Principles
sales”. i The system seeks gradual improvements in the existing situation,
A complete JIT system begins with production, includes deliveries to a at an acceptable cost.
company’s production facilities, continues through the manufacturing i It encourages collective decision making and application of
plant, and even includes the types of transactions processed by the knowledge.
accounting system. i There are no limits to the level of improvements that can be
implemented.
Features i Kaizen involves setting standards and then continually improving
Spare Parts/ Materials Straight delivery to Visit of engineering staff at these standards to achieve long-term sustainable improvements.
from suppliers on the exact the production floor supplier sites to examine
date and at the exact time for immediate use in supplier’s processes
i The focus is on eliminating waste, improving systems, and
when they are needed manufactured products improving productivity.
Installation of EDI system Dropping off products at Shorten the setup times i Involves all employees and all areas of the business.
that tells suppliers exactly the specific machines
how much of which parts
are to be sent 5S
Eliminating the need for Training to employees how Several alterations in the
5S is the name of a workplace organization method that uses a list
long production runs/ to operate a multitude of supporting accounting of five Japanese words: seiri, seiton, seiso, seiketsu, and shitsuke.
Streamlined flow of parts different machines, perform systems
from machine to machine limited maintenance It explains how a work space should be organized for efficiency and

effectiveness by identifying and storing the items used, maintaining

the area and items, and sustaining the new order.
Six Sigma
It is quality improvement technique whose objective is to eliminate
Set in Order (Seiton)
defects in any aspect that affects customer satisfaction. The premise
Sort (Seiri) Shine (Seiso)
Arrange all necessary Clean your workplace of Six Sigma is that by measuring defects in a process, a company can
Make work easier by items into their
eliminating obstacles most efficient
on daily basis develop ways to eliminate them and practically achieve “zero defects”.
and evaluate completely or set
and accessible cleaning frequency. Six sigma can be used with balanced scorecard by providing more
necessary items. arrangements. rigorous measurement system based on statistics.
Standardize Sustain (Shitsuke)

(Seiketsu) Not harmful to Numerical Concept of Six Sigma
Standardize the best anyone, training and
practices in the work discipline, to maintain ‘Sigma’ is a statistical term that measures how far a process deviates
proper order.
area. from perfection. The higher the sigma number, the closer the process
is to perfection.
5S methodology is being applied to a wide variety of industries
The values of Defect Percentage
including Manufacturing, Health care, Education & Government.
Six Sigma is 3.4 defects per million opportunities or getting things
Total Productive Maintenance (TPM) right 99.99966% of the time. It is possible to develop ways of reducing
defects by measuring the level of defects in a process and discovering
Total Productive Maintenance (TPM) is a system of maintaining and the causes.
improving the integrity of production and quality systems. This is
done through the machines, equipment, processes, and employees
that add to the value in Business Organisation. TPM helps in keeping
Implementation of Six Sigma
all equipment in top working condition so as to avoid breakdowns and There are two methodologies for the implementation of Six Sigma-
delays in manufacturing processes. DMAIC: This method is very robust. It is used to improve existing
TPM Strategy focuses on eight pillars of success with 5S strategy as business process. To produce dramatic improvement in business
foundation. process, many entities have used it successfully. It has five phases:
TPM Goals
Zero Defects, Zero Breakdowns, Define the problem,
Zero Accidents the project goals
and customer
requirements.
Autonomous Maintenance
Safety & Environmental

Focused Improvement
Planned Maintenance
Education & Training

Quality Maintenance
TPM in the Office

Early Equipment
Management
Management
Control means
Measure the process maintaining the
to determine current improved process
performance. and future process
performance.
5S
Analyze the process Improve the process
to determine root
Performance Measurement in TPM causes of variation
by addressing and
eliminating the root
and poor performance causes.
The most important approach to the measurement of TPM (defects).
performance is known as Overall Equipment Effectiveness (OEE)
measure.
Performance × Availability × Quality = OEE % DMADV: The application of these methods is aimed at creating a
high-quality product keeping in mind customer requirements at
OEE may be applied to any individual assets or to a process. It is every stage of the product. It is an improvement system which is
unlikely that any manufacturing process can run at 100% OEE. used to develop new processes or products at Six Sigma quality levels.
According to Dal et al (2000), Nakajima (1998) suggested that ideal Phases are described in diagram:
values for the OEE component measures are:
Availability > 90%

Define the project
goals and customer
Performance > 95% deliverables.
Quality > 99%
Accordingly, OEE at World Class Performance would be
approximately 85%. Kotze (1993) contradicted, that an OEE figure
Measure and Verify the design
greater than 50% is more realistic and therefore more useful as an determine performance and
acceptable target. customer needs and ability to meet
specifications. customer needs.
Cellular Manufacturing/ One Piece Flow

Production System
A Sub Section of JIT and Lean System is Cellular Manufacturing. It Design (detailed)
Analyze the process the process to meet
encompasses a group technology. The goals of cellular manufacturing are: options to meet the customer needs.
customer needs.
i To move as quickly as possible,
i Make a wide variety of similar products,
i Making as little waste as possible.

Both DMADV and DMAIC are fundamental six sigma critical contemporary measures of performance, such as cost, quality,
methodologies for improving quality of product/process. Broadly, service, and speed.”
DMAIC deals with improving some existing process to make it
align with customer’s needs while DMADV deals with new design
or redesign.
Main Stage of BPR
Lean Six Sigma Process Identification Process Reassembly
Each task performed being Re-engineered processes are
Lean Six Sigma is the combination of Lean and Six Sigma which reengineered is broken down into implemented in the most
help to achieve greater results that had not been achieved if Lean a series of processes. efficient manner.
or Six Sigma would have been used individually. It increases the
speed and effectiveness of any process within any organization. Process Rationalisation Process Redesign
By using lean Six Sigma, organisations will be able to Maximize Processes which are non value Remaining processes are
Profits, Build Better Teams, Minimize Costs, and Satisfy adding, to be discarded. redesigned.
Customers.
Porter’s Value Chain is commonly used in Business Process Re-
Process Innovation engineering as a technique to identify and analyse processes that are
of strategic significance to the organisation.
Process Innovation means the implementation of a new or
significantly improved production or delivery method (including
significant changes in techniques, equipment and/ or software).
Business Process Reengineering

Hammer defines Business Process Reengineering (BPR) (or simply
reengineering) as “the fundamental rethinking and radical
redesign of business processes to achieve dramatic improvements in
COST MANAGEMENT TECHNIQUES

Value Analysis is a planned, scientific approach to cost reduction
Chapter Overview which reviews the material composition of a product and production
design so that modifications and improvements can be made which
Cost Management Techniques do not reduce the value of the product to the customer or to the user.
Value Engineering is the application of value analysis to new

products. Value engineering relates closely to target costing as it is cost
avoidance or cost reduction before production.
Cost Control Life Cycle Cost
Costing Reduction The initial value engineering may not uncover all possible cost
savings. Thus, Kaizen Costing is designed to repeat many of the value
engineering steps for as long as a product is produced, constantly
Target
Pareto Analysis Costing
refining the process and thereby stripping out extra costs.
Further, Target Costing System is based on involving representatives

Value Analysis/ of all the Value Chain such as suppliers, agents, distributors and
Environmental Management
Engineering
Accounting existing after-sales service in the target costing system.
Life Cycle Costing

Life Cycle Costing involves identifying the costs and revenue over a
Target Costing product’s life i.e. from inception to decline. Life cycle costing aims to
It can be defined as “a structured approach to determining the cost maximize the profit generated from a product over its total life cycle.
at which a proposed product with specified functionality and quality
The life cycle of a product consists of four phases/ stages viz.,
must be produced, to generate a desired level of profitability at its
Introduction; Growth; Maturity; Saturation and Decline.
anticipated selling price”.
In Target costing, we first determine what price we think the
consumer will pay for our product. We then determine how much of
a profit margin we expect and subtract that from the final price. The
remaining amount left is what is available as a budget to be used to
Annual Sales Volume
create the product.
Components of Target Costing System

Typically, the total target is broken down into its various components,
each component is studied and opportunities for cost reductions are
identified. These activities are often referred to as Value Analysis Time
(VA) and Value Engineering (VE). I: Introduction II: Growth III: Maturity or IV: Decline
Stabilization

Life Cycle Characteristics

Introduction Growth Maturity Decline
Objectives Create product Maximise market share Maximise profits while Reduce expenditures &
awareness & trial defending market share milk the brand
Sales Low sales Rapidly rising Peak sales Declining sales
Costs per Customer High cost per customer Average cost per customer Low cost per customer Low cost per customer
Profits Negative Rising profits High profits Declining profits
Customers Innovators Early adopters Middle majority Laggards
Competitors Few Growing number Steady number Declining number
beginning to decline
Strategies
Introduction Growth Maturity Decline
Product Offer basic product Offer product extensions, Diversify brands and Phase out weak items
service & warranty models
Price Cost plus profit Price to penetrate market Price to match or beat Price cutting
competitors
Advertising Build product awareness Build awareness & interest Stress on brand Reduce level to keep hard
amongst early adopters in mass market differences and benefits core loyalty
& dealers
Distribution Build selective Build Intensive Build more intensive Go selective: Phase out
distribution distribution distribution unprofitable outlets
Sales Promotion Use heavy sales Reduce to take advantage Increase to encourage Reduce to minimal level
promotion to entice trial of heavy consumer brand switching
demand
Pareto Analysis ,GHQWLÀFDWLRQRI(QYLURQPHQWDO&RVWV

Pareto Analysis is a rule that recommends focus on the most To prepare environmental management accounts an intense review
important aspects of the decision making in order to simplify the of general ledger containing costs of materials, utilities and waste
process of decision making. It is based on the 80:20 rule that was a disposal etc. is required. Since the environmental costs are generally
phenomenon first observed by Vilfredo Pareto, a nineteenth century ‘hidden’ in ‘general overheads’ of the company, it becomes difficult for
Italian economist. He noticed that 80% of the wealth of Milan was management to identify opportunities to cut environmental costs
owned by 20% of its citizens. This phenomenon, or some kind but nonetheless it is crucial for them to do so to preserve natural
of approximation of it say, (70: 30 etc.) can be observed in many resources getting scarcer.
different business situations. The management can use it in a number In 2003, the UNDSD identified four management accounting
of different circumstances to direct management attention to the key techniques for the Identification and Allocation of Environmental
control mechanism or planning aspects. It helps to clearly establish Costs:
top priorities and to identify both profitable and unprofitable targets.
Input-Output Analysis
Environmental Management Accounting [EMA] This technique records material inflows and balances this with
i EMA identifies and estimates the costs of environment-related outflows on the basis that, what comes in, must go out.
activities and seeks to control these costs.
i The focus of EMA is not on financial costs but it also considers the Flow Cost Accounting
environmental cost or benefit of any decisions made. This technique uses not only material flows but also the organizational
i EMA is an attempt to integrate best management accounting structure. Classic material flows are recorded as well as material losses
thinking with best environmental management practice. incurred at various stages of production. Flow cost accounting makes
material flows transparent by using various data, which are quantities
(physical data), costs (monetary data) and values (quantities x costs).
Environmental Costs The material flows are divided into three categories, material, system,
Environmental Prevention Environmental Appraisal Costs– and delivery and disposal.
Costs– The cost of activities executed
Those costs associated with to determine whether products, Life Cycle Costing
preventing adverse process and activities are in
environmental impacts. compliance with environmental Lifecycle costing considers the costs and revenues of a product
standards, policies and laws. over its whole life rather than one accounting period. Therefore, the
full environmental cost of producing a product will be taken into
account. In order to reduce lifecycle costs, an organization may adopt
Environmental External Failure a TQM approach.
Environmental Internal Failure Costs –
Costs – Costs incurred on activities
Costs incurred from activities performed after discharging Activity Based Costing (ABC)
that have been produced but not waste into the environment. These
discharged into the environment. costs have adverse impact on the ABC allocates internal costs to cost centres and cost drivers on the
organisation’s reputation and basis of the activities that give rise to the costs. In an environmental
natural resources. accounting context, it distinguishes between environment-related

costs, which can be attributed to joint cost centres, and environment- Consumables and Raw Materials
driven costs, which tend to be hidden on general overheads. These are directly attributable costs and discussions with
The environment-driven costs are removed from general management can reduce such costs. For example, toner cartridges
overheads and traced to products or services. The cost drivers are for printers could be refilled rather than replaced.
determined based on environment impact that activities have and
costs are charged accordingly. This should give a good attribution Reasons for Controlling Environmental Cost
of environmental costs to individual products and should result in There are three main reasons why the management of environmental
better control of costs. costs is becoming increasingly important in organizations.
Controlling Environmental Costs First, a ‘carbon footprint’ (as defined by the Carbon Trust) measures
the total greenhouse gas emissions caused directly and indirectly by
After Identification and Allocation of Environmental Costs, task of
a person, organization, event or product.
controlling starts. An organization may try to control these costs as
mentioned below-
Second, environmental costs are becoming huge for some companies,
particularly those operating in highly industrialized sectors such as
Waste
oil production. Such significant cossts need to be managed.
‘Mass balance’ approach can be used to determine how much
material is wasted in production, whereby the weight of materials Third, regulation is increasing worldwide at a rapid pace, with
bought is compared to the product yield. penalties for non-compliance also increasing accordingly.
Water Role of EMA in Product/ Process Related Decision

Businesses pay for water twice – first, to buy it and second, to dispose Making
of it. If savings are to be made in terms of reduced water bills, it is
The correct costing of products is a pre-condition for making sound
important for organizations to identify where water is used and how
business decisions. The accurate product pricing is needed for
consumption can be decreased.
strategic decisions regarding the volume and choices of products
to be produced. EMA converts many environmental overhead costs
Energy
into direct costs and allocate them to the products that are responsible
Often, energy costs can be reduced significantly at very little for their incurrence. The results of improved costing by EMA may
cost. Environmental management accounts may help to identify include:
inefficiencies and wasteful practices and, therefore, opportunities for i Different pricing of products as a result of re-calculated costs;
cost savings.
i Re-evaluation of the profit margins of products;
Transport and Travel i Phasing-out certain products when the change is dramatic;
i Re-designing processes or products in order to reduce
Again, EMA techniques may be used to identify savings in terms
environmental costs and
of travel and transport of goods and materials. At a simple level, a
business can invest in more fuel-efficient vehicles. i Improving housekeeping and monitoring of environmental
performance.
PRICING DECISION
Chapter Overview Pricing Methods

Pricing
The Pricing Decision Structured Methods
Approach
Competition-
Based Cost-Based Value- Based
• Theory of Price • Pricing Policy • Pricing • Strategic Pricing

• Profit • Principles of Methods of New
Maximisation Product Pricing - Competition Products
Model - Price Sensitivity Based - Skimming Going Rate True Economic
- Price - Cost Based - Penetration Pricing Value
• Pricing under Customization - Value Based
Different • Pricing and
Market • Pricing • Price in Periods Product
Structures Adjustment of Recession Life Cycle
Polices • Price below
Marginal Cost
Sealed Bid- Perceived
Pricing Value
• Pricing of
Services
- Key Issues

Cost-Based Pricing Method Value- Based Pricing Method

In many businesses, the common method of price determining is to There is an increasing trend to price the product on the basis of
estimate the cost of product & fix a margin of profit. The term ‘cost’ customer’s perception of its value. This method helps the firm in
here means Full Cost at current output and wages level since these reducing the threat of price wars. Marketing research is important
are regarded as most relevant in price determination. for this method. It is based on:
Pricing based on total costs is subjected to two limitations. They are: Objective Value or True Economic Value (TEV)
i The allocation of inter-departmental overheads is based on an This is a measure of benefits that a product is intended to deliver to
arbitrary basis; and the consumers relative to the other products without giving any regard
i The allocation overheads will require estimation of normal whether the consumer can recognize these benefits or not.
output which often cannot be done precisely.
True economic value for a consumer is calculated taking two
In order to avoid these complications, Variable Costs which are differentials into consideration:
considered as relevant costs are used for pricing, by adding a mark-
up (to include fixed costs allocation also). TEV = Cost of the Next Best Alternative + Value of
Performance Differential
Sometimes, instead of arbitrarily adding a percentage on cost for
profit, the firm determines an average mark-up on cost necessary to Cost of the next best alternative is the cost of a comparable product
produce a desired Rate of Return on Investment. The rate of return offered by some other company. Value of performance differential is
to be earned by the firm or industry must depend on the risk involved. the value of additional features provided by the seller of a product.
A firm’s product may be superior to the next best alternative in some
Competition-Based Pricing Method dimensions but inferior in others.
When a company sets its price mainly on the consideration of what
Perceived Value
its competitors are charging, its pricing policy under such a situation
is called competitive pricing or competition-oriented pricing. It is This is the value that consumer understands the product deliver to it.
not necessary under competitive pricing to charge the same price as It is the price of a product that a consumer is willing to spend to have
charged by the concern’s competitors. But under such a pricing, the that product.
concern may keep its prices lower or higher than its competitors by
At the time of fixing price, it is to be kept in the mind that any
a certain percentage.
price which set below the perceived value but above the cost of
It is a competitive pricing method under goods sold give incentives to both buyers and the seller. This can be
which a firm tries to keep its price at the understood with the help the diagram given below.
Going Rate average level charged by the industry. The
Pricing use of such a practice of pricing is especially True Economic Value
useful where it is difficult to measure costs.
The objective of the firm in the bidding Perceived Value

situation is to get the contract, and this means Benefit to consumer = Perceived value – Price
that it hopes to set its price lower than that
set by any of the other bidding firms. But Price
Price
Sealed
Bid-Pricing however, the firm does not ordinarily set its Profit = Price – Cost of Sales
price below a certain level. Even when it is
Cost of Sales
anxious to get a contract in order to keep
the plant busy, it cannot quote price below
marginal cost. On the other hand, if it raises
its price above marginal cost, it increases
its potential profit but reduces its chance of
getting the contract. 0 0
Strategic Pricing of New Products

The pricing of new product poses a bigger problem because of the uncertainty involved in the estimation of their demand. In order to overcome
this difficulty, experimental sales are conducted in different markets using different prices to see which price is suitable. A new product is
analysed into three categories for the purpose of pricing:
A product is said to be Revolutionary product may
Revolutionary Product revolutionary when it is new enjoy the premium price as a
for the market and has the reward for its innovation and
potential to create its own taking first initiative.
value.
A product introduces
upgraded version with few The evolutionary products may
Pricing of New Product Evolutionary Product additional characteristics be priced taking cost-benefit,
of the product is known as competitor, and demand for
evolutionary product. the product into account.
A product is said to be me-too The me-too products are

product when its emergence price takers as the price is
Me-too Product is a result of the success of a determined by the market
revolutionary product. mainly by the competitive
forces.

Three New Product Pricing Situations Skimming Pricing

Perceived Price
It is a policy of high prices during the early period of a product’s
existence. This can be synchronised with high promotional
expenditure and in the later years the prices can be gradually reduced.
The reasons for following such a policy are:
Revolutionary
High Company
Mid Company
The change of high price
Evolutionary The demand is likely to in the initial periods
Low Company be inelastic in the earlier serves to skim the cream
stages till the product is of the market that is
established in the market. relatively insensitive to
Me-too price.
Perceived Benefits
The demand for the High initial capital
product is not known the outlays, needed for
Existing Offerings New Offerings price covers the initial manufacture, results in
cost of production. high cost of production.
While preparing to enter the market with a new product, management
must decide whether to adopt a skimming or penetration pricing
strategy.
Penetration Pricing When there are

When demand of the
This policy is in favour of using a low price as the principal instrument product is elastic to substantial savings
for penetrating mass markets early. It is opposite to skimming price. price. on large scale
production.
The low price policy is introduced for the sake of long-term survival
and profitability and hence it has to receive careful consideration
before implementation. The three circumstances in which
penetrating pricing policy can be adopted are: When there is threat of
competition.
PERFORMANCE MEASUREMENT AND EVALUATION

Chapter Overview
Performance
Measurement
Benchmarking and Evaluation
Responsibility Centre
• Cost Centre Performance
• Revenue Centre Measurement in
• Profit Centre the Not for Profit
Performance Reports Sector
• Investment Centre
• VFM
• Adapted Balanced
Divisional Scorecard
Performance
Measures
Financial Financial & Non-financial Social & Environmental

• Return on Investment • Balanced Scorecard • Triple Bottomline
• Residual Income • The Performance Pyramid
• Economic Value Added • Building Block Model
• The Performance Prism
Linking CSFs to KPIs and Corporate Strategy

Divisional Performance Measures Triple Bottom Line (TBL)

TBL incorporates the three dimensions-
Return on
Investment (ROI)
Residual Income (RI)

Economic
Pure Financial
Economic Value
Added (EVA)
Social
Shareholder Value
Added (SVA)
Divisional Environmental
Performance Balanced Scorecard
Measures
The Performance
Pyramid
i Environmental- measures the impact on resources, such as air,

Other Building Block
Measures Model water, ground and waste emissions (Baumgartner & Ebner, 2010,
p.79).
i Social- relates to corporate governance, motivation, incentives,
The Performance
Prism health and safety, human capital development, human rights and
ethical behaviour.
Triple Bottom Line i Economic- refers to measures maintaining or improving the
(TBL) company’s success.
Return on Investment (ROI) Linking CSFs to KPIs and Corporate Strategy

i ROI expresses divisional profit as a percentage of the assets In order to truly achieve effective measurement of business
employed in the division. performance, the KPIs must be selected and designed in
i ROI is a common measure and thus is ideal for comparison across a way that ensures that the CSF is delivered if the KPI meets
corporate divisions for companies of similar size and in similar the threshold, and the CSFs in turn must be designed and
sectors. ROI can therefore lead to a lack of goal congruence. constructed in a way that ensures that the company’s strategic
vision is delivered if the CSFs are met.
Residual Income (RI)
i To overcome some of the dysfunctional consequences of ROI, Balanced Scorecard
the residual income approach can be used. The balanced scorecard is a method which displays organisation’s
i For evaluating the economic performance of the division, residual performance into four dimensions namely financial, customer,
income can be defined as divisional contribution less a cost of internal and innovation. The four dimensions acknowledge the
capital charge on the total investment in assets employed by the interest of shareholders, customers and employees taking into
division. account of both long-term and short-term goals. Kaplan and Norton
i Residual income suffers from the disadvantages of being an classified performance measures into four business ‘perspectives’
absolute measure, which means that it is difficult to compare
the performance of a division with that of other divisions or Financial Perspective Customer Perspective
companies of a different size. Financial performance measures In this stage, companies identify
indicate whether the company’s customers and market segments in
strategy implementation and which they compete and also the
Economic Value Added (EVA) execution are contributing to its
revenue and earnings.
means by which they provide value
to these customers and markets.
i Economic Value Added is a measure of economic profit.
Economic Value Added is calculated as the difference between the
Net Operating Profit After Tax (NOPAT) and the Opportunity Internal Business Perspective
Learning and Growth Perspective
Cost of Invested Capital. This opportunity cost is determined In this stage companies identify processes
In the learning and growth
and activities which are necessary to
by multiplying the Weighted Average Cost of Debt and Equity achieve the objectives as identified at perspective, Companies determine
the activities and infrastructure that
Capital (WACC) and the amount of Capital Employed. financial perspectives and customer
the company must build to create
perspective stage. These objectives may
be achieved by reassessing the value chain long term growth, which are necessary
EVA = NOPAT – WACC × Capital and making necessary changes to the to achieve the objectives set in the
existing operating activities. previous three perspectives.
Performance Pyramid
The Performance Pyramid is also known as Strategic Measurement
and Reporting Technique by Cross and Lynch 1991. They viewed
businesses as performance pyramids. The attractiveness of this

framework is that it links the business strategy with day-to-day Performance Prism
operations.
The Performance Prism is an approach to performance management
which aims to effectively meet the needs and requirements of all
stakeholders. This is in contrast with the performance pyramid
Objectives
Corporate
Vision
which tends to concentrate on customers and shareholders and is
also in contrast with value based management, which prioritizes
the needs of shareholders. There are five ‘facets’ to the Performance
Market Financial
Business
Units Measures Prism which lead to key questions for strategy formulation and
measurement design:
Business
Operating Stakeholders Strategies
Customer Flexibility Productivity Systems Satisfaction What are the strategies Processes
Satisfaction What are the necessary
The organization needs required by the
to focus on who are the organization to fulfill the processes required for
Departments stakeholders? What are wants and needs of the satisfying the above
and the needs and wants of stakeholders? strategies?
Quality Delivery Cycle Time Waste Workcenters the stakeholders.
Operations Capabilities Stakeholders’ Contributions

What capabilities does It further takes into account
the organization need for what contribution does the
External Effectiveness
operating and enhancing management need from its
Internal Efficiency the process? stakeholders?
In the above pictorial presentation: Comprehensiveness of Performance Prism

i ‘Objectives’ are shown from top to bottom. Stakeholder
Satisfaction
i ‘Measures’ are from bottom to the top.
i At the top is the organization’s corporate vision through which
long term success and competitive advantages are described. Processes
i The ‘business level’ focuses on achievements of organization’s Capabilities

CSF in terms of market and financial measures.
i The marketing and financial success of a proposal is the initial Strategies
focus for the achievement of corporate vision.
i The above business are linked to achieving customers’ satisfaction,
increase in flexibility and high productivity. Stakeholder
Contribution
i The above driving forces can be monitored using the operating
forces of the organization. Performance Measurement in the Not for
i The left-hand side of the pyramid contains external forces which 3URÀW6HFWRU
are ‘non-financial’.
The following are key challenges for measuring performance in not-
i On the other hand, the right-hand side of the pyramid contains for-profit organisations –
internal efficiency which are predominantly ‘financial’ in nature.
The Building Block Model Benefits cannot be quantified Benefits may accrue over a
Fitzgerald and Moon proposed a Building Block Model which longer term
suggests the solution of performance measurement problems in
service industries. But it can be applied to other manufacturing and
Key Challenges
retail businesses to evaluate business performance.
Fitzgerald & Moon: Measurement of utilisation of Multiple objectives

Building Block Model funds & expenditure
Equity
Motivation
Value for Money (VFM) Framework

Standards
Dimensions
Rewards
A framework which can be used for measurement of performance
in not-for-profit sector is the Value for Money framework. Not-for-
profit organisations are expected to provide value for money which
is demonstrated by:
Achievable Clear
Results Determinants
Economic
Ownership Quality Controllability
Financial
Performance
Flexibility
Efficiency
Innovation
Effectiveness
Comperative
Performance
Resource
Utilization

i Effectiveness: Whether the organisation has achieved its desired i The best use of financial as well as non-financial resources to
mission and objectives? achieve desired objectives and mission.
i Efficiency: Whether the resources and funds available to the i The long-term impact (benefits) of the activities of the not-for-
organisation has been utilised efficiently i.e, maximum output profit organisations.
has been obtained with minimum input? i The quality of services provided by the organisations.
i Economy: Whether the desired output has been obtained using
the lowest cost? It must be noted that use of lowest cost approach
should not compromise quality.
Performance Measurement Process
The performance measurement

Adapted Balanced Scorecard process typically starts with The various objectives/mission of
identification of the overriding the organisation are broken down
Kaplan developed the ‘Adapted Balanced Scorecard’ for measuring objectives and mission of the and mapped with key strategies:
performance at NGOs. The main assumption of this adapted not-for-profit organisation. Stakeholder (Customer), Financial,
This includes evaluating the Internal Process and Learning &
scorecard is that mission statement and not profits is the main point mission, vision and strategy on a Growth.
to be met. continuous basis
Satisfaction of
Customer beneficiary and
Perspective other stakeholder’s
interest
Fund raising, funds The performance measures/ The actual outcome is measured
Financial growth and funds key performance indicators and evaluated against the
Perspective distribution of each of the perspectives is performance measures defined.
defined.
Adapted Balanced
Scorecard
Internal Internal efficiency,
Processes volunteer
development and
Perspective quality
Innovation The capability of

and Learning organisation to adjust Any changes which are
to the changing required to the performance
Perspective environment measures are carried out after
analysis of the outcome on a
Other Performance Measures periodic basis.
i The ability to raise funds to meet the objectives efficiently.

i Submitting periodic reports to the stakeholders in a transparent
manner.
DIVISIONAL TRANSFER PRICING

Chapter Overview
Divisional Transfer Pricing
Concept/Utility of Transfer Pricing Methods International

Transfer Pricing Transfer Pricing
• Market Based
• Share Profit Relative to Cost
• Marginal Cost Based
• Standard Cost Based
• Full Cost Based Capacity Constraint
Goal Congruence
• Cost Plus Markup Based
• Negotiation Based
Proposal for Resolving Conflict
• Dual Rate Transfer Pricing

System
Behavioural • Two Part Transfer Pricing
Consequences System

Transfer Pricing Methods Marginal Cost Based Transfer Price

Transfer price is recorded marginal cost required to produce one
additional unit:
Transfer
Pricing Advantages Disadvantages
Methods
i Useful when the supplying i No fixed cost or mark-up is
division has excess capacity. allowed to be charged to the
purchasing division. Each unit of
internal sale will hence result in
Negotiation a loss at approximately fixed cost
Market Based Cost Based Based per unit.
Behavioral Consequences
Marginal Cost Standard Cost Full Cost Cost Plus In such a setup, profit evaluation is centralized at the entity level.
Based Based Based Markup Based
Therefore, the supplying division may have little incentive to
find measures for making cost efficient. Non-recovery of fixed
Market Based Transfer Price costs would demotivate the supplying division. It may oppose
certain decisions like capacity expansion or further infusion of
Transfer price is based on market price of goods or services similar to
the ones transferred internally within divisions. The transfer can be investment, that lead to higher fixed costs.
recorded at the external market price, adjusted for any costs that can
be saved by internal transfer e.g. selling and distribution expenses,
Standard Cost Based Transfer Price
packaging cost.
Transfer price is recorded at a predetermined cost, which is based
Advantages Disadvantages on budgets and certain assumptions regarding factors of productions
like capacity utilization, labor hours etc.
i Since demand and supply i Market price may not be completely
determine market price, it is unbiased, if a competitive
likely to be unbiased. environment does not exist. Advantages Disadvantages
i Market prices are less ambiguous i May not be suitable when market
compared to cost-based pricing. prices can fluctuate widely or iPerformance evaluation can iProfit performance measurement
quickly. be done against budgeted cost is centralized and cannot
i Since the pricing is competitive, targets. be measured for individual
divisional performance can be i Goods that are transferred may divisions.
linked more objectively to its be at an intermediate stage in the
contribution to the company’s production process. At times market
overall profits. price may not be available for such
intermediate goods.
Budgeted costs are generally based on historic records.
Shared Profit Relative to Cost Based Transfer Price Therefore, little incentive exists to make costs more efficient to
Shared profit relative to cost method is an alternative to market price improve profitability.
method. Cost incurred by each division indicates the value it has
added to the product cost, that is finally used to arrive at the selling Full Cost Based Transfer Price
price of the final product. The primary advantage of this method is
Transfer price is based on full product cost. It includes cost of
that it allocates profit based on the proportion of value addition to the production plus a share of other costs of the value chain like selling
product in terms of cost. and distribution, general administrative expense, research and
development etc.
Cost Based Transfer Price
Cost based pricing models are based on the internal cost records Advantages Disadvantages
of the company. They may be used when the management wants to

iFull cost of goods transferred is i Since mark-up cannot be
benchmark performance with the cost targets set within the company recovered, hence the supplying charged on internal transfers,
or may be an alternative when market prices for the goods cannot be division will not show a loss. the supplying division does not
record any profit on these sales.
determined due to lack of comparable market. Cost based transfer This is a disincentive for the
price may consider variable cost, standard cost, full cost and full cost supplying division.
plus mark-up. Therefore, the basis for cost price may be subjective
and has to be adapted based on its suitability to the entity.
Cost plus a Mark-up Based Transfer Price
Advantages Disadvantages Transfer price is based on full product cost plus a mark-up. Mark-up
could be a percentage of cost or of capital employed.
i Performance can be i The cost basis on which transfer
benchmarked to internal cost pricing is used can be subjective
Advantages Disadvantages
targets (budgets). since there can be multiple ways of
interpreting costs.
i Information is more easily
i Since cost is passed on to another i Since the supplying division i Since the transfer price under
available as compared to market
division, there may be instances makes a profit, this method this method could closely
price.
when managers of the supplying addresses the disincentive approximate its market price,
division may find little incentive problem discussed above in the the purchasing division may bear
to lower the cost of production by full cost method. a share of the selling expenses
adopting cost efficient methods. although none was incurred for
such internal sales.

Behavioral Consequences Transfer Pricing Decision, Different Circumstances

Special orders from purchasing division may typically be placed Different Capacity Levels
to meet short term demands. If transfer price is quoted at below When the supplying division has excess capacity, the range for
full cost, it may be rejected because they could result in a loss for transfer pricing would be
the supplying division. This could lead to sub-optimization of (i) (ii)
resources. Fixed costs remain constant in the short run, while i Maximum Transfer
the contribution margin from such special orders may have i Minimum Transfer Price = Marginal Cost p.u.
Price = Lower of Net
i This ensures that the supplying department
benefited the company as a whole. In such cases, management Marginal Revenue and
is able to recoup at least its additional outlay the External Buy-in
intervention has to happen for goal congruence. incurred on account of the transfer. Fixed cost Price
is a sunk cost hence ignored.
i Since capacity can be utilized further, it would
Negotiation Based Transfer Price
be optimum for the supplying division to
This is a go-between between market and cost methods. Managers of charge only the marginal cost for internal
the purchasing and supplying divisions independently negotiate and transfer.
arrive at a mutually agreeable transfer price. i The purchasing division gets the advantage,
Advantages Disadvantages getting the goods at a lower cost than market.
i Managers are given autonomy iThis method requires sufficient

to decide whether to purchase external information to be
(or sell) from its sister unit or available regarding the external
market price, terms of trade When the supplying division operates at full capacity, the range for
source then from (or to) external
etc. Internal cost information transfer pricing would be
market.
must also be shared in order to
negotiate a reasonable price. (i) (ii)
i Minimum Transfer Price = Marginal i Maximum Transfer Price
Cost p.u. + Opportunity Cost p.u. = Lower of Net Marginal
While autonomy is given to the managers, top management i Since the supplying division is operating Revenue and the External
intervention may be required if decisions lead to sub-optimal Buy-in Price
at full capacity, it has no incentive to sell
utilization of resources.
the goods to the purchasing division at
Negotiated prices depend on the ability of the manager to a price lower than the market price.
bargain on behalf of the division. This could affect the division’s
i If the internal order is accepted,
performance. The process may be time consuming that could
even lead to conflict among the units. capacity is diverted towards this sale.
Hence the supplying division would
additionally charge the lost contribution
Transfer Pricing and Goal Congruence from external sales that had to be
Since internal transfer pricing develops a competitive setting for curtailed.
managers of each division, it is possible that they may operate in the
best interest of their individual performance. This can lead to sub-
optimal utilization of resources. In such cases, transfer pricing policy
Different Demand Levels
may be established to promote goal congruence. Therefore, while catering to different levels of demand, any change
in cost should also be accounted for to calculate transfer pricing.
Range of transfer price that promotes goal congruence:
The general rule for minimum and maximum range of transfer price
(i) (ii) applies here too.
i Minimum Transfer Price i Maximum Transfer Price
(determined by the supplying (determined by the purchasing 3URSRVDOV)RU5HVROYLQJ7UDQVIHU3ULFLQJ&RQÁLFW
division) = Additional Outlay division) = Lower of Net Conflict of interest between interests of individual divisions and the
Cost per unit + Opportunity Marginal Revenue and the company can also be addressed by following the following systems
Cost per unit. External Buy-in Price for transfer pricing:
i Additional Outlay Cost =
i Net Marginal Revenue =
Marginal Cost+ Any Additional
Marginal Revenue (i.e. Selling Dual Rate Transfer Pricing System Two Part Transfer Pricing System
Incidental Costs incurred by the
Price p.u.) – Marginal Cost to
supplying division e.g. storage, iThe supplying division records transfer iThis pricing system is again aimed
transportation etc. Purchasing Division price by including a normal profit at resolving problems related to
i Opportunity Cost is the benefit margin thereby showing reasonable distortions caused by the full cost
that is foregone from selling revenue. based transfer price.
internally rather than externally. iThe purchasing division records transfer iTransfer price = marginal cost of
price at marginal cost thereby recording production + a lump-sum charge
purchases at minimum cost.
(two part to pricing).
iThis allows for better evaluation of each iWhile marginal cost ensures
division’s performance.
recovery of additional cost of
iIt also improves co-operation between
production related to the goods
divisions, promoting goal congruence
and reduction of sub-optimization of transferred, lump-sum charge
resources. enables the recovery of some
iDrawbacks of Dual Pricing include: portion of the fixed cost of the
It can complicate the records, thereby supplying division.
may result in errors in the company’s iTherefore, while the supplying
overall records. (ii) Profits shown by the division can show better
divisions are artificial and need to be profitability, the purchasing
used only for internal evaluations. division can purchase the goods a
lower rate compared to the market
price.

BUDGETARY CONTROL
Chapter Overview
Budgetary Control
Limitations of Traditional Budgets
Control Schemes Behavioural Aspects of Budgetary Control Beyond Budgeting

iFeedback Control iEffect of the Budget Difficulty on Performance iCharacteristics
iFeedforward Control iParticipation in Budget Setting Process iSuitability
iUse of Accounting Information in Performance iBenefits
Evaluation iPrinciples for Adaptive Performance
Management
iImplementation of Beyond Budgeting
iTraditional vs. Beyond Budgeting
Feed-forward Control
Budgetary Control In certain cases, we may be able to measure the amount of error
Budget is an estimation of revenues and expenses over a specified before it has actually taken place. We may thus be able to place a
future period of time which needs to be compiled and re-evaluated control mechanism before the error takes place. Feed-forward
on a periodic basis based on the needs of the organisation. Control is one such Controlling system.
Budgetary Control is the process by which budgets are prepared
for the future period and are compared with the actual performance According to the CIMA’s Official Terminology, It is defined as the
for finding out variances, if any. In other words, Budgetary Control ‘forecasting of differences between actual and planned outcomes
is a process with the help of which, managers set financial and and the implementation of actions before the event, to avoid such
performance goals, compare the actual results with the budgets, and differences.’
adjust performance, as it is needed.
A feed-forward control system operates by comparing budgeted
)HHGEDFNDQG)HHG)RUZDUG&RQWURO results against a forecast. Control action is triggered by differences
Feedback and Feed-forward are two types of control schemes between budgeted and forecasted results.
for systems that react automatically to changing environmental
Any manager who ignores feed-forward control will contribute to the
dynamics.
downfall of a company.
Performance Levels, System Objectives etc. Limitations
The feed-forward process is an evaluation Study of future is not well developed;

Controller (Comparisons, Analysis, Decision) process and is concerned with the estimates neither are the tools that have
of uncertain future. This problem of potential for overcoming the problem
uncertainty is likely to limit application of of uncertainty.
the concept.
Feedforward Information Controlled Variables Feedback Information )

(System Inputs) (Outcome Measurement)
7KH(IIHFWRI%XGJHW'LIÀFXOW\RQ
System being Controlled Performance
Non-controllable Variables Outcomes
(Environmental Disturbances) (System Outputs)
Optimal
Performance Budget
Expectations Budget
)HHGEDFN&RQWURO Budget Level
Feedback as the name suggests is a reaction after an action has taken

place. So, there has to be an error if we want to take corrective actions. Adverse Budget
Variance
Performance
According to the CIMA’s Official Terminology, It is defined as:

‘Measurement of differences between planned outputs and actual
outputs achieved, and the modification of subsequent action and/
or plans to achieve future required results. Feedback control is an
integral part of budgetary control and standard costing systems.’
Actual
A feedback system would simply compare the actual historical results Performance
with the budgeted results.
Limitations Easy Budget Difficulty Difficult
Feedback control system does have some operational limitations.
First, it depends heavily on success of the error detection system.
Second, there may be a time lag between the error detection, error “Budget level that motivates the best level of performance may not
confirmation, and error revision during which actual results may be achievable. In contrast, the budget that is expected to be achieved
change again. motivates a lower level of performance as managers no longer aspire to

meet the budget target.” The balanced scorecard approach of Kaplan

and Norton, and the building block approach of Fitzgerald and
Beyond Budgeting (BB)
Norton can be a great help in ensuring that objectives (or targets),
Developed Time-
or budgets are set for a very wide range of factors, both financial and and consuming and Constrain
non-financial. updated too costly to put responsiveness
infrequently, together and flexibility
usually
annually
Circumstances Where Top-Down Budget Setting is
3UHIHUDEOH
Concentrate Limitations
on cost of Traditional
reduction and Budgets Often a
Where personality characteristics of the Where participation by itself is not not on value barrier to
participation may limit the benefits of adequate in ensuring commitment to creation change
participation standards and managers can significantly
influence the results
Add little Rarely
Circumstances Where Top-Down value, strategically
Budget Setting is Preferable especially focused and
given the time are often
required to contradictory
prepare
Where a process is highly programmable Where a firm has large number of

and clear, stable input-output homogeneous units and operating in a To overcome these limitations a tool came into force known as
relationships stable environment Beyond Budgeting. Beyond Budgeting is a leadership philosophy
that relates to an alternative approach to budgeting which should be
used instead of traditional annual budgeting.
Use of Accounting Information in Performance Eval- According to CIMA’s Official Terminology- ‘An idea that
uation companies need to move beyond budgeting because of the
inherent flaws in budgeting especially when used to set contracts.
Some dysfunctional consequences that arise with accounting
It is argued that a range of techniques, such as rolling forecasts
measures of performance may not be due to the insufficiency of and market related targets, can take the place of traditional
the performance measures, but rather may be outcome from the budgeting.’
way in which the accounting measures are used. The accounting
information provided by an accounting system must be interpreted BB identifies its two main advantages.
and used with care. i It is a more adaptive process than traditional budgeting.
Hofstede (1968) found that stress on the actual results in i It is a decentralised process, unlike traditional budgeting where
performance evaluation led to more extensive use of budgetary leaders plan and control organisations centrally.
information, and this made the budget more relevant. However, this
stress was associated with a feeling that the performance appraisal Implementation of Beyond Budgeting
was unjust. To overcome this problem, the correct balance must be There are nine steps that Hope and Fraser consider to be essential to
established when the budgeted performance is evaluated. implementing the Beyond Budgeting approach.
Hopwood (1976) observed three distinct styles of using
budget and actual cost information in performance evaluation in Define the Case for Change Behaviour –
manufacturing division of a large US company: Change and Provide Rethink the Role of New Processes, Not
an Outline Vision Finance Management Orders
i Budget Constrained Style: The evaluation is based upon the Cost
Centre head’s ability continually to meet the budget on short
term basis.
i Profit Conscious Style: Performance of the Cost Centre’s head is Be Prepared to Train and Educate Evaluate the Benefits
Convince the Board People
linked to ability in increase the general effectiveness of his unit’s
operations in relation to the long- term goals of the organisation.
i Non-Accounting Style: Accounting data plays a relatively
Design and
unimportant part in the supervisor’s evaluation of the Cost Get Started Implement New Consolidate the Gains
Centre head’s performance. Processes
A Summary of the Effects of Three Styles of Management
Style of Evaluation Conclusion on Budgeting

Budget- Profit - Non-
Constrained Conscious Accounting Shift from the top-down, It highlights the level
Budgeting is evolving, centralised process to of improvement that
Involvement with Costs High High Low rather than becoming a more participative, can be achieved even
obsolete- it depends on bottom-up exercise in with relatively simple
Job-related Tension High Medium Medium trust and transparency. many firms. modifications and a great
deal of trust.
Manipulation of Extensive Little Little
Accounting Information Budgeting has changed, the
change has been neither
Relations with Superiors Poor Good Good dramatic nor radical. Instead, Forecasting in fact is more
incremental improvements, important.
Relations with Poor Good Good with traditional budgets being
Colleagues supplemented by new tools and
techniques.

CASE STUDY
Essentials for Case Study
i Case Study is not about the quantity, but the quality. i Quality of discussion on each issue which is most important,
i Prepare a plan for each issue. not the ranking order.
i Decide what models to use and prioritize the issues. i Discuss each of the issues in depth, explaining their impact.
i Identify the impact and alternative actions that could be taken, i Do not leave any of the issues undecided.
as well as the relevant concepts and calculations required. i Recommendations should include ‘what to do’, ‘why to do it’
i Answer should have a logical flow. and ‘how to do it’.
i Offer a detailed analysis of the issues and conclude with sound, i Identify ethical issues and then briefly justify.
well justified recommendations. i Recommendation should appear at the end of the report.
i Not to spend too much time on calculations. i Practice makes perfect.
i Do not place too much attention and time on the presentation.
Note:
Not all topics of SCMPE have been covered in this capsule. However, our selection doesn’t attach more importance to some topics and less
to others.

“Competition on dimensions other than price—on product features, support services, delivery time, or brand image,
for instance—is less likely to erode profitability because it improves customer value and can support higher prices.”
– Michael Porter
STANDARD COSTING
Planning & Operational Variances
CHAPTER OVERVIEW
When the current environmental conditions are different from
Contemporary the anticipated environmental conditions (prevailing at the time
Behavioural Issues Standard Costing Business Environmet of setting standard or plans) the use of routine analysis of variance
for measuring managerial performance is not desirable / suitable.
The variance analysis can be useful for measuring managerial
Analysis of Advanced performance if the variances computed are determined on the basis
Variances Reconcilliation of Profit Reporting of Variances of revised targets / standards based on current actual environmental
t 1MBOOJOH BOE t #VEHFUFE 1SPmU
conditions.
t 7BSJBODF In order to deal with the above situation i.e. to measure managerial
Operational variances to Actual Profit Investigation
t 7BSJBODF "OBMZTJT (Absorption Techniques performance with reference to material, labour and sales variances,
in Activity Based Costing)
Environment t #VEHFUFE 1SPmU
t 1PTTJCMF it is necessary to compute the Planning and Operational Variances.
Interdependence
t 3FMFWBOU $PTU "QQSPBDI to Actual Profit between Variances
to Variance Analysis (Marginal Costing) t *OUFSQSFUBUJPO PG
t 7BSJBODF "OBMZTJT BOE t 4UBOEBSE 1SPmU UP Variances
Throughput Accounting Actual Profit
t -FBSOJOH $VSWF*NQBDU A Planning An Operational Variance simply
on Variances Planning Variance Variance simply compares the actual results
t 7BSJBODF "OBMZTJT JO compares a against the revised amount.
t *OUFHSBUJPO PG
Advanced
Standard Costing with revised standard Operating Variances would be
Manufacturing
Environment Marginal Costing to the original calculated after the planning
- Service Industry standard. variances have been established
- Public Sector
Operational Variance
and are thus a realistic way of
Classification of assessing performance.
variances caused
by ex-ante budget Classification of variances
allowances being in which non-standard
ANALYSIS OF ADVANCED VARIANCES changed to an performance is defined as being
Variance analysis is examinable both at Intermediate Level (Cost ex post basis. that which differs from an ex
and Management Accounting) and at Final Level (Strategic Cost Also, known as a post standard. Operational
Management and Performance Evaluation). One main difference revision variance. variances can relate to any
in syllabus between the two papers is that the Final Level syllabus element of the standard product
includes analysis of advanced variances, as follows: specification.
Standard ex ante
Before the event. An ex ante budget or standard is set before a period
Planning and of activity commences.
Operational
Standard, ex post
Variances After the event. An ex post budget, or standard, is set after the end
of a period of activity, when it can represent the optimum achievable
Variance level of performance in the conditions which were experienced.
Advanced Thus, the budget can be flexed, and standards can reflect factors
Analysisi n
Environment/ such as unanticipated changes in technology and in price levels.
Activity Based
Services This approach may be used in conjunction with sophisticated cost
Costing and revenue modelling to determine how far both the plan and the
achieved results differed from the performance that would have been
Advanced expected in the circumstances which were experienced.
Variances
compared with
Actual Results Ex-ante Standard
=Total Variance
Variance
Learning Curve split into
Analysisa nd
Impact o n P
by nt O orti
Variances ble e
pe on
Accounting lla gem
ra U
tio n
o
r a na con
nt an l M tr
Co l M an olla
Relevant Cost t i on ona ag bl
r ti em e b
Approacht o Po era en y
p t
Variance O
Analysis
Actual compared Ex-post Ex-post compared Ex-ante
Results Standard Standard Standard
with with
= Operational Variances = Planning Variances
(valued in Opportunity Cost terms)

Direct Material Usage Variance Direct Labour Rate Variance
Traditional Variance
Traditional Variance Actual vs. Original Standard
Actual vs. Original Standard [Standard Rate – Actual Rate] × Actual
Time
[Standard Quantity – Actual Quantity] ×
Standard Price
Planning Variance Operational Variance

Planning Variance Operational Variance Revised Standard vs. Actual vs. Revised
Original Standard Standard
Revised Standard vs. Actual vs. Revised
Original Standard Standard [Standard Rate – Revised [Revised Standard Rate –
Standard Rate] × Revised Actual Rate] × Actual Time
[Standard Quantity – [Revised Standard Quantity Standard Time
Revised Standard Quantity] – Actual Quantity] ×
× Standard Price Revised Standard Price
Note:
Direct Labour Efficiency Operational Variance using Standard
Rate, and the Direct Labour Rate Planning Variance based on
Direct Material Price Variance Actual Hours can also be calculated. This approach reconciles
the Direct Labour Rate Variance and Direct Labour Efficiency
Traditional Variance Variance calculated in part.
Actual vs. Original Standard
[Standard Price – Actual Price] × Actual
The conventional Sales Volume Variance reports the difference
Quantity between actual and budgeted sales valued at the standard price
per unit. The variance just indicates whether sales volume is
greater or less than expected. It does not indicate how will sales
management has performed. In order to assess the performance
of sales management, market conditions prevailing during the
period should be taken into consideration.
Planning Variance Operational Variance
Revised Standard vs. Actual vs. Revised Accordingly, the sales volume variance can be sub-divided into
Original Standard Standard a planning variance (market size variance) and operational
[Standard Price – Revised [Revised Standard Price variance (market share variance).
Standard Price] × Revised – Actual Price] × Actual
Standard Quantity Quantity
A Planning Variance simply compares a revised standard to the
original standard. An Operational Variance simply compares
Note: the actual results against the revised amount. Controllable
Variances are those variances which arises due to inefficiency of
Direct Material Usage Operational Variance using Standard a cost centre /department. Uncontrollable Variances are those
Price, and the Direct Material Price Planning Variance based on variances which arises due to factors beyond the control of the
Actual Quantity can also be calculated. This approach reconciles management or concerned department of the organization.
the Direct Material Price Variance and Direct Material Usage
Variance calculated in part. Planning variances are generally not controllable. Where
a revision of standards is required due to environmental/
technological changes that were not anticipated at the time
Like Material Variances, here also Labour Efficiency and Wage Rate the budget was prepared, the planning variances are truly
Variances should also be adjusted to reflect changes in environmental uncontrollable. However, standards that failed to anticipate
conditions that prevailed during the period. known market trends when they were set will reflect faulty
standard-setting: it could be argued that these variances were
controllable at the planning stage.
Direct Labour Efficiency Variance

Variance Analysis in Activity-Based Costing
Variance analysis can be applied to activity costs (such as setup
Traditional Variance costs, product testing, quality testing etc.) to gain understanding
Actual vs. Original Standard into why actual activity costs vary from activity costs in the static
[Standard Time – Actual Time] × Standard budget or in the flexible budget.
Rate Interpreting cost variances for different activities requires
understanding whether the costs are output unit-level, batch
level, product sustaining, or facility sustaining costs2.
We use the similar track to variance analysis for activity-
Planning Variance Operational Variance based costing as for traditional costing. The price variance is
the difference between standard price and actual price for the
Revised Standard vs. Actual vs. Revised
Standard actual quantity of input used for each cost driver. The efficiency
Original Standard
variance measures the difference between the actual amount
[Standard Time – Revised [Revised Standard Time of cost driver units used, and the standard allowed to make the
Standard Time] × Standard – Actual Time] × Revised
Standard Rate output. We multiply the difference in quantities by the standard
Rate
price per cost driver to get the rupee value of the variance3.

devices, Nanotechnology, Semiconductors, Telecommunication

ABC approach is based on the assumption that the overheads apply the model somewhat differently. Now much of electronic
are basically variable (but variable with the delivery numbers industry is highly automated. A large part of manufacturing
and not the units output). The efficiency variance reports the process is computerized.
cost impact of undertaking more or less activities than standard,
and the expenditure variance reports cost impact of paying
more or less than standard for the actual activities undertaken4. In the high-technology environment that is emerging, many
costs that once were largely variable have become fixed,
most becoming committed fixed cost. Some high technology
Learning Curve- Impact on Variances manufacturing organizations have found that the two largest
Learning curve is a geometrical progression, which reveals variable costs involve materials and power to operate machines.
that there is steadily decreasing cost for the accomplishment In these companies, the emphasis of variance analysis is placed
of a given repetitive operation, as the identical operation is on direct materials and variable manufacturing overhead.
increasingly repeated. The amount of decrease will be less and
less with each successive unit produced. As more units are Much of the manufacturing labour consists of highly skilled
produced, people involved in production become more efficient experts/ operators/ programmers are largely committed
than before. Each additional unit takes less time to produce. The cost. Firms don’t want to take risk losing such highly trained
amount of improvement or experience gained is reflected in a personnel even during an economic downturn. The result is
decrease in man-hours or cost. Where learning takes place with less direct labour and more overhead. For these firms labour
a regular pattern it is important to take account of reduction in variances may no longer be meaningful because direct labour is a
labour hours and cost per unit. committed cost, not a cost expected to vary with output.
Automated manufacturing is unlikely to have much variation or Standard Costing in Service Sector
to display a regular learning curve. In less-automated processes, Standard Costing can be equally applicable for various types
however, where learning curves do occur, it is important to take of industries for example accountants, solicitors, dentists,
the resulting decline in labour hours and costs into account in hairdressers, transport companies and hotels. Service industries
setting standards, determining prices, planning production, or comprise a wide range of different businesses that differ in size
setting up work schedules. and types of service provided. Standard costing and variance
analysis is more tough to apply to service sector organizations
With the help of the learning curve theory the standard time of as major portion of their cost is comprised of overhead expenses
any batch or unit can be computed then compare the actual data rather than production expenses. While traditional variance
with the standard and compute the variances. analysis of overheads does not deliver very useful information
for overheads control purposes, application of activity based
Relevant Cost Approach to Variance Analysis costing can provide an effective basis for variance analysis of
Traditional approach to variance analysis is to compute overheads in service sector organizations although this may need
variances based on total actual cost for production inputs and significant time and effort in the implementation of a MIS.
total standard cost applied to the production output. This is
ambiguous, when inputs are limited. Failure to use limited inputs
McDonaldization5
properly leads not only to increased acquisition cost but also to
a lost contribution. Therefore, it is necessary to consider the lost McDonaldization is a process of rationalisation, which takes
contribution in variance analysis. When this approach is used, a task and breaks it down into smaller tasks. This is repeated
price or expenditure variances are not affected. until all tasks have been broken down to the smallest possible
level. The resulting tasks are then rationalised to find the
Variance Analysis and Throughput Accounting single most efficient method for completing each task. All
Variance analysis has no emphasis on the constrained resources. other methods are then deemed inefficient and discarded.
Instead, it is based on the efficiency and cost of operation of each
part of the manufacturing system, rather than the ability of the The impact of McDonaldization is that standards can be
entire system to generate a profit. Thus, a firm may find that it more accurately set and assessed. It can be easily ascertained
attains excellent efficiency and price variances by having long that how much time and cost should go into each activity.
manufacturing rounds and buying in large quantities. A system The principles can be applied to many other services, such as
based on constraint management will likely show very odd hairdressing, dentistry, or opticians' services.
results under a variance reporting system.
Standard Costing in Public Sector6
For example, when a terminal upstream from the constrained In order to cost control in public sector (e.g. street cleaning
resource runs out of work, a manager functioning under throughput refuse disposal and so on), regular variance analysis is required.
accounting system will shut it down in order to avoid the formation Actual unit costs should be calculated on a monthly basis and
of an unnecessary level of work-in-process inventory. However, compared with estimated unit cost. To achieve this comparison,
this will result into a negative labor efficiency variance, since the information needs to be maintained about the unit of service
terminal’s staff is not actively producing anything.
adopted. For example, statistics would be maintained on the
number of visits made and the number of hours worked. In
Throughput accounting does use variance analysis, but not the this example, time recording may be beneficial in providing the
ones used by a traditional system. Instead, its main emphasis is detailed information necessary for variance analysis. Actual
on tracking variations in the size of the inventory buffer placed monthly costs should be taken from the organisation’s financial
before the constrained resource, to confirm that the constraint management system and each month financial reports should be
is never halted due to an inventory shortage.
produced which offer an accurate image of budgeted vs actual
expenditure. These reports are must for budgetary control.
Variance Analysis in Advanced Manufacturing Environment/ Actual expenditure reported on financial systems may require
High-Technology Firms some modification to take account of:
The variance analysis generally applies to all types of i Trade Payables (services used but bills unpaid)
organizations; however, high-technology firms like Audio i Accruals (services used but bills yet to be received)
Technology, Automotive, Computer Engineering, Electrical i Timing Differences (some costs are not incurred evenly over
and Electronic Engineering, Information Technology, Medical the year)

STANDARD MARGINAL COSTING Reconciliation Statement-II

Budgeted Profit to Actual Profit (Marginal Costing)
Standards and Variances can be calculated on the basis of marginal
costing. A standard marginal costing system incorporates
only costs which are variable to the product. Accordingly, the Budgeted Profit
absorption of fixed costs, and the variances derived therefrom, (Budgeted Quantity × Standard Margin)
do not feature in a standard marginal costing system. When
Effect of Variances
Marginal Costing is in use there is no Overhead Volume
Variance, because Marginal Costing does not absorb Fixed Material Cost Variance
Overhead. Fixed Overhead Expenditure Variance is the only Material Price Variance
variance for Fixed Overhead in a Marginal Costing system. It is
calculated as in an Absorption Costing system. Material Usage Variance
Material Mix Variance
Material Yield Variance
RECONCILIATION OF PROFIT
Labour Cost Variance
Generally, under variance analysis we compute various variances
from the actual and the standard/budgeted data. Sometimes all Labour Rate Variance
or a few variances and actual data are made available and from Labour Idle Time Variance
that we are required to prepare standard product cost sheet,
original budget and to reconcile the budgeted profit with the Labour Efficiency Variance
actual profit. Some important concepts are given below: Labour Mix Variance
Reconciliation Statement-I Labour Sub-Efficiency Variance
Budgeted Profit to Actual Profit (Absorption Costing) Variable Overhead Cost Variances
Variable Overhead Expenditure
Budgeted Profit Variance
(Budgeted Quantity × Standard Margin) Variable Overhead Efficiency Variance
Effect of Variances Fixed Overhead Cost Variances
Material Cost Variance Fixed Overhead Expenditure Variance
Material Price Variance Fixed Overhead Volume Variance
Material Usage Variance Fixed Overhead Capacity Variance NA
Material Mix Variance Fixed Overhead Efficiency Variance NA NA
Material Yield Variance Sales Contribution Variances
Labour Cost Variance Sales Contribution Price Variance
Labour Rate Variance Sales Contribution Volume Variance
Labour Idle Time Variance Sales Contribution Mix Variance
Labour Efficiency Variance Sales Contribution Quantity
Variance
Labour Mix Variance
Actual Profit
Labour Sub-Efficiency Variance
Variable Overhead Cost Variances
Variance
Variable Overhead Efficiency Variance
Fixed Overhead Cost Variances
Fixed Overhead Expenditure Variance
Fixed Overhead Volume Variance
Fixed Overhead Capacity Variance
Fixed Overhead Efficiency Variance
Sales Margin Variances (in terms of
Profit)
Sales Margin Price Variance
Sales Margin Volume Variance
Sales Margin Mix Variance
Sales Margin Quantity Variance
Actual Profit

Reconciliation Statement-III INVESTIGATION OF VARIANCES

Standard Profit to Actual Profit (Absorption Costing)
Variances focus attention on deviations, but all deviations
cannot be taken as ‘out of Control’ situations. However, variance
Standard Profit investigation on the other hand may not be fruitful in any given
(Actual Quantity × Standard Margin) situation considering that it requires resources and thus a cost
Effect of Variances benefit analysis should be considered before undertaking
investigation.
Material Cost Variance
Material Price Variance Investigating variances is a key step in using variance analysis as
part of performance management. “Interpretation may suggest
Material Usage Variance possible cause of variances but investigation must arrive at
Material Mix Variance definite conclusions about the cause of the variance so that action
Material Yield Variance to correct the variance can be effective.” There are behavioural
as well as technical consequences to the decision to investigate
Labour Cost Variance variances. If no variances are investigated, it may cease to be
Labour Rate Variance motivated by the system which produce variances. Investigating
Labour Idle Time Variance favourable and adverse variances may create positive behavioural
reinforcements, with implications for motivation, aspiration
Labour Efficiency Variance levels and inter-departmental relationships.
Labour Mix Variance Factors to be Considered When Investigating Variance
Labour Sub-Efficiency Variance Certain set of factors should be considered before undertaking
Variable Overhead Cost Variances the variance investigation of the actual performance against the
estimates set.
Variance
Variable Overhead Efficiency Variance
Size: A standard is seen as an average of the estimates
Fixed Overhead Cost Variances and therefore small variations seen from the standard
Fixed Overhead Expenditure Variance should be ignored and not investigated further. In
addition, organizations can establish limits and
Fixed Overhead Volume Variance
the variances seen beyond those limits should be
Fixed Overhead Capacity Variance undertaken for further investigation.
Sales Margin Variance (in terms of
Profit)
Sales Margin Price Variance Type of Variance: Adverse variance is given more
importance by the organization over favourable
Sales Margin Volume Variance
variances seen with regards to the estimates.
Sales Margin Mix Variance NA
Sales Margin Quantity Variance NA NA
Actual Profit
Cost: The costs associated with the undertaking of
the investigation should be lower than the benefits
associated with the investigation of variances for the
organization to undertaken the said investigation.
Pattern in Variance: The variances need to be

monitored over a period of time and if the variance of
a particular cost is seen to be worsening over time then
in that case the investigation in relation to the variance
needs to be undertaken.
Budgetary Process: In case the budgetary process is

uncontrollable and unrealistic then in that case the
investigation should be re-evaluating the budgetary
process rather than undertaking investigation of the
variances.

Method Used for Investigating Variance7
Simple Rule of Thumb Model
It is based on arbitrary criteria such as investigating if the absolute

size of a variance is greater than a certain amount or if the ratio
of the variance to the total cost exceeds some predetermined
percentage. They are based on managerial judgement and do not
consider statistical significance.
Statistical Decision Model

For the statistical models, two mutually exclusive states are
possible. First assumes that the system is 'In Control' and a
variance is simply due to random fluctuations around the
expected outcome. The second possible state is that the system is
in some way 'Out of Control' and corrective action can be taken
to remedy the situation.
POSSIBLE INTERDEPENDENCE BETWEEN

VARIANCES
It is a term used to express the way in which the cause of one
variance may be wholly or partially explained by the cause of another
variance. For control purposes, it might therefore be essential to look
at several variances together and not in isolation. Some examples of
interdependence between variances are listed below:
Use of cheaper material which is poorer quality, the

material price variance will be favourable, but this can
cause more wastage of materials leading to adverse usage
variance.
Using more skilled labour to do the work will result in an

adverse labour rate variance, but productivity might be
higher as a result due to experienced labour.
Changing the composition of a team might result in a

cheaper labour mix (favourable mix variance) but lower
productivity (adverse yield variance).
Workers trying to improve productivity (favourable

efficiency variance) in order to get bonus (adverse rate
variance) might use materials wastefully in order to save
time (adverse materials usage).
Cutting sales prices (adverse sales price variance) might

result in higher sales demand from customers (favourable
sales volume variance).
Similarly, favourable sales price variance may result in

adverse sales volume variance.

INTERPRETATION OF VARIANCES Labour Rate Variance Labour Efficiency Variance
There can be a number of potential causes leading to variances i Change in the i Learning curve effect
composition of the upon the labour
in the operational costs
workforce can impact efficiency levels.
direct labour costs.
i Resource shortages
causing an unexpected
Material delay and lowering of
Variances labour efficiency levels.
i Using inferior quality of
Sales Labour material.
Volume Rate i Introduction of new
Variance Variance machinery resulting in
improvement of labour
Interpretation productivity levels.
Fixed Overhead Variance Variable Overhead Variance

Labour
Sales Price i Fixed Overhead i Variable Overhead
Variance
Variance Expenditure Variance Expenditure Variance
(adverse) are caused by are often caused by
Overhead spending in excess of the changes in machine
Variances budget. running costs.
i Fixed Overhead Volume i Variable Overhead
Variance is caused by Efficiency Variances-
changes in production Causes are similar to
volume. those for a direct labour
Material Price Variance Material Usage Variance efficiency variance.
i Might be caused due i Purchase of inferior
to the use of a different quality material.
Sales Price Variance Sales Volume Variance
supplier. i Implementation of better
i Order size can result in quality control. i Higher discounts given i Successful or
variance. i Increased efficiency in to customers in order unsuccessful direct
i Any form of unexpected production can help in to encourage bulk selling efforts.
increase in buying costs bringing down wastage purchases. i Successful or
such as higher delivery rate. i The effect of low price unsuccessful marketing
charges. i Changes made in the offers during a marketing efforts (for example, the
i Efficiency or inefficiency material mix. campaign. effects of an advertising
associated with the i Careless way of handling i Poor performance by campaign).
buying procedure material by production sales personnel. i Unexpected changes in
adopted. department. i Market conditions or customer preferences and
i Lack of appropriate i Change in method of economic conditions buying patterns.
inventory control can production/ design. forcing changes in prices i Failure to satisfy demand
result in emergency i Pilferage of material across the industry. due to production
purchase of material from the production difficulties.
resulting in adverse department. i Higher demand due to
variance. i Poor inspection. a cut in selling prices, or
lower demand due to an
Labour Rate Variance Labour Efficiency Variance increase in sales prices.
i Unexpected increase in i Improvement in work or
the pay rate of labour. productivity efficiency. REPORTING OF VARIANCES
i Level of experience of the i Workforce mix can have Computation of variances and their reporting is not the final
labour can impact the an impact upon labour step towards the control of various elements of cost. It in fact
demands an analysis of variances from the side of the executives,
direct cost of labour. efficiency levels.
to ascertain the correct reasons for their occurrence. After
i Payment of bonuses i Industrial action in knowing the exact reasons, it becomes their responsibility to
added to the direct relation to workforce. take necessary steps so as to stop the re-occurrence of adverse
labour costs. i Poor supervision of the variances in future. To enhance the utility of such a reporting
system it is necessary that such a system of reporting should
workforce. not only be prompt but should also facilitate the concerned

managerial level to take necessary steps. Variance reports an organization's performance measurement system to be based
should be prepared after keeping in view its ultimate use and on an extensive range of quantitative and qualitative measures
its periodicity. Such reports should highlight the essential cost so as to encourage management to adopt a long-term view that is
deviations and possibilities for their improvements. In fact the aligned with an organization's strategic direction.
variance reports should give due regard to the following points:-
Ethics9
The concerned Variance analysis for evaluating performance can have strong
How close the actual ethical consequences. For example, standard costing methods
executives should be have been proposed for medicine as a means for improving
cost performance is with
informed about what performance. Interpretation of a favourable variance may
reference to standard be difficult because it either reflects insufficient treatment or
the cost performance compliance to guidelines. Most hospitals in various countries
cost performance.
should have been. are reimbursed as specified by the diagnostic related groups
(DRG). Each DRG has specified standard “length of stay”. If
a patient leaves the hospital early, the hospital is financial
impacted favourably but a patient staying longer than the
specified time costs the hospital money.
Reporting should be
The analysis and based on the principle
causes of variances. of management by
STANDARD COSTING IN CONTEMPORARY
exception.
BUSINESS ENVIRONMENT 10
Products Standard Production

not to be costs become is highly
The magnitude of outdated
variances should standardised automated
quickly
also be stated.
Often use ideal The emphasis is Analysis

BEHAVIOURAL ISSUES8 on continuous
standards may not give
Variance analysis may encourage short-termism due to their improvement enough detail
inherent tendency towards short-term, quantified objectives and
results.
A negative perception of an organization's variance analysis
process can also encourage other sub-optimal behaviour among
employees such as attempts to include budget slacks. Reports may
arrive too
The behavioural issues connected with variance analysis could late to solve
be managed by participating employees during budget setting so
problems
that they do not assess the procedure as biased. It is also vital for
FORMULAE
Operating Profit Variance
Cost Variance Sales Margin Variance
Direct Material Direct Labour Fixed Overhead Variable Overhead Sales Margin Sales Margin
Variance Variance Variance Variance Price Variance Volume Variance
Price Usage Rate Efficiency Expenditure Volume Expenditure Efficiency

Variance Variance Variance Variance Variance Variance Variance Variance Sales Margin Sales Margin
Mix Variance Quantity Variance
Mix Yield Gang Sub-efficiency Capacity Efficiency

Variance Variance Variance Variance Variance Variance Market Size Market Share
Variance Variance

Sales Variances (Absorption Costing) Sales Variances (Marginal Costing)
Sales Margin Variance* Sales Contribution Variance

(Actual Margin) Less (Budgeted Margin) (Actual Contribution) Less (Budgeted
[(AQ × AM) – (BQ × SM)] Contribution) [(AQ × AC) – (BQ × SC)]
Sales Margin Price Sales Margin Volume Sales Contribution Price Sales Contribution Volume
Variance Variance Variance Variance
(Actual Margin) Less (Standard Margin) Less (Actual Contribution) Less (Standard Contribution) Less
(Standard Margin) (Budgeted Margin) (Standard Contribution) (Budgeted Contribution)
[(AM × AQ) – (SM × AQ)] [(SM × AQ) – (SM × BQ)] [(AC × AQ) – (SC × AQ)] [(SC × AQ) – (SC × BQ)]
Or [AQ × (AM – SM)] Or [SM × (AQ – BQ)] Or [AQ × (AC – SC)] Or [SC × (AQ – BQ)]
Sales Margin Mix Sales Margin Quantity Sales Contribution Mix Sales Contribution Quantity
Variance Variance Variance Variance
(Standard Margin) Less (Revised Standard Margin) (Standard Contribution) (Revised Standard
(Revised Standard Margin) Less (Budgeted Margin) Less (Revised Standard Contribution) Less (Budgeted
(AQ × SM) – (RAQ × SM) (RAQ × SM) – (BQ × SM) Contribution) Contribution)
Or SM × (AQ – RAQ) Or SM × (RAQ – BQ) (AQ × SC) – (RAQ × SC) (RAQ × SC) – (BQ × SC)
Alternative Formula Alternative Formula Or SC × (AQ – RAQ) Or SC × (RAQ – BQ)
[Total Actual Qty. (units) × [Average Budgeted Margin Alternative Formula Alternative Formula
{Average Standard Margin per unit of Budgeted Mix × [Total Actual Qty. (units) × [Average Budgeted Contribution
per unit of Actual Mix Less {Total Actual Qty. (units) {Average Standard Contribution per unit of Budgeted Mix ×
Average Budgeted Margin Less Total Budgeted Qty. per unit of Actual Mix Less {Total Actual Qty. (units) Less
per unit of Budgeted Mix}] (units)}] Average Budgeted Contribution Total Budgeted Qty. (units)}]
per unit of Budgeted Mix}]
Market Size Variance Market Share Variance

[Budgeted Market Share [(Actual Market Share % Market Size Variance Market Share Variance
% × (Actual Industry Sales – Budgeted Market Share [Budgeted Market Share [(Actual Market Share %
Quantity in units – Budgeted %) × (Actual Industry Sales % × (Actual Industry Sales – Budgeted Market Share
Industry Sales Quantity in Quantity in units) × (Average Quantity in units – Budgeted %) × (Actual Industry Sales
units) × (Average Budgeted Budgeted Margin per unit)] Industry Sales Quantity in Quantity in units) × (Average
Margin per unit)] units) × (Average Budgeted Budgeted Contribution per
Contribution per unit)] unit)]
* in terms of profit
Note: Note:
BQ = Budgeted Sales Quantity BQ = Budgeted Sales Quantity
AQ = Actual Sales Quantity AQ = Actual Sales Quantity
RAQ = Revised Actual Sales Quantity RAQ = Revised Actual Sales Quantity
= Actual Quantity Sold Rewritten in Budgeted Proportion = Actual Quantity Sold Rewritten in Budgeted Proportion
SM = Standard Margin SC = Standard Contribution
= Standard Price per Unit – Standard Cost per Unit = Standard Price per Unit – Standard Cost (variable) per Unit
AM = Actual Margin AC = Actual Contribution
= Actual Sales Price per Unit – Standard Cost per Unit = Actual Sales Price per Unit – Standard Cost (variable) per Unit
Market Size Variance Market Size Variance

Budgeted Market Share % × (Actual Industry Sales Quantity in units Budgeted Market Share % × (Actual Industry Sales Quantity in units
– Budgeted Industry Sales Quantity in units) × (Average Budgeted – Budgeted Industry Sales Quantity in units) × (Average Budgeted
Margin per unit) Or Contribution per unit) Or
(Budgeted Market Share % × Actual Industry Sales Quantity in units – (Budgeted Market Share % × Actual Industry Sales Quantity in units –
Budgeted Market Share % × Budgeted Industry Sales Quantity in units) Budgeted Market Share % × Budgeted Industry Sales Quantity in units)
× (Average Budgeted Margin per unit) Or × (Average Budgeted Contribution per unit) Or
(Required Sales Quantity in units –Total Budgeted Quantity in units) × (Required Sales Quantity in units – Total Budgeted Quantity in units) ×
(Average Budgeted Margin per unit) (Average Budgeted Contribution per unit)
Market Share Variance Market Share Variance
(Actual Market Share % – Budgeted Market Share %) × (Actual Industry (Actual Market Share % – Budgeted Market Share %) × (Actual Industry
Sales Quantity in units) × (Average Budgeted Margin per unit) Or Sales Quantity in units) × (Average Budgeted Contribution per unit) Or
(Actual Market Share % × Actual Industry Sales Quantity in units – (Actual Market Share % × Actual Industry Sales Quantity in units –
Budgeted Market Share % × Actual Industry Sales Quantity in units) × Budgeted Market Share % × Actual Industry Sales Quantity in units) ×
(Average Budgeted Margin per unit) Or (Average Budgeted Contribution per unit) Or
(Total Actual Quantity in units– Required Sales Quantity in units) × (Total Actual Quantity in units– Required Sales Quantity in units) ×
(Average Budgeted Margin per unit) (Average Budgeted Contribution per unit)
Market Size Variance + Market Share Variance
Market Size Variance + Market Share Variance
(Required Sales Quantity in units – Total Budgeted Quantity in (Required Sales Quantity in units – Total Budgeted Quantity in
units) × (Average Budgeted Margin per unit) Add units) × (Average Budgeted Contribution per unit) Add
(Total Actual Quantity in units– Required Sales Quantity in units) × (Total Actual Quantity in units– Required Sales Quantity in units) ×
(Average Budgeted Margin per unit) Equals to (Average Budgeted Contribution per unit) Equals to
(Total Actual Quantity in units – Total Budgeted Quantity in units) (Total Actual Quantity in units – Total Budgeted Quantity in units)
× (Average Budgeted Margin per unit) × (Average Budgeted Contribution per unit)
Sales Margin Quantity Variance Sales Contribution Quantity Variance

Market Size Variance

i Sales Price Variance is equal to Sales Margin/ Contribution
Price Variance. This is because, for the actual quantity sold, Budgeted Market Share % × (Actual Industry Sales Quantity in units –
standard cost remaining constant, change in selling price will Budgeted Industry Sales Quantity in units) × (Average Budgeted Price
have equal impact or turnover and profit/ contribution. per unit) Or
i Sales Margin Volume Variance is equal to Sales Volume (Budgeted Market Share % × Actual Industry Sales Quantity in units –
Variance × Budgeted Net Profit Ratio Budgeted Market Share % × Budgeted Industry Sales Quantity in units)
i Sales Contribution Volume Variance is equal to Sales × (Average Budgeted Price per unit) Or
Volume Variance × Budgeted PV Ratio (Required Sales Quantity in units –Total Budgeted Quantity in units) ×
(Average Budgeted Price per unit)
Market Share Variance
A Relation
Sales Margin Volume Variance in terms of Profit & Contribution (Actual Market Share % – Budgeted Market Share %) × (Actual Industry
Sales Quantity in units) × (Average Budgeted Price per unit) Or
Sales Margin Volume Standard Margin Per Unit × (Actual (Actual Market Share % × Actual Industry Sales Quantity in units –
Variance Quantity − Budgeted Quantity) Or Budgeted Market Share % × Actual Industry Sales Quantity in units) ×
Sales Margin Volume [Standard Contribution Per Unit (Average Budgeted Price per unit) Or
Variance − Standard Fixed Overheads Per (Total Actual Quantity in units– Required Sales Quantity in units) ×
Unit] × (Actual Quantity − Budgeted (Average Budgeted Price per unit)
Quantity) Or
Sales Margin Volume [Standard Contribution Per Unit Market Size Variance + Market Share Variance
Variance × (Actual Quantity − Budgeted
Quantity)] − [Standard Fixed (Required Sales Quantity in units – Total Budgeted Quantity in
Overheads Per Unit × (Actual units) × (Average Budgeted Price per unit) Add
Quantity − Budgeted Quantity)] Or (Total Actual Quantity in units– Required Sales Quantity in units) ×
Sales Margin Volume Sales Contribution Volume Variance (Average Budgeted Price per unit) Equals to
Variance − Fixed Overhead Volume Variance
Or (Total Actual Quantity in units – Total Budgeted Quantity in units)
Sales Contribution Sales Margin Volume Variance + × (Average Budgeted Price per unit)
Volume Variance Fixed Overhead Volume Variance
Sales Quantity Variance
Note: Production units equals to Sales units for both actual &
budget. Direct Material Variances
Direct Material Total Variance#
Sales Variances (Turnover or Value) [Standard Cost* Less Actual Cost]
(The difference between the Standard Direct Material Cost
Sales Variance of the actual production volume and the Actual Cost of
(Actual Sales ) Less (Budgeted Sales) Direct Material)
[(AQ × AP) – (BQ × SP)] [(SQ × SP) – (AQ × AP)]
Sales Price Variance Sales Volume Variance Direct Material Price Direct Material Usage Variance
(Actual Sales) Less (Standard Sales) Less Variance [Standard Cost of Standard
(Standard Sales) (Budgeted Sales) [Standard Cost of Actual Quantity for Actual Production
[(AP × AQ) – (SP × AQ)] [(SP × AQ) – (SP × BQ)] Quantity Less Actual Cost] Less Standard Cost of Actual
Or [AQ × (AP – SP)] Or [SP × (AQ – BQ)] (The difference between the Quantity]
Standard Price and Actual (The difference between the
Price for the Actual Quantity) Standard Quantity specified for
Sales Mix Variance Sales Quantity Variance actual production and the Actual
(Standard Sales) Less (Revised Standard Sales) Less Quantity used, at Standard
(Revised Standard Sales) (Budgeted Sales) Purchase Price)
[(SP – AP) × AQ] [(SQ – AQ) × SP]
(AQ × SP) – (RAQ × SP) (RAQ × SP) – (BQ × SP) Or Or
Or SP × (AQ – RAQ) Or SP × (RAQ – BQ) [(SP × AQ) – (AP × AQ)] [(SQ × SP) – (AQ × SP)]
Alternative Formula Alternative Formula
[Total Actual Qty. (units) [Average Budgeted Price per
× {Average Standard Price unit of Budgeted Mix × {Total Direct Material Yield Direct Material Mix
per unit of Actual Mix Less Actual Qty. (units) Less Total Variance Variance
Average Budgeted Price per Budgeted Qty. (units)}] [Standard Cost of Standard [Standard Cost of Actual
Quantity for Actual Quantity in Standard
unit of Budgeted Mix}]
Production Less Standard Proportion Less Standard
Cost of Actual Quantity in Cost of Actual Quantity]
Standard Proportion] (The difference between
(The difference between the the Actual Quantity in
Market Size Variance Market Share Variance Standard Quantity specified standard proportion and
[Budgeted Market Share % × [(Actual Market Share % for actual production and Actual Quantity in actual
(Actual Industry Sales Quantity in – Budgeted Market Share Actual Quantity in standard proportion, at Standard
units – Budgeted Industry Sales %) × (Actual Industry Sales proportion, at Standard Purchase Price)
Quantity in units) × (Average Quantity in units) × (Average Purchase Price)
Budgeted Price per unit)] Budgeted Price per unit)] [(SQ – RAQ) × SP] [(RAQ – AQ) × SP]
Or Or
[(SQ × SP) – (RAQ × SP)] [(RAQ × SP) – (AQ × SP)]
Note: Alternative Formula Alternative Formula
BQ = Budgeted Sales Quantity [Average Standard Price per [Total Actual Quantity (units)
AQ = Actual Sales Quantity
unit of Standard Mix × {Total × {Average Standard Price per
RAQ = Revised Actual Sales Quantity
Standard Quantity (units) unit of Standard Mix Less
= Actual Quantity Sold Rewritten in Budgeted Proportion
SP = Standard Selling Price per Unit
Less Total Actual Quantity Average Standard Price per
AP = Actual Selling Price per Unit
(units)}] unit of Actual Mix}]

Note: Direct Labour

SQ = Standard Quantity = Expected Consumption for Actual Output Idle Time Variance
AQ = Actual Quantity of Material Consumed
RAQ = Revised Actual Quantity = Actual Quantity Rewritten in [Standard Rate per Hour × Actual Idle
Standard Proportion Hours]
SP = Standard Price per Unit
AP = Actual Price per Unit (The difference between the Actual
(*) = Standard Cost refers to ‘Standard Cost of Standard Quantity for Hours paid and Actual Hours worked at
Actual Output’ Standard Rate)
(#) = Direct Material Total Variance (also known as material cost
variance) [(AH* – AH#) × SR]
Or
[(AH* × SR) – (AH# × SR)]
Material Purchase Price Variance
[Standard Cost of Actual Quantity – Note:
Actual Cost] SH = Standard Hours = Expected time (Time allowed) for Actual
(The difference between the Standard Output
Price and Actual Price for the actual AH* = Actual Hours paid for
quantity of material purchased) AH #
= Actual Hours worked
[(SP – AP) × PQ] RAH = Revised Actual Hours = Actual Hours (worked) rewritten in
Or Standard Proportion
[(SP × PQ) – (AP × PQ)] SR = Standard Rate per Labour Hour
AR = Actual Rate per Labour Hour Paid
(b) = Standard Cost refers to ‘Standard Cost of Standard Time for
Note: Actual Output’
PQ = Purchase Quantity ()
a
= Direct Labour Total Variance (also known as labour cost
SP = Standard Price variance)
AP = Actual Price In the absence of idle time
Actual Hours Worked = Actual Hours Paid
Direct Labour Variances

Idle Time is a period for which a workstation is available for
Direct Labour Total Variancea production but is not used due to e.g. shortage of tooling,
[Standard Costb – Actual Cost] material, or operators. During Idle Time, Direct Labour Wages
(The difference between the Standard Direct are being paid but no output is being produced. The cost of this
Direct Labour Cost and the Actual Direct Labour
Labour can be identified separately in an Idle Time Variance, so that it is
Cost incurred for the production achieved)
Idle Time not ‘hidden’ in an adverse Labour Efficiency Variance.
[(SH × SR) – (AH* × AR)]
Variance
Some organizations face Idle Time on regular basis. In this
situation, the Standard Labour Rate may include an allowance
Direct Labour Rate Direct Labour Efficiency for the cost of the expected idle time. Only the impact of any
Variance Variance unexpected or abnormal Idle Time would be included in the Idle
[Standard Cost of Actual [Standard Cost of Standard
Time – Actual Cost] Time for Actual Production – Time Variance.
(The difference between the Standard Cost of Actual Time]
Standard Rate per hour and (The difference between the Fixed Production Overhead Variances
Actual Rate per hour for the Standard Hours specified for
Actual Hours paid) actual production and Actual Fixed Overhead Total Variance@
Hours worked at Standard Rate) (Absorbed Fixed Overheads) Less
[(SR – AR) × AH*] Or [(SH – AH#) × SR] Or
[(SR × AH*) – (AR × AH*)] [(SH × SR) – (AH# × SR)] (Actual Fixed Overheads)
Fixed Overhead Fixed Overhead

Direct Labour Mix Variance Direct Labour Yield Variance Expenditure Volume
Or Gang Variance Or Sub-Efficiency Variance Variance Variance
[Standard Cost of Actual Time [Standard Cost of Standard
Worked in Standard Proportion Time for Actual Production (Budgeted Fixed Overheads) (Absorbed Fixed Overheads)
– Standard Cost of Actual Time – Standard Cost of Actual Less Less
Worked] Time Worked in Standard (Actual Fixed Overheads) (Budgeted Fixed Overheads)
(The difference between Proportion]
the Actual Hours worked (The difference between the
in standard proportion and Standard Hours specified for Fixed Overhead Efficiency Variance
Actual Hours worked in actual actual production and Actual (Absorbed Fixed Overheads)
proportion, at Standard Rate) Hours worked in standard Less
[(RAH – AH#) × SR] Or proportion, at Standard Rate) (Budgeted Fixed Overheads for Actual
[(RAH × SR) – (AH# × SR)] (SH – RAH) × SR Or
Alternative Formula (SH × SR) – (RAH × SR) Hours#)
[Total Actual Time Worked Alternative Formula
(hours) × {Average Standard [Average Standard Rate per
Rate per hour of Standard Gang hour of Standard Gang × Fixed Overhead Capacity Variance
Less Average Standard Rate per {Total Standard Time (hours) (Budgeted Fixed Overheads for Actual
hour of Actual Gang@}] Less Total Actual Time Hours#)
@
on the basis of hours worked Worked (hours)}] Less
(Budgeted Fixed Overheads)
Or

Fixed Overhead Capacity Variance

Fixed Overhead Total Variance@
(Absorbed Fixed Overheads) Less (Budgeted Fixed Overheads for Actual Hours) – (Budgeted Fixed
(Actual Fixed Overheads) Overheads) Or
(Standard Fixed Overhead Rate per Hour × Actual Hours) –
(Standard Fixed Overhead Rate per Hour × Budgeted Hours) Or
Standard Fixed Overhead Rate per Hour × (Actual Hours –
Fixed Overhead Fixed Overhead Budgeted Hours)
Expenditure Volume
Variance Variance Fixed Overhead Volume Variance-I
(Budgeted Fixed Overheads) (Absorbed Fixed Overheads) (Absorbed Fixed Overheads) – (Budgeted Fixed Overheads) Or
Less Less (Standard Fixed Overhead Rate per Unit × Actual Output) –
(Actual Fixed Overheads) (Budgeted Fixed Overheads) (Standard Fixed Overhead Rate per Unit × Budgeted Output) Or
Standard Fixed Overhead Rate per Unit × (Actual Output –
Budgeted Output)
Fixed Overhead Calendar Variance
(Possible Fixed Overheads)
Less Fixed Overhead Volume Variance-II
(Budgeted Fixed Overheads) (Absorbed Fixed Overheads) – (Budgeted Fixed Overheads)
Or
(Standard Fixed Overhead Rate per Hour × Standard Hours for
Actual Output) – (Standard Fixed Overhead Rate per Hour ×
Fixed Overhead Capacity Variance Budgeted Hours)
(Budgeted Fixed Overheads for Actual Or
Hours#) Standard Fixed Overhead Rate per Hour × (Standard Hours for
Less Actual Output – Budgeted Hours)
(Possible Fixed Overheads) Or
Standard Fixed Overhead Rate per Hour × (Standard Hours per
Unit × Actual Output – Standard Hours per Unit × Budgeted
Fixed Overhead Efficiency Variance Output)
(Absorbed Fixed Overhead) Or
Less (Standard Fixed Overhead Rate per Hour × Standard Hours per
(Budgeted Fixed Overheads for Actual Unit) × (Actual Output – Budgeted Output)
Hours#) Or
Standard Fixed Overhead Rate per Unit × (Actual Output –
Budgeted Output)
# Actual Hours (Worked)
Note: Overhead Variances can also be affected by idle time. It is usually

Standard Fixed Overheads for Production (Absorbed) assumed that Overheads are incurred when labour is working, not
= Standard Fixed Overhead Rate per Unit × Actual Production in when it is idle. Accordingly, hours worked has been considered for
Units the calculation of Variable and Fixed Overheads Variances.
= Standard Fixed Overhead Rate per Hour × Standard Hours for
Actual Production
Budgeted Fixed Overheads Variable Production Overhead Variances
= It represents the amount of fixed overhead which should be spent
according to the budget or standard during the period Variable Overhead Total Variance@
= Standard Fixed Overhead Rate per Unit × Budgeted Production in
Units
(Standard Variable Overheads for
= Standard Fixed Overhead Rate per Hour × Budgeted Hours Production – Actual Variable Overheads)
Actual Fixed Overheads Incurred
Budgeted Fixed Overheads for Actual Hours
= Standard Fixed Overhead Rate per Hour × Actual Hours
Possible Fixed Overheads Variable Overhead Variable Overhead
= Expected Fixed Overhead for Actual Days Worked Expenditure (Spending) Efficiency Variance
Budgeted Fixed Overhead Variance (Standard Variable Overheads
= × Actual Days (Budgeted Variable Overheads for Production)
Budgeted Days
for Actual Hours#) Less
(@)
= Fixed Overhead Total Variance also known as ‘Fixed Overhead Cost Less (Budgeted Variable
Variance’ (Actual Variable Overheads) Overheads for Actual Hours#)
# Actual Hours (Worked)

Note:
(Absorbed Fixed Overheads) – (Budgeted Fixed Overheads for Standard Variable Overheads for Production/Charged to
Actual Hours) Production
Or = Standard/Budgeted Variable Overhead Rate per Unit × Actual
Production (Units)
(Standard Fixed Overhead Rate per Hour × Standard Hours for = Standard Variable Overhead Rate per Hour × Standard Hours for
Actual Output) – (Standard Fixed Overhead Rate per Hour × Actual Production
Actual Hours) Actual Overheads Incurred
Or Budgeted Variable Overheads for Actual Hours
Standard Fixed Overhead Rate per Hour × (Standard Hours for = Standard Variable Overhead Rate per Hour × Actual Hours
Actual Output – Actual Hours) (@)
= Variable Overhead Total Variance also known as ‘Variable Overhead
Cost Variance’

Variable Overhead Efficiency Variance Variable Overhead Expenditure Variance

(Standard Variable Overheads for Production) – (Budgeted (Budgeted Variable Overheads for Actual Hours) – (Actual
Overheads for Actual Hours) Variable Overheads)
Or Or
(Standard Variable Overhead Rate per Hour × Standard Hours for (Standard Rate per Hour × Actual Hours) – (Actual Rate per Hour
Actual Output) – (Standard Variable Overhead Rate per Hour ×
Actual Hours) × Actual Hours)
Or Or
Standard Variable Overhead Rate per Hour × (Standard Hours for Actual Hours × (Standard Rate per Hour – Actual Rate per Hour)
Actual Output – Actual hours)
DECISION MAKING
CHAPTER OVERVIEW unit-based costs vary with respect to other cost drivers. In contrast,
the volume based approach combines the cost of these activities and
DECISION MAKING treat them as fixed costs since they do not vary with output volume.
Activity based costing provides a more accurate determination of
costs because it separately identifies and traces non- unit based costs
to products rather than combining them in a pool of fixed costs as
CVP Analysis Short-term Decision volume based approach does.
Making: Relevant Cost
t "DUJWJUZ #BTFE CVP Concept
Analysis The Break-even can then be expressed as follows:
t $71 "OBMZTJT t 0VUTPVSDJOH %FDJTJPO
under Conditions of
Break-even units = [Fixed costs + (Setup cost × Number of Setups)
t 4FMM PS 'VSUIFS 1SPDFTTJOH
Uncertainly Decision + (Engineering Cost × Number of Engineering
t $71 "OBMZTJT JO
Service and Non-
t .JOJNVN 1SJDJOH Hours)]/ (Price - Unit Variable Cost)
Decision
Profit Organisations t ,FFQ PS %SPQ %FDJTJPO
t $71 "OBMZTJT +VTU JO t 1SPEVDU t 4QFDJBM 0SEFS %FDJTJPO A comparison of the ABC break-even point with the conventional
Time Environment Mix Decision
break-even point reveals two important differences.
First, the fixed costs differ. Some costs previously identified as being
t &UIJDT fixed may actually vary with non-unit cost drivers, in this case setups
t /POmOBODJBM $POTJEFSBUJPOT
and engineering hours.
CVP ANALYSIS11 Second, the numerator of the ABC break-even equation has two
CVP analysis involves analysing the interrelationships among non-unit-variable cost terms: one for batch-related activities and
revenues, costs, levels of activity, and profits. CVP analysis is useful one for product- sustaining activities.
for numerous decisions related to production, pricing, marketing,
cost structure, and many more. Although CVP analysis is most useful “The use of activity-based costing does not mean that CVP analysis
for planning, it can also be used to assist with controlling decisions is less valuable. In fact, it becomes more valuable, since it delivers
and evaluating decisions. more precise understandings concerning cost behaviour. These
understandings produce better decisions. CVP analysis within an
Consider a decision about choosing additional features of an existing activity-based framework, however, must be improved”.
product i.e. product modification. Different choices can affect selling
prices, variable cost per unit, fixed costs, units sold, and operating
income. CVP analysis helps managers make product decisions by
estimating the expected profitability of these choices.
Activity Based CVP Analysis

CVP Analysis under Conditions
of Uncertainty
CVP Analysis
CVP Analysis in CVP Analysis
Service and Non- in Just in Time
Profit Organisations Environment
Activity Based CVP Analysis

Conventional CVP analysis assumes volume based measures. An
alternative approach is activity based costing. In an activity-based
costing system, costs are segregated into unit and non-unit-based
categories. Activity-based costing acknowledges that some costs vary
with units produced and some costs do not. However, while activity-
based costing admits that non-unit- based costs are fixed with
respect to production volume changes, it also argues that many non-

CVP Analysis in Service and Non-Profit Organisations Therefore, the cost equation for Just in Time can be expresses as
CVP analysis can also be applied to decisions by service and non- follows:
profit organisations. To apply CVP analysis in service and non- Total Cost = Fixed Cost + (Unit variable Cost × Number
profit organisations, we need to focus on measuring their output, of Units) + (Engineering Cost × Number of
which is different from tangible units sold by manufacturing and Engineering hours)
merchandising companies.
“Managers often use CVP analysis to guide other decisions, many
CVP Analysis in Just in Time Environment of them are of strategic nature due to tremendous potential of
increase in the profitability and organisational effectiveness”
In a firm has implemented Just in Time, the variable cost per unit sold
is reduced, and fixed costs are increased. Direct labor is considered
as fixed instead of variable. On the other hand, direct material vary SHORT RUN DECISION MAKING
with production volume (unit- based variable cost) due to emphasis
on total quality and long-term purchasing. Waste, scrap, and quantity
discounts are removed. Other unit-based variable costs, such as
power and sales commissions, also exist. Further, the batch - level Based on
variable is absent as in Just in Time, the batch is equal to one unit. relevant costs
Small-scale
Referred to as
that
serve a larger
decisions
purpose
Short Run
Decision Making
Immediate or Choosing
limited among
frame
have
long-run
consequences
Short-run decision making involves the act of choosing one course

of action among various feasible alternatives available. Short-
term decisions sometimes are referred to as tactical, or relevant,
decisions because they involve choosing between alternatives with
an immediate or limited time frame.
Strategic decisions, on the other hand, usually are long term in nature
because they involve choosing between different strategies that
attempt to provide a competitive advantage over a long time frame.
Short run decisions involve evaluation of the costs and benefits of

short term actions, such as whether to make a product or outsource,
whether to accept a special order, whether to keep or drop an
unprofitable segment, and whether to sell a product as is or process
it further. If resources are limited, managers may also have to decide
on the most appropriate product mix. While such decisions tend to
be short run in nature, it should be emphasized that they often have
long-run consequences.
Consider a second example, suppose that a company is thinking

about producing a component instead of buying it from suppliers.
The immediate objective may be to lower the cost of making the main
product. Yet this decision may be a small part of the overall strategy
of establishing a cost leadership position for the firm. Therefore,
short-run decisions often are small-scale actions that serve a larger
purpose12.
The tactical decision making approach just described emphasized

the importance of identifying and using relevant costs. But how do
we identify and define the costs that affect the decision?

Ethics
For a cost to be relevant to a decision it must be Ethics are moral principles that guide the conduct of individuals. By
their behaviour and attitude, managers set the company culture.
A future cost, i.e. related to the future.
Identify an
ethical decision Consider
by using obligations and
A differential Cost, i.e. its level must be different personal ethical responsibilities
standards of to those that
for each of the alternatives under consideration. honesty and will be affected
fairness. by decision.
Accordingly, only future costs can be relevant to decisions. However,

to be relevant, a cost must not only be a future cost but must also differ
from one alternative to another. If a future cost is the same for more
than one alternative, it has no effect on the decision. Such a cost is
irrelevant cost. The ability to identify relevant and irrelevant costs is Identify the Make a decision
consequences that is ethical
a vital decision making skill. of the decision and fair to those
and its effect affected by it13.
on others.
Non-Financial Considerations
With increase in competition, dynamic market changes and changing
needs of customers, non-financial information have gained relevance Some ethical problems can be can be avoided simply by using
in the decision-making process. Information to which monetary common sense and not focusing solely on the short term at the
value can be attached is in the nature of financial information. expense of long term.
Information of an organization like number of employees, employee
morale, customer satisfaction that cannot be expressed in monetary Firms with a strong code of ethics can create strong customer and
terms is termed non -financial in nature. Non- financial information employee loyalty. Furthermore, a firm that values people more than
is long term focused and ensures profitability and sustainability profit and is viewed as operating with integrity and honour is more
in long term for an organization thereby evaluating the internal likely to be a commercially successful business14.
performance of the company. Non- Financial information which a
company should focus that would turn out to be advantageous while Decision Making Model
making decisions for a company are:
An Application
Employee Customer Define The Problem Identify Alternatives

Quality t %VF UP FDPOPNJD EPXO t 4IVU EPXO UIF QMBOU
Satisfaction Satisfaction
turn, it is not feasible t 0QFSBUF UIF QMBOU
to operate the plant at
the normal capacity,
Corporate
Environmental Intellectual at least during the
Social
Responsibility quarter
Factors Property
Intangible Competitor's Brand Total Relevant Costs &

Identify Costs, Benefits
Assets Movements Name Benefits
t "MU $PTUT #FOFmUT
t "MU 3FMFWBOU $PTUT
t "MU $PTUT #FOFmUT
+ Benefits
t "MU 3FMFWBOU $PTUT
Decisions made in a business rest on the balance between the + Benefits
perceived effects of financial and non-financial information. Following t %JĉFSFOUJBM $PTU
are Limitations of Non- Financial Information-
Limitations of Non- Financial Information

Assess Non-Financial Make Decision
t 5JNF BOE $PTU PG UIF DPNQBOZ JOWPMWFE Factors t 0QFSBUF UIF QMBOU
t 4VCKFDUJWF NFBTVSFNFOU o /P QSPQFS PG DPNNPO t *OUFSFTU PG XPSLFST
denominator to measure performance. t 3FFTUBCMJTINFOU PG UIF
t *NQSPQFS NFBTVSFT XJMM MFBE UIF DPNQBOJFT UP ESBX
market for the product.
attention on wrong objectives.
t -BDL PG 4UBUJTUJDBM 3FMJBCJMJUZ o 1PTTJCMF DIBODFT PG t 1MBOU NBZ HFU SVTUFE
error.
t .BOBHFNFOU %JTJOUFHSBUJPO XIFO FYDFTT PG
measures and indications used by the company.

SOME APPLICATIONS OF CVP ANALYSIS AND Outsourcing Decisions- Accept or Reject?

COST CONCEPTS
Short run decisions are many and varied but some of the more t *G JODSFNFOUBM t *G JODSFNFOUBM t *G JODSFNFOUBM
cost savings + cost savings + cost savings +
important ones, we shall look in this chapter include: opportunity
opportunity opportunity
costs < costs > costs are
incremental incremental = incremental
costs costs costs
Out-
sourcing t reject the t accept the t focus primarily
Decision outsourcing, outsourcing on qualitative
unless qualitative unless qualitative factors to
Product Sell or factors fiercely factors fiercely
Mix evaluate the
Further impact the impact the
Decision decision.
Process decision. decision.
Short
Run Qualitative Factors
Decisions While considering the decision to Outsourcing the management
should consider qualitative aspects like quality of goods, reliability of
Special Minimum suppliers, impact on the customers and suppliers etc.
Order Pricing
Decisions Decisions
A firm generally decides to outsource:
Keep or
Drop t *G JU DPTUT MFTT SBUIFS UIBO UP NBOVGBDUVSF JU JOUFSOBMMZ
Decisions t *G UIF SFUVSO PO UIF OFDFTTBSZ JOWFTUNFOU UP CF NBEF UP
manufacture is not attractive enough;
t *G UIF DPNQBOZ EPFT OPU IBWF UIF SFRVJTJUF TLJMMFE
Outsourcing Decision15
manpower to make;
Outsourcing decision is often called a ‘make or buy’ decision. It
involves a decision of whether to continue 'making' a product versus t *G UIF DPODFSO GFFMT UIBU NBOVGBDUVSJOH JOUFSOBMMZ XJMM
‘buying’ it from an external firm. Outsourcing enables a firm to mean additional labour problem;
i reduce costs or t *G BEFRVBUF NBOBHFSJBM NBOQPXFS JT OPU BWBJMBCMF UP
i benefit from supplier efficiencies take charge of the extra work of manufacturing;
Outsourcing decision requires incremental analysis. The incremental
t *G UIF DPNQPOFOU TIPXT NVDI TFBTPOBM EFNBOE
amounts are based on the difference in the cost of buying a product
or service compared to the cost of producing the item or providing the resulting in a considerable risk of maintaining
service in house. inventories;
t *G USBOTQPSU BOE PUIFS JOGSBTUSVDUVSF GBDJMJUJFT BSF
adequately available;
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costs incurred from outsourcing. The t *G UIF QSPDFTT PG NBLJOH JT DPOmEFOUJBM PS QBUFOUFE
main cost is the purchase price of the t *G UIFSF JT SJTL PG UFDIOPMPHJDBM PCTPMFTDFODF GPS UIF
products or the cost of the services that
Incremental are being provided by external firms. component such that it does not encourage capital
Costs investment in the component.
t *ODSFNFOUBM $PTU 4BWJOHT are reductions

of costs that will no longer be incurred Sell or Further Process
as a result of outsourcing. They are
often called avoidable costs because if a Sell or process further refers to a decision-making situation where
company outsources, it can 'avoid' certain an executive has to decide either to sell a component/ product/
costs. Variable product cost savings are raw material as it is or alternatively process it further by incurring
Incremental always incremental. Because they reduce
Cost Savings total costs, they cause profits to increase. additional expenses. For instance, sometime, a redundant material
In some circumstances, a portion of fixed lying in stores for a long time may be sold as scrap at a small value
costs can be saved such as equipment or may be thrown away as waste. This material may, however, be
rental costs or supervisor salaries that can converted into a product of higher saleable value by carrying out
be avoided.
some further operations or processes. On further processing the
component/product/raw material may not only be improved or
t 0QQPSUVOJUZ $PTUT are the costs reconditioned but will mostly fetch a higher sale value as well. Here
forgone as a result of selecting a different if the differential sales value is more than the further processing cost,
alternative. They are always incremental.
For example, if a company decides to then it is beneficial to process the product further otherwise sell it
Opportunity outsource, it is able to lease its factory without further processing. Such type of decision making problems
Costs space that the product being outsourced usually arise in the case of joint products.
no longer will occupy.

There are two rules to follow when ascertaining whether the further Decision - Keep or Drop?
processing is worthwhile:
t *G JODSFNFOUBM t *G JODSFNFOUBM t *G JODSFNFOUBM
Only the incremental costs and revenues of the cost savings > revenue lost = cost savings <
further process are relevant incremental incremental cost incremental
revenue lost savings revenue lost
The joint process costs are irrelevant - they are
already 'sunk' at the point of separation t the segment t qualitative t the segment
should be effects must be should not be
dropped, unless used to make dropped, unless
Qualitative Factors qualitative the decision. qualitative
Qualitative factors related to processing further decisions include characteristics characteristics
resource availability such as the readiness of employees to work extra fiercely impact fiercely impact
hours to further process the products and availability of materials the decision. the decision.
required for the processing. In addition, the influence on customers
that prefer the original product should also be considered, as sales to Qualitative Factors
these customers may be lost to competitors. Qualitative factors related to keep or drop decisions often include
considerations of employees that will be terminated if the product
Minimum Pricing Decisions is dropped, the effect a lay off might have on employees that are not
The minimum pricing approach is a useful method in situations terminated, effects of suppliers from which the materials needed for
where there is a lot of intense competition, surplus production the product will no longer be purchased, and the effect of customers
capacity, clearance of old inventories, getting special orders and/or who previously purchased the product being dropped.
improving market share of the product.
Special Order Decisions15
The minimum price should be set at the incremental costs of Special order decisions focus on whether a special priced order
manufacturing, plus opportunity costs (if any). should be accepted or rejected. These orders often can be attractive,
especially when the firm is operating below its maximum productive
For this type of pricing, the selling price is the lowest price that a capacity.
company may sell its product at usually the price will be the total
relevant costs of manufacturing. Price discrimination laws require that firms sell identical products at
the same price to competing customers in the same market. This law
Keep or Drop Decisions15 does not apply to
Another type of operating decision that management must make i Noncompeting customers from the same market.
is whether to keep or drop unprofitable segments, such as product i Potential customers in markets not ordinarily served.
lines, services, divisions, departments, stores, or outlets. Special order decisions are based on incremental analysis.
Incremental analysis enables managers to emphasis on the relevant
The decision is based on whether or not the segment’s revenue areas of a decision.
exceeds the costs directly traceable to the segment, including any
direct fixed costs. t Incremental Revenues are the additional
revenues generated from accepting the
t Incremental Revenue is the difference special order. The revenue can result
in revenue between the original sales from additional sales of products or from
revenue and the new revenue that is providing services.
expected to result due to dropping a
segment. Incremental t *G UIF DPNQBOZ JT PQFSBUJOH BU MFTT UIBO
Revenue capacity, revenue of regular customers
Incremental t If dropping a product will cause will not be affected.
Revenue an increase in demand for another
product, the additional revenue for t *G UIF DPNQBOZ JT PQFSBUJOH BU DBQBDJUZ JU
the other product should be taken into will have to give up some regular sales in
consideration. order to provide the special order.
t Variable costs associated with a segment t *ODSFNFOUBM $PTUT are the additional
to be dropped are Incremental Cost costs incurred from accepting a special
Savings that cause profit to increase. order. Variable operating costs include
t Direct fixed costs related to a segment special packing, commissions, and
being dropped are avoidable if that shipping costs.
Incremental segment is dropped because they can be t Most often, a firm's recurring fixed costs
Cost Savings eliminated if the segment is dropped. will remain the same in total if a special
Incremental
Costs order is accepted.
t Opportunity Costs are common in t Occasionally the acceptance of a special
keep or drop decisions. They often arise order may cause additional fixed costs
due to rental of production space that such as special purpose tool, Inspection
will become vacant if the decision is Cost. In these cases, these additional
made to drop a product. Opportunity fixed costs are relevant and should be
Opportunity considered in an incremental analysis.
Costs costs are always incremental.

Decision - Accept or Reject? 10

Accounting: An Introduction, 6/E by Peter Atrill, Eddie McLaney, David Harvey;
11
Accounting: Concepts and Applications by W. Albrecht, James Stice, Earl Stice, Monte
Swain; Cost Management: A Strategic Emphasis by Blocher; Managerial Accounting,
t *G JODSFNFOUBM t *G JODSFNFOUBM t *G JODSFNFOUBM Hansen Mowen; Cost Accounting: A Managerial Emphasis, 13/e by Charles T. Horngren;
revenue < revenue = revenue > Cost Management: Accounting and Control by Don Hansen, Maryanne Mowen, Liming
incremental Guan; Essentials of Modern Business Statistics with Microsoft Excel by David R.
incremental cost cost incremental cost Anderson, Dennis J. Sweeney, Thomas A. Williams;
12
Managerial Accounting: The Cornerstone of Business Decision-Making by Maryanne M.
t reject the special t qualitative t accept the Mowen, Don R. Hansen, Dan L. Heitger;
order, unless effects must order, unless 13
Financial & Managerial Accounting by Carl S. Warren, James M. Reeve, Jonathan
qualitative be used to qualitative Duchac;
make the
14
Cost Management: Accounting and Control by Don Hansen, Maryanne Mowen, Liming
characteristics characteristics Guan;
decision. fiercely impact
fiercely impact 15
Managerial Accounting: The Cornerstone of Business Decision-Making by Maryanne M.
the decision. the decision. Mowen, Don R. Hansen, Dan L. Heitger; http://www.unf.edu/;
16
Management Accounting for Business By Colin Drury
Dangers of Concentrating Excessively on a Short- t 'PS QSFWJPVT DBQTVMF mOBM TUVEFOUT NBZ SFGFS
Run Time Horizon16 November 2017 Journal.
t *OUFSNFEJBUF TUVEFOUT NBZ BMTP SFGFS QBHFT UP
i It is vital that the information presented for of this capsule for quick reference of ‘Cost Variance’
decision-making relates to the appropriate time
formulae.
horizon.
i If inappropriate time horizons are selected there
is a risk that misleading information will be
presented.
i Long-term considerations should always be taken
into account when special pricing decisions are
being evaluated.
i The effect of accepting a series of successive
special orders over several periods constitutes a
long-term decision.
i If demand from normal business is considered
to be permanently insufficient to utilize existing
capacity, then a long-term capacity decision is
required.
i This decision should be based on a comparison
of the relevant revenues and costs arising from
using the excess capacity for special orders with
the capacity costs that can be eliminated if the
capacity is reduced.
Product Mix Decision

Many times, the management has to take a decision
whether to produce one product or another instead.
Generally, decision is made on the basis of contribution
of each product. Other things being the same the product
which yields the highest contribution is best one to
produce. But, if there is shortage or limited supply of
certain other resources which may act as a key factor like
for example, the machine hours, then the contribution is
linked with such a key factor for taking a decision.
For example, in an undertaking the availability of machine

capacity is limited and the machine hours required for
one unit of the two products are different. In such cases
the contribution is to be linked with the machine hour
and the product which yields the highest contribution per
machine hour is to be preferred for taking decision.
Sources / References:
1
CIMA Article (Feb. 2010) by David Harris;
2
Cost Accounting: A Managerial Emphasis, 13/e by Charles T.
Horngren, p275;
3
Managerial Accounting: An Introduction to Concepts, Methods and
Uses by Michael W. Maher, Clyde P. Stickney, Roman L. Weil, p 362;
4
Performance Operations by Robert Scarlett, p119;
5
www.mcdonaldization.com/whatisit.shtml;
6
Costing and Pricing Public Sector Services: Essential Skills for the
Public Sector (2011) by Jennifer Bean, Lascelles Hussey;
7
Management and Cost Accounting by Colin M. Drury;
8
Managerial Accounting: A Focus on Ethical Decision Making by Steve
Jackson, Roby Sawyers, Greg Jenkins;
9
Cornerstones of Financial and Managerial Accounting (2011) by
Jay Rich, Jeff Jones, Dan L. Heitger, Maryanne Mowen, Don Hansen,
Standard Costing: A Managerial Control Tool, p 1020;

“Corporate social responsibility is a hard-edged business decision. Not because it is a nice thing
to do or because people are forcing us to do it... because it is good for our business.”
– Niall FitzGerald, Former CEO, Unilever
IN A NUTSHELL
KNOWLEDGE UPDATE
FRAMEWORKS FOR REPORTING TO EXTERNAL STAKEHOLDERS
Background
Triple Bottom Line Reporting
t %JNFOTJPO TFUT
PG 5#-
Global Reporting Initiative (GRI)*
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t (MPCBM 3FQPSUJOH 4UBOEBSET
Integrated Reporting (IR)*
t *OUFHSBUFE 3FQPSUJOH 'SBNFXPSL BOE UIF *OUFHSBUFE 3FQPSU
t 'VOEBNFOUBM $PODFQUT SFMBUFE UP UIF *OUFHSBUFE 3FQPSU
t 1SFQBSBUJPO BOE 1SFTFOUBUJPO PG UIF *OUFHSBUFE 3FQPSU
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CAPSULE
CASE STUDY
Triple Bottom Line
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CASE SCENARIO
Six Sigma
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Performance Measurement
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SKILL ASSESSMENT BASED PROBLEMS

Questions and Answers
t -JGF $ZDMF $PTUJOH
t ͳFPSZ PG $POTUSBJOUT
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*This portion of the article aims to provide an understanding of the framework – Integrated Reporting (as
presented by the International Integrated Reporting Council (IIRC)) and Sustainability Reporting as presented
by the Global Reporting Initiative (GRI). Since these frameworks are good indicator of the performance of an
organisation, it is good to have at least basic understanding of the concepts involved. These topics are for the
“Knowledge Update” of the Students and not for examination purpose.

long run. When these resources run out, organisations may have to
Frameworks for Reporting to External close down unless they take corrective action now. So, there is an
Stakeholders about Sustainability and important realisation that “Sustainability” of the environment is
Value Creation: Global Trends critical for “sustainability” of organisation. An organisation should
try to reduce its “ecological footprint” for example minimise
“carbon footprint” generated by its activities. It should avoid
Framework for external reporting on wastage of natural resources in business operations. Develop CSR
sustainability and value creation activities that can nurture the natural resource, like use renewable
t 5SJQMF #PUUPN -JOF TVTUBJOBCJMJUZ
energy, recycling waste, rehabilitation of mines from which mining
t (3* TVTUBJOBCJMJUZ
activities are done, rehabilitation of wildlife, fisheries etc.
t *OUFHSBUFE 3FQPSUJOH 'SBNFXPSL t Societal impact: Business operations impact the lives of the
Performance Reports employees that work with them as well as the society in large.
(sustainability through value
creation) Organisations have to be socially responsible. Exploitation of
workforce through long work hours, low wages, child labour
etc. are examples of unethical business practices that should
Background cease. If businesses can impact the community it influences
through corporate social responsibility programs, it will improve
Corporate Reporting is the platform used by organisations to the quality of life for such communities. CSR programs help in
provide information to its users about its business. Corporate building healthier communities, this nurtures talent.
Reporting is a useful tool to connect with stakeholders, external to
the organisation because: t Economic impact: For profit organisations have their main
objective to deliver financial returns to their investors. While
t 1SFTFOUBUJPO PG UIFJS CVTJOFTT QFSGPSNBODF JO QBSUJDVMBS UIFJS profit is important, it is crucial for organisations to ensure that
financial performance, enables them to get access to equity, debt profit objective does not negatively impact the environment or
or other types of financing. society. The investing community has become more sensitive to
t #Z TIPXDBTJOH UIFJS QFSGPSNBODF DBQBCJMJUJFT BOE TUSBUFHZ UIFTF these issues and wants transparency about how the organisation
reports can assist organisations to negotiate with customers and creates “value”.
suppliers. To address this change in investor mindset, a number of initiatives to
t 4IPXDBTJOH UIFJS TUSPOH QFSGPSNBODF XPVME BTTJTU UIFN UP SFDSVJU develop useful, transparent corporate reporting was undertaken that
talented employees and retain them. Talented employees in turn has culminated in development of few Frameworks that organisations
are an asset that every company should nurture for future growth. can use to report about their activities in relation to sustainability
Therefore, corporate reporting is an important exercise that goes and value creation. Organisations can choose to present their
beyond reporting past performance. Instead, it is a very important information using any of the following frameworks:
tool to present the organisation’s business and its future prospects. 1. Triple Bottom Line (TBL report). As explained earlier, traditional
A widely read corporate report would be the annual report released accounting systems had a restricted view limited to the financial
each year by organisations. It has a plethora of vital information performance of the organisation. This concept expands this view
that is useful to assess an organisation’s performance. Information to include the impact of business on environment and society as
contained here is largely focussed on financial performance, well. The 3Ps draws the organisation’s attention to not just “Profit”
current year and of past years. At the same time, it also focusses on motive but also to nurturing “Planet” and “People” towards a
management narratives and non-financial issues. sustainable future.
Good quality corporate reporting helps an organisation 2. Global Reporting Initiative report (GRI report) as per the
demonstrate to its stakeholders its operational capabilities, take GRI Guidelines issued by an independent institute called GRI
advantage of opportunities and its ability to manage risks due to whose mission is to develop and disseminate globally acceptable
changes in the business environment. To enable this understanding, sustainability reporting guidelines.
the report should contain information that is concise, relevant 3. Integrated Report <IR> as per the Integrated Reporting
and transparent. Importantly, the user must be able to connect Framework laid out by the International Integrated Reporting
information spread over many pages/ reports to get a complete Council (IIRC). It provides the providers of ‘capital’ with a holistic
understanding of the business model. view of the organisation’s value creation process.
Many frameworks govern corporate reporting. Examples are Indian
Accounting Standards (Ind AS), International Financial Reporting
Standards (IFRS), disclosures under Companies Act 2013, SEBI Triple Bottom Line Reporting
Guidelines and Disclosures etc. All of them aim at full, accurate and British business author John Brett Elkington in year 1994 coined the
timely disclosures of financial and relevant non-financial information. term TBL. But the origin of concept actually lies in Brundtland report
In the recent past users of the corporate reports, felt that information, by World Commission on Environment and Development, (now
while available in sufficient detail, was scattered within different known as Brundtland Commission) published in year 1987, in which
reports or sections of the annual report. It has been difficult to piece Sustainable Development is explained as is “development that meets
together relevant information to get complete information about the the needs of the present without compromising the ability of future
business. generations to meet their own needs”. It is also important here to note
that United Nations Conference on Environment and Development
In the recent past, human race has taken quantum leaps due to
taken place in year 1992, gave stress on sustainable development.
globalisation and changes in technology impacting daily life. There is
also a highlighted concern about climate change and its impact. This As mentioned earlier every business needs to be sustainable
has led to the following realisations: rather only profitable.
t Environmental impact: Businesses utilise natural resources as But what comes to mind is:
inputs, convert them into outputs to make profits out this activity. ¼ When can a business be called sustainable?
So, businesses deplete natural resources to earn profits. Natural ¼ The obvious answer is when management makes sustainable
resources are limited in supply since nature cannot replenish business decisions.
the deleted resource at the same rate. For example, the resource
Hence, the real question is:
that gets deplete faster than its replenishment rate is fossil fuel.
Likewise, there are many other resources that get utilised without ¼ When does a business decision become sustainable? How
the sources being allowed renew itself. It might lead to scenarios does one measure the performance of business decisions in
where these resources may not be available to future generations. terms of sustainability?
It could also affect the ability of the businesses to sustain in the Answer lies in TBL i.e. Triple Bottom Line.

Global Reporting Standards

A Sustainability Report prepared as per GRI Framework is used by
organisations to report their impact on the economy, environment
and society. Impact includes both positive and negative matters.
Users can then be better informed about the risks and opportunities
that the organisation faces.
The degree to which the GRI Standards have been applied gives an
To measure the performance of business decisions in economic organisation the choice to prepare the report as per:
terms we consider only one bottom line i.e. profit, but to consider i) Core Option : indicates that the report has minimum information
sustainability of business decisions, there are three bottom lines i.e. needed to understand the organisation, material topics and
People, Planet and Profit (also known as dimensions of TBL). related impacts and how they are managed.
or
TBL truly extends the scope of traditional accountancy, and
(ii) Comprehensive Option: In addition to information that comes
transforms it into modern day sustainability reporting (which
under the “core option”, it has additional disclosures regarding an
is beyond financial reporting because it considers social and
organisation’s strategy, ethics and integrity. The report should have
environmental performance too). Some organisations even have
extensive discussion about the material topics and related impacts.
separate business sustainability reporting system and they apply the
standard of sustainability reporting pronounced by Global Reporting The report has to clearly state that it is “in accordance” with Core
Initiative, which is the independent, international organisation that Option or Comprehensive Option.
helps businesses and other organisations take responsibility for their Thus, Core Option has less details than Comprehensive Option.
impacts, by providing them with the global common framework Organisations can also prepare “GRI referenced” report when
(standards) to report those impacts. it wants to report on specific economic, environmental or social
impact as per selected standards but is not looking to provide a full
report as per the GRI Standards. Include specific reference to which
Dimension (sets) of TBL standard or section has been used.
t Planet – the environmental bottom line measures the impact on
An overview of the GRI Standards are:
resources, such as air, water, ground and emissions to determine the
environment impact and ecological footprints. Universal Standards
t People – the social equity bottom line relates to corporate 3 Universal Standards are applicable to all organisations.
governance, motivation, incentives, health and safety, human (1) GRI 101 – Foundation, starting point for using GRI Standards.
capital development, human rights and ethical behaviour. It contains the Reporting Principles that define the report
t Profit – the economic bottom line refers to measures maintaining content and quality.
or improving the company’s success in term of adding value to
shareholders. Reporting Principles for ‘Report Content’ include: Stakeholder
Inclusiveness, Sustainability Context, Materiality and
A sustainable decision is one which is acceptable from the aspect Completeness.
of each bottom line.
Reporting Principles for ‘Report Quality’ include: Accuracy,
TBL believes in a stakeholder approach rather than a shareholder Balance (positive and negative impacts), Clarity, Comparability,
approach. TBL implies that businesses must consider the full Reliability and Timeliness.
cost, hence becoming a substitute to full cost accounting with even
wider perspectives. GRI 101 is used to identify material matters related to the
economy, environment and society. The organisation will then
TBL can be used to encourage each division and manager within the use the topic specific standards to report on them.
organisation to act in a responsible manner from holistic perspective.
(2) GRI 102 – General Disclosures, to report contextual
information about an organisation. Information related to”
Global Reporting Initiative (GRI) (a) organisation’s profile,
Global Reporting Initiative (GRI) is an independent organisation (b) strategy,
that is working at promoting the use of globally applicable reporting (c) ethics and integrity,
standards. They are promoting the GRI Standards that promote (d) governance,
transparency and accountability on sustainable development by (e) reporting process, and
reporting on economic, environmental and social issues. They (f ) stakeholder engagement process are reported here.
have a range of partners who believe in their vision that include (3) GRI 103 – Management Approach, to report management’s
governments and various donor foundations. approach to material matters. It discusses why a matter is
material, where is the impact and how is the organisation
Need for “Global Reporting Initiative” managing the impact. Management Approach will include the
policies, goals, responsibilities, resources, grievance methods,
The Framework has been developed to encourage organisations
specific actions related to the material topic.
across the world to report on how their business activities are
impacting “Economic, Environmental and Social” sustainability. The
need for standardised reporting globally is that users can compare Topic Specific Standards
reports of different organisations to identify the ones that are more Circumstances unique to each organisation’s business operations will
sustainable to these three aspects – economy, environment and social. determine what to report under the Topic Specific Standards.
Sustainability is important to leave behind a conducive environment Below is a summary of the discussions that happen under each
and healthy society for our future generations. category covered under the Topic Specific Standards.
Under each of the sub-topics under the economic, environmental
and social categories, the report should include discussion about
management’s approach disclosures, topic specific disclosures or both.
This list is only for the student’s reference to help them understand
the content of the report better.
The below standards will apply to all reports published on or after
July 1, 2018 except GRI 207, GRI 303 and GRI 403 w.e.f. Jan 2021
and GRI 306 w.e.f. Jan 2022.

(A) GRI 200 – Economic 402: Labor / t .JOJNVN OPUJDF QFSJPET SFHBSEJOH PQFSBUJPOBM DIBOHFT
201: t %JSFDU FDPOPNJD WBMVF HFOFSBUFE BOE EJTUSJCVUFE Management
Economic t 'JOBODJBM JNQMJDBUJPOT BOE PUIFS SJTLT BOE PQQPSUVOJUJFT Relations
Performance due to climate change 403: t 0DDVQBUJPOBM IFBMUI BOE TBGFUZ NBOBHFNFOU TZTUFN
t %FmOFE CFOFmU QMBO PCMJHBUJPOT BOE PUIFS SFUJSFNFOU QMBOT Occupational t )B[BSE JEFOUJmDBUJPO SJTL BTTFTTNFOU BOE JODJEFOU
t 'JOBODJBM BTTJTUBODF SFDFJWFE GSPN UIF HPWFSONFOU Health and investigation
202: Market t 3BUJPT PG TUBOEBSE FOUSZ MFWFM XBHF CZ HFOEFS DPNQBSFE UP Safety t 0DDVQBUJPOBM IFBMUI TFSWJDFT
Presence local minimum wage t 8PSLFS QBSUJDJQBUJPO DPOTVMUBUJPO BOE DPNNVOJDBUJPO
t 1SPQPSUJPO PG TFOJPS NBOBHFNFOU IJSFE GSPN UIF MPDBM on occupational health and safety
community t 8PSLFS USBJOJOH PO PDDVQBUJPOBM IFBMUI BOE TBGFUZ
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203: Indirect t *OGSBTUSVDUVSF JOWFTUNFOUT BOE TFSWJDFT TVQQPSUFE
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Economic t 4JHOJmDBOU JOEJSFDU FDPOPNJD JNQBDUT
safety impacts directly linked by business relationships
Impacts
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204: Procure- t 1SPQPSUJPO PG TQFOEJOH PO MPDBM TVQQMJFST management system
ment Practices t 8PSLSFMBUFE JOKVSJFT
205: Anti- t 0QFSBUJPOT BTTFTTFE GPS SJTLT SFMBUFE UP DPSSVQUJPO t 8PSLSFMBUFE JMM IFBMUI
corruption t $PNNVOJDBUJPO BOE USBJOJOH BCPVU BOUJDPSSVQUJPO 404: t "WFSBHF IPVST PG USBJOJOH QFS ZFBS QFS FNQMPZFF
policies and procedures Training and t 1SPHSBNT GPS VQHSBEJOH FNQMPZFF TLJMMT BOE USBOTJUJPO
t $POmSNFE JODJEFOUT PG DPSSVQUJPO BOE BDUJPOT UBLFO Education assistance programs
206: Anti- t -FHBM BDUJPOT GPS BOUJDPNQFUJUJWF CFIBWJPVS BOUJUSVTU t 1FSDFOUBHF PG FNQMPZFFT SFDFJWJOH SFHVMBS QFSGPSNBODF
competitive and monopoly practices and career development reviews
behaviour 405: t %JWFSTJUZ PG HPWFSOBODF CPEJFT BOE FNQMPZFFT
207: Tax t "QQSPBDI UP UBY Diversity t 3BUJP PG CBTJD TBMBSZ BOE SFNVOFSBUJPO PG XPNFO UP NFO
t 5BY HPWFSOBODF DPOUSPM BOE SJTL NBOBHFNFOU and Equal
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related to tax 406: Non- t *ODJEFOUT PG EJTDSJNJOBUJPO BOE DPSSFDUJWF BDUJPOT UBLFO
t $PVOUSZCZDPVOUSZ SFQPSUJOH Discrimination
(B) GRI 300 – Environmental 407: t 0QFSBUJPOT BOE TVQQMJFST JO XIJDI UIF SJHIU UP GSFFEPN PG
301: Material t .BUFSJBMT VTFE CZ XFJHIU PS WPMVNF Freedom of association and collective bargaining may be at risk
t 3FDZDMFE JOQVU NBUFSJBMT VTFE Association
t 3FDMBJNFE QSPEVDUT BOE UIFJS QBDLBHJOH NBUFSJBMT and
Collective
302: Energy t &OFSHZ DPOTVNQUJPO XJUIJO UIF PSHBOJTBUJPO Bargaining
t &OFSHZ DPOTVNQUJPO PVUTJEF PG UIF PSHBOJTBUJPO 408: Child t 0QFSBUJPOT BOE TVQQMJFST BU TJHOJmDBOU SJTL GPS JODJEFOUT
t &OFSHZ JOUFOTJUZ Labour of child labour
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409: t 0QFSBUJPOT BOE TVQQMJFST BU TJHOJmDBOU SJTL GPS JODJEFOUT
t Reductions in energy requirements of products and services
Forced and of forced or compulsory labour
303: Water t *OUFSBDUJPOT XJUI XBUFS BT B TIBSFE SFTPVSDF Compulsory
and Effluents t .BOBHFNFOU PG XBUFS EJTDIBSHF SFMBUFE JNQBDUT Labour
t 8BUFS XJUIESBXBM 410: Security t 4FDVSJUZ QFSTPOOFM USBJOFE JO IVNBO SJHIUT QPMJDJFT PS
t 8BUFS EJTDIBSHF Practices procedures
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411: Rights of t *ODJEFOUT PG WJPMBUJPOT JOWPMWJOH SJHIUT PG JOEJHFOPVT
304: Bio- t 0QFSBUJPOBM TJUFT PXOFE MFBTFE NBOBHFE JO PS BEKBDFOU Indigenous peoples
diversity to, protected areas and areas of high biodiversity value People
outside protected areas
412: Human t 0QFSBUJPOT UIBU IBWF CFFO TVCKFDU UP IVNBO SJHIUT SFWJFXT
t 4JHOJmDBOU JNQBDUT PG BDUJWJUJFT QSPEVDUT BOE TFSWJDFT PO
Rights or impact assessments
biodiversity
Assessment t &NQMPZFF USBJOJOH PO IVNBO SJHIUT QPMJDJFT PS QSPDFEVSFT
t )BCJUBUT QSPUFDUFE PS SFTUPSFE
t 4JHOJmDBOU JOWFTUNFOU BHSFFNFOUT BOE DPOUSBDUT UIBU
t *6$/ 3FE -JTU TQFDJFT BOE OBUJPOBM DPOTFSWBUJPO MJTU
include human rights clauses or that underwent human
species with habitats in areas affected by operations
rights screening
305: t %JSFDU 4DPQF
()( FNJTTJPOT 413: Local t 0QFSBUJPOT XJUI MPDBM DPNNVOJUZ FOHBHFNFOU JNQBDU
Emissions t &OFSHZ JOEJSFDU 4DPQF
()( FNJTTJPOT Communities assessments, and development programs
t 0UIFS JOEJSFDU 4DPQF
()( FNJTTJPOT t 0QFSBUJPOT XJUI TJHOJmDBOU BDUVBM BOE QPUFOUJBM OFHBUJWF
t ()( FNJTTJPOT JOUFOTJUZ impacts on local communities
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414: Supplier t /FX TVQQMJFST UIBU XFSF TDSFFOFE VTJOH TPDJBM DSJUFSJB
t &NJTTJPOT PG P[POFEFQMFUJOH TVCTUBODFT 0%4
Social t /FHBUJWF TPDJBM JNQBDUT JO UIF TVQQMZ DIBJO BOE BDUJPOT

t /JUSPHFO PYJEFT /09
TVMGVS PYJEFT 409
BOE PUIFS
Assessment taken
significant air emissions
415: Public t 1PMJUJDBM DPOUSJCVUJPOT
306: Waste t 8BTUF HFOFSBUJPO BOE TJHOJmDBOU XBTUF SFMBUFE JNQBDUT
Policy
t .BOBHFNFOU PG TJHOJmDBOU XBTUF SFMBUFE JNQBDUT
t 8BTUF HFOFSBUFE 416: t "TTFTTNFOU PG UIF IFBMUI BOE TBGFUZ JNQBDUT PG QSPEVDU
t 8BTUF EJWFSUFE GSPN EJTQPTBM Customer t *ODJEFOUT PG OPODPNQMJBODF DPODFSOJOH UIF IFBMUI BOE
t 8BTUF EJSFDUFE UP EJTQPTBM Health and safety impacts of products and services
Safety
307: t /PODPNQMJBODF XJUI FOWJSPONFOUBM MBXT BOE SFHVMBUJPOT
417: t 3FRVJSFNFOUT GPS QSPEVDU BOE TFSWJDF JOGPSNBUJPO BOE
Environment
Marketing labelling
Compliance
and t *ODJEFOUT PG OPODPNQMJBODF DPODFSOJOH QSPEVDU BOE
308: Supplier t /FX TVQQMJFST UIBU XFSF TDSFFOFE VTJOH FOWJSPONFOUBM Labelling service information and labelling
Environmental criteria t *ODJEFOUT PG OPODPNQMJBODF DPODFSOJOH NBSLFUJOH
Assessment t /FHBUJWF FOWJSPONFOUBM JNQBDUT JO UIF TVQQMZ DIBJO BOE communications
actions taken
418: t 4VCTUBOUJBUFE DPNQMBJOUT DPODFSOJOH CSFBDIFT PG
(C) GRI 400 – Social Customer customer privacy and losses of customer data
401: t /FX FNQMPZFF IJSFT BOE FNQMPZFF UVSOPWFS Privacy
Employment t #FOFmUT QSPWJEFE UP GVMMUJNF FNQMPZFFT UIBU BSF OPU 419: Socio t /PODPNQMJBODF XJUI MBXT BOE SFHVMBUJPOT JO UIF TPDJBM
provided to temporary or part-time employees Economic and economic area
t 1BSFOUBM MFBWF Compliance
Source: https://www.globalreporting.org/standards/gri-standards-download-center/?g=9c1bfe70-c407-4c4b-9139-04d64d5ba335

Integrated Reporting Definition of Integrated Report <IR>

An Integrated Report <IR> can be defined as: “An integrated report is a
This article is based on the International <IR> Framework (Dec’2013). concise communication about how an organisation’s strategy, governance,
The International Integrated Reporting Council (IIRC) has published performance and prospects, in the context of its external environment,
on 19 Jan’2021 revisions to the International <IR> Framework, lead to the creation of value over the short, medium and long term”.
originally released in 2013, to enable more decision-useful reporting.
Source: https://integratedreporting.org/resource/international-ir-framework/
This latest version applies to reporting periods commencing 1
January 2022. Objectives of Integrated Report
Information presented in an integrated or connected manner can
Integrated Reporting Framework and the enable the user to understand the following:
Integrated Report t ͳF various types of capitals (defined later), in addition to financial
The International Integrated Reporting Council (IIRC) is a global capital that the organisation uses to create value. Understand their
coalition of regulators, investors, companies, standard setters, the interdependencies, including trade-offs between them.
accounting profession, academia, NGOs. IIRC’s long-term vision t $BQBDJUZ PG UIF PSHBOJTBUJPO UP SFTQPOE UP WBSJPVT stakeholder’s
is to promote “integrated thinking” that will result in efficient legitimate needs and interests. Stakeholders here include not
allocation of capital, that enable financial stability and sustainability. just the providers of financial capital, but includes customers,
Integrated thinking takes into account the inter-relationships suppliers, local communities, government authorities, employees
between its various functional and operating units and “the capital” and any other interested party.
that the organisation uses. As explained later, the term “capital” is not t "CJMJUZ PG UIF PSHBOJTBUJPO UP respond to changes in the external
restricted to financial capital alone but is defined to include a wider environment towards both risks and opportunities.
variety of resources / enablers that support the value creation process t 1SPNPUFT VOEFSTUBOEJOH PG UIF PSHBOJTBUJPOT business model, its
of a business. This “integrated thinking” is facilitated by presenting activities, performance (financial and non-financial metrics) outcome
the “Integrated Report” (<IR>). over a period of time – past, present and future. Traditional corporate
Need for “Integrated Thinking” reporting has primarily presented historic (past) information.
Impact of “intangibles” to the business model: Traditionally <IR> is a more future oriented report that focusses on how an
assets of an organisation have been tangible assets, that have been organisation's strategy can be aligned to the external environment.
reported within the financial statements. Intangibles have also been t &OBCMFT BDDPVOUBCJMJUZ BOE TUFXBSETIJQ GPS UIF EJĉFSFOU UZQFT
recognised, pegged a monetary value and reflected in the financial of capital (financial, manufactured, human, intellectual, natural,
statements. The tangible assets have traditionally formed major part social and relationship). An organisation can create value only
of the assets side of the balance sheet. This worked well as long as when it is able to develop the interest of its key stakeholders,
value created by business was more internally driven. “Internally broadly contained within the various “capitals”.
driven” implies that business being less impacted by the changes in the t Disclosure about how the organisation is working towards
external environment in which it operates. Examples of which could maintaining its capital in the report can serve as a tool for better
include: its ability to get raw materials directly from the source rather corporate governance.
than depending on suppliers, business reach being more regional t 4VQQPSUT JOUFHSBUFE UIJOLJOH UIBU DBO FOBCMF CFUUFS EFDJTJPO NBLJOH
rather than having national or globalised reach, labour force creating to create value over short, medium and long term time horizons.
products being majorly semi-skilled therefore easily replaceable etc. In India SEBI has mandated the reporting of “Business Responsibility
However, due to globalisation many businesses have become national Report” (BRR) for the top 500 listed companies. For the year 2017-
/international players rather than being limited to being regional in 18 they may voluntarily adopt “Integrated Reporting” and include it
scope. Due to outsourcing of business processes, the supply chain in the annual report. Alternatively, they may present this separately
of organisations has changed. An organisation is now dependent on on their website and give reference to it in the annual report.
other organisations for its materials, labour, IT systems etc. Use of Integrated Framework as prescribed by IIRC
technology within the business many times becomes a game changer The <IR> should be prepared in accordance with the Integrated
driving value for the business. (e. g.) Online sales versus brick and Framework laid out by IIRC. The Framework provides Guiding
mortar outlets). The service sector has seen tremendous boom in Principles and Content Elements that can be referred to while preparing
development (e.g. IT industry, banking). Consequently, human the <IR>. The Framework does not prescribe any specific KPI metrics
capital has become more skilled, so talented employees have become or measurement methods or about the disclosure of individual matters.
a critical value driver of business. It is left to the judgement of the preparers of the report to decide on the
To summarise, during the last two decades, every organisation has content based on the case-specific scenario of each organisation. Points
become inter-dependent on other organisations and the external to consider while preparing an Integrated Report:
environment to conduct its business. Businesses have become dependent t 1SFQBSFST NVTU VTF KVEHFNFOU BCPVU materiality of a matter under
on relationships with suppliers /customers /government agencies, consideration to determine its inclusion in the report.
natural resources, human capital, infrastructure and technology. These t 1SFQBSFST NVTU VTF KVEHFNFOU BCPVU manner of disclosure of
relationships and interactions are intangibles, that cannot be strictly matters including the basis for measurement, disclosure methods
quantified and reflected in the balance sheet. These can be looked upon as found appropriate.
as “capitals” beyond the regular financial capital of the balance sheet. t *G JOGPSNBUJPO QSFTFOUFE JO UIF *3 JT TJNJMBS UP JOGPSNBUJPO
This aspect cannot be immediately perceived by the users of corporate presented elsewhere, then the content in the <IR> should be
reports unless they are informed about it. However, this interdependency prepared on the basis or should be reconciled with the information
is very critical for an organization to function. For example, if it runs presented elsewhere.
out of a particular natural resource with which it makes products, then t *U NBZ CF QSFQBSFE JO DPNQMJBODF XJUI governing regulations.
this could impact business. (World is facing shortage of ‘Silica’ which t *3 BJNT BU FYQMBJOJOH IPX BO PSHBOJTBUJPO DSFBUFT WBMVF
is used in innumerable industries like electronics, construction. The over time. The report can contain quantitative and qualitative
other natural resources in short supply are energy giving fossil fuels information to explain this. It is more than just a summary of other
and water.) Likewise, only talented employees can deliver on attaining communication that an organisation publishes. It makes explicit
strategic objectives, therefore talent has to be groomed. In the modern connectivity of how value is created by an organisation.
world innovation is the key to success, something that can be driven t *U NBZ FJUIFS CF B TUBOEBMPOF SFQPSU PS CF JODMVEFE BT B
only by motivated, talented employees. distinguishable part of another report (example an annual report).
Therefore, the need to have a narrative in the form of an Integrated It has to be clearly identified as an <IR>.
Report <IR> that spells out how an organisation can manage, preserve t ͳPTF DIBSHFE XJUI HPWFSOBODF TIPVME acknowledge the (i) integrity
and grow /deplete these “capitals”. Information about managing these of the information in the report (ii) that the report was prepared by
capitals has become paramount to assess business performance, seeking their opinion and (iii) an opinion as to whether the report
stability and sustainability. is in accordance with the Framework.

Users of <IR> would primarily be those who provide financial leadership and culture are internal factors that need to be aligned
capital to the organisation. However, there may be interested with the external environment in which the business operates. The
parties like suppliers, customers, employees, business partners, business model should promote development of all stakeholders in
local communities, regulators, legislators and policy makers who order to sustain in the long run. Therefore, by disclosing issues that
may also want to understand <IR>. are relevant to stakeholders, an organisation can align itself better to
promote mutual development. It will also give the user insight about
the building blocks in the value creation process. <IR> thus serves
Fundamental Concepts related to the Integrated Report as a tool to make the organisation align towards its own financial
Value creation for the organisation and for others stability and sustainability and better corporate governance. Capital
The integrated report provides qualitative and quantitative disclosures allocation can then be streamlined to support activities that would
about how the organisation creates, diminishes or preserves value. enable sustainability and stability of the organisation.
Value created for the organisation itself enables financial returns to The Framework also includes scenarios where there may have
the providers of financial capital. been no change in the value or that the value of the company
Value created for others is also of interest to the providers of financial is preserved. Scenarios when value preservation may need to be
capital. Notably it must be understood that: discussed would be:
t 7BMVF JT JOnVFODFE CZ external environment. (i) Businesses being merged and acquired. Generally the “value
t 7BMVF JT DSFBUFE UISPVHI relationships with stakeholders, internal creation” of an acquired /merged business does not happen
and external. Internal factors like management and operations, immediately. In reality, integration of two businesses is challenging
employees, licenses, patents, financial stability of the organisation. due to operational and organisational cultural differences. So in
External factors that impact value creation are suppliers, reality, although the deal may be closed, the “value creation” from
customers, prevailing economic conditions, government policies the acquired business is deferred. Here, the management may
etc. Together they can enhance /deter /preserve the value created wish to point out the steps it wishes to take to steer the business
by the organisation. integration so that it creates value in the long run. This could
include measures to stabilise the acquired business. Discussion
t 7BMVF DSFBUJPO JT subjective and changes based on the perspective
could centre around how the experience of the top management
of each stakeholder. Example could be: A good employer may not
(strategic initiative) will enable the management at the operational
be very profitable. Therefore, while the employee may be satisfied
level (tactical initiatives) to have seamless integration. These are
with the value an organisation provides them, but if the target
steps taken by an organisation to “preserve value”.
financial metrics are not met, the investors may not be satisfied
with the value an organisation provides them. This discussion may be needed in order to reassure the providers
of finance that the management has a clear road map on how
Value creation is not an independent activity within the organisation’s to manage the “business /value acquired” so that it generated
sole control. Value is created using capital. In integrated reporting, sustainable value in the long run. Others such as employees of the
capital is not limited to just financial capital. There are six different company may also be interested in the management’s outlook.
categories: financial, manufactured, human, natural, intellectual, (ii) Debt Restructuring: Challenges faced by an organisation may
social and relationship capitals (details are covered later). A lead to situations where there is a cash flow crunch in operations.
combined effect of these capital is what results in value creation for This may hinder it from meeting its debt obligations. If fresh
the company. capital investments cannot be infused, the organisation may go
The ability of an organisation to create value is linked to the value it for debt restructuring. It negotiates with the bank to draw up
creates for others. This happens through a wide range of activities, a better scheme of arrangement that can enable it to meet its
interactions and relationships. Example: obligations. Such instances put concerns about the organisation’s
Sales to customers will change financial capital. This is reflected in the liquidity on various stakeholders like investors, bankers,
financial statements. At the same times, after sales support interactions suppliers, employee union, government who would be anxious if
handled by after-sales personnel (human capital) can impact customer the organisation would be able to meet its obligations.
satisfaction (social capital). Customer satisfaction will determine A discussion by the management on the road map that the
their willingness to give more business to the organisation in future organisation plans to follow to improve its solvency would highlight
(developing a relationship). Any material issues with customer the risks that the organisation faces. Accordingly, the stakeholders
satisfaction like harmful content detected while consuming product can make informed judgements about the organisation’s value.
that has resulted in causalities, faulty technology leading to product The report should also take into consideration the effects of business
recalls will have to be disclosed and discussed in the Integrated Report. operations that have been “externalised”. For example, smoke
Positive instances like superior technology (intellectual capital) emission from the factory does not impact the organisation directly.
enhancing customer satisfaction can also be discussed. However, the impact is felt in the form of air pollution in the city.
Another instance would be willingness of key suppliers to trade with Similarly, waste dumped in landfill does not impact the organisation
the organisation and the terms and conditions of these agreements. but does impact the city living conditions. These are impacts that
Suppose there is a case of vendor lock-in, where the organisation has are externalised. Where judged material they need to be discussed
to be dependent on one particular supplier and is unable to switch in the report. Providers of financial capital may need to be aware of
to other suppliers without substantial switching costs. This may be material information of these externalities to assess their effects.
disclosed and discussed to make the users aware of potential risks Example, externality could negatively impact business: Chennai
to business. Likewise highlighting positive instances where long city faced severe drinking water supply the summer of 2019. The
term procurement agreements will improve business operations and crisis impacted normal life for many months. Many IT firms had
product quality can also be disclosed in the report. to request their employees to work from home since they could not
Therefore, the play of activities, interactions and relationship are provide water facilities at office. If unprepared, this crisis could have
building blocks for the value chain. An organisation’s strategy, disrupted business for some of these firms.
Do You Know?
The Business Roundtable (BRT) is an association of CEO’s of America’s top companies. These CEO members lead companies with more
than 15 million employees and more than $7 trillion in annual revenues. The BRT released an updated statement on the ‘Purpose of
a Corporation’ in Aug’ 2019. The statement stated a fundamental commitment to all stakeholders- customers, employees, suppliers,
communities and shareholders; representing a move away from the long-standing view that shareholder profit is the only purpose of
corporations. The statement received support from 181 CEOs, including the leaders of Abbott, Accenture, Amazon, Apple, American
Airlines, American Express, Bank of America, Boston Consulting Group, Citigroup, The Coca-Cola Company, Cognizant, Dell, Procter &
Gamble and Walmart.

The Capitals – Financial, Manufactured, Human, Intellectual, Social and Relationship capital refers to:
Natural, Social and Relationship a. The shared norms, common value and behaviour stakeholders
Capitals are the stocks of value change through activities and outputs may have with the organisation. For example, both the
of an organisation. For example, financial capital increases when organisation and supplier may value not to employ child
profit is made, human resource capital improves when employees are labour, value safe working environment for employees etc.
better trained. Overall Value of stock of capital keeps changing. One An organisation may take due diligence while doing business
type of capital can be transformed into another, so there is constant with a supplier to ensure that these norms are met.
flow between the capital. For example, (i) New equipment purchased b. Key stakeholder relationships and the trust and willingness an
increases manufactured capital while decreasing financial capital or organisation has built with external stakeholders. Trust must
(ii) talented employees (human resource capital) have developed be earned but can be easily lost. Therefore, an organisation
a patent for a component (intellectual capital) that increases the must strive to build trust be it with customers, suppliers
product’s sales, thus profits (financial capital) or (iii) a school is built or regulatory authorities. For example, timely settlement
for local community children to study in (societal and relationship of suppliers’ dues will build strong relationships. This will
with the outflow of financial capital). contribute positively because they will be more willing to
engage with the organisation while doing business.
Categories and descriptions of capitals
c. Relationship is built on the brand and reputation that the
(1) Financial Capital: Refers to the conventional “monetary” capital. organisation has developed. For example, the trust that
It is generated through financing (either in the form of equity or the customer places on the organisation while consuming
debt), investments and surplus generated from business operations. products manufactured by it, with the belief that it is not
Businesses use this pool of funds to create value by transforming it detrimental to the users’ health. This trust and willingness of
into other forms of capital like manufactured, intellectual, people, the customer forms the very basis of brand loyalty, value that
environmental, social and relationship capitals. the organisation has to maintain.
(2) Manufactured Capital: The “physical infrastructure” needed d. An organisation’s social license to operate: Social license is
to manufacture a product or provide service. These are the acceptance of an organisation’s business practices by its
manufactured physical objects (as against natural physical employees, stakeholders and larger public. An organisation
objects like lakes and mountains). Examples, machinery, has to work to build trust within itself and with the external
building, infrastructure such as roads, bridges or even inventory environment it operates in. Closely linked to the Triple
held for sale / captive consumption. Bottom Line concept, it should take care of its employees,
(3) Intellectual Capital: These are resources that are critical to the environment and corporate social responsibility. Any
value creation. Examples, of intellectual property are patents, issue that arises that can erode this social license should be
copyrights, software, licenses, brand value. quickly resolved.
(4) Human Capital: The combined know-how, skill, effort and The management may discuss any material matters relating
experience of the workforce of an organisation forms its human to its social and relationship capital like the corporate social
capital. A motivated workforce can enable the organisation responsibility initiatives that it has undertaken. Any issue that
to achieve its objectives. To derive this mutual benefit, their can threaten social license to operate may also be addressed here.
work should be aligned with the organisation’s governance (6) Natural Capital: Renewable and non-renewable natural
framework, risk management approach, ethical values. They also resources that an organisation uses for its business operations.
need to understand the organisation’s strategy and develop and These would be land, water, air, fossil fuel etc. Certain industries
implement it. To retain the work force loyalty, an organisation for example those in the agriculture and mining industries are
has to groom talent and the leadership team. highly dependent on natural resources for their business. Proper
(5) Social and Relationship Capital: An organisation has multiple utilisation and maintenance of these resources can determine the
stakeholders, direct and indirect, internal and external to the future sustainability of the organisation.
organisation. They include customers, vendors, suppliers,
associates, alliances, dealers, sales network, government, Not all capitals are equally relevant or applicable in all
regulatory authorities, communities and society. organisations. However, the Framework provides this guideline so
that no aspect of the “value chain” is overlooked.
Source : https://integratedreporting.org/wp-content/uploads/2015/03/13-12-08-THE-INTERNATIONAL-IR-FRAMEWORK-2-1.pdf

Value Creation Process be both quantitative or qualitative, financial or non-financial,

The business model of an organisation uses capitals as inputs and internal or external to the organisation and relate to different
through various business activities converts them as outputs time frames (short, medium or long). Disclosure of material
(products or service). The organisation’s activities and its outputs matters requires judgement, an ability to think from different
lead to outcomes in terms of their effects on the capital. Nurturing perspectives. This can be developed with regular engagement
capital in terms of its availability, quality and affordability in order with the providers of capital and other stakeholders.
to sustain business in the long run. For example, if a company’s food 5. Conciseness : The information should be presented in a logical
product (activity leading to output) causes health issues like diabetes structure, avoiding repetition and clearly cross-linked within the
or obesity to the consumers (affects the society and relationship report to establish connectivity of information. The narrative
capital), in the long run the public will avoid its products. This should be written in lucid language that is easy to understand.
can impact business sustainability. Therefore, the company has to 6. Reliability and completeness : Information presented should
change its strategy to additionally provide healthy offerings so that include both positive and negative matters to make the report
consumers have a choice about the food they want to consume. This complete. Information should be without material error to
change can nurture both customer satisfaction and public health to enhance its reliability.
promote business stability and sustainability. Therefore, business 7. Consistency and comparability: Information presented should
models need to be flexible to adapt to changes internal and external. be consistently prepared over time. Any change in compilation
or measurement of information should be disclosed. Tools such
Preparation and Presentation of the Integrated as industry benchmarks, presenting information in the form of
Report ratios or comparing standard quantitative indicators enables
users to compare the report with that of other organisations.
An <IR> is prepared with the help of Guiding Principles and Content
Elements, preparers of the report can refer to Guiding Principles
to understand the concepts that underpin the preparation and Content Elements of the Integrated Report
presentation of the report. They can refer to Content Elements to The content of an organisation’s Integrated Report would vary
understand to understand what the report should include. These depending on the individual circumstances of each organisation.
are not water-tight guidelines. Preparers must exercise judgement to Therefore, Content Elements are stated in the form of questions
decide on these matters while preparing the report. rather than of checklists of specific disclosures. Judgements need
to be made to decide on what to report on using the Integrated
Guiding Principles of the Integrated Report Reporting Framework as a reference. Questions can be posed for
each of the categories of Content Elements below:
1. Strategic focus and future orientation: The report has to provide
insight into the organisation’s strategy and enumerate how it can 1. Organisational overview and external environment
create value in the short, medium and long term time horizons. t 8IBU JT UIF 7JTJPO BOE .JTTJPO PG UIF PSHBOJTBUJPO
It might want to highlight significant risks, opportunities and t 8IBU JT UIF PXOFSTIJQ TUSVDUVSF JUT DVMUVSF FUIJDT WBMVFT
dependencies flowing from the organisation’s market position and t 8IBU BSF UIF QSJODJQBM BDUJWJUJFT BOE NBSLFUT
business model. The management has to clearly articulate about t 8IBU JT UIF DPNQFUJUJWF MBOETDBQF UIF PSHBOJTBUJPOT QPTJUJPO
the continued availability, quality and affordability of significant in the value chain?
capitals relevant to the organisation’s business since only when t 4JHOJmDBOU MFHBM TPDJBM FOWJSPONFOUBM QPMJUJDBM DPNNFSDJBM
capital is nurtured, it will help sustain business in future. They may aspects from the external environment in which the
provide their opinion about learnings from past experiences that organisation operates may also be discussed.
have influenced future directions, relationship between past and t ,FZ RVBOUJUBUJWF JOGPSNBUJPO NBZ CF QSFTFOUFE IFSF
future performance and factors that can change them. 2. Governance
2. Connectivity of information : The usefulness of the <IR> t )PX EPFT BO PSHBOJTBUJPOT HPWFSOBODF TUSVDUVSF
is enhanced when it is logically structured, presented in an influence value?
understandable yet concise way. Information has to be clearly t 8IBU BSF UIF TLJMMT BOE FYQFSJFODF PG UIPTF DIBSHFE XJUI
delineated but linked together to present a holistic picture of governance? Actions they take to influence and monitor the
business model and value creation process. The Content Elements strategic direction of the company.
(subject matter of the report) should have a clear narrative that t 1SPDFTTFT JO QMBDF UP NBLF TUSBUFHJD EFDJTJPOT BOE
helps conjure a total picture of dynamic and systemic interactions its implementation.
of the organization’s activities. Connectivity of information could t )PX BSF SFNVOFSBUJPO BOE DPNQFOTBUJPO MJOLFE UP
talk about the flexibility and ability of the organisation’s strategy value creation?
to help the business model adapt to changes within and to the t ͳFTF BSF TPNF PG UIF EJTDVTTJPOT UIBU DBO CF MBJE PVU JO
external environment. Qualitative, Quantitative and KPI metrics this section.
information can be used in the narrative to connect information. 3. Business model
3. Stakeholder relationships : An effective <IR> report would be t " CVTJOFTT NPEFM XJUI UIF IFMQ PG CVTJOFTT BDUJWJUJFT
transparent in providing accountability to key stakeholders by transforms inputs into outcomes or outputs that fulfill the
their disclosing legitimate needs and interests. Accountability organisation’s strategic objectives.
places the organisation in the role of stewardship to take care t ͳF SFQPSU IBT UP FOVNFSBUF XIBU DPOTUJUVUFT JOQVUT CVTJOFTT
of the value creating capitals. Engagement with stakeholders activities, outputs and outcomes.
like suppliers, consumers and employees would happen in the t ͳFSF DBO CF B QJDUPSJBM SFQSFTFOUBUJPO PG UIF NPEFM BMPOH
regular course of business. In some cases, engagement with local with an explanatory narrative.
communities or regulatory authorities, NGOs may happen in t $POOFDUJPO XJUI PUIFS $POUFOU &MFNFOUT MJLF TUSBUFHZ SJTL
special circumstances. An organisation has to understand their and opportunities, performance (financials and KPIs).
information needs and concerns. Needs and concerns that are 4. Risks and opportunities
material may be discussed in the <IR> along with the actions t 4QFDJmD SJTLT BOE PQQPSUVOJUJFT UIBU BĉFDU UIF PSHBOJTBUJPOT
and decisions the organisations have taken to address them. Thus ability to create value.
<IR> could serve as a tool to build trust and resilience between the t )PX JT UIF PSHBOJTBUJPO EFBMJOH XJUI UIFN
organisation and its stakeholders. t "EESFTT UIF DPOUJOVFE BWBJMBCJMJUZ RVBMJUZ BOE BĉPSEBCJMJUZ
4. Materiality : A matter related to value creation is material when of capital.
its known or potential impact on the organisation’s value creation t %JTDMPTVSF BCPVU UIF MJLFMJIPPE PG PDDVSSFODF PG UIF QFSDFJWFE
ability is significant and important. While exercising judgement risk and opportunity.
about the magnitude of the effect it should be noted that it can t %JTDVTT TQFDJmD TUFQT UP NJUJHBUF SJTL PS UP DSFBUF WBMVF GSPN
opportunities.

t 8IFSF B QBSUJDVMBS SJTL DBO UISFBUFO UIF GVOEBNFOUBM BCJMJUZ 7. Outlook

of the organisation to create value, it needs to be reported t 3FQPSU DBO EJTDVTT UIF DIBOHFT UIF PSHBOJTBUJPO DBO FYQFDU JO
even if the likelihood of occurrence is small. the external environment.
5. Strategy and resource allocation t )PX JT UIF PSHBOJTBUJPO FRVJQQFE UP SFTQPOE UP DSJUJDBM SJTLT
t *EFOUJmDBUJPO PG TIPSU NFEJVN BOE MPOH UFSN and uncertainties that can arise?
strategic objectives. 8. Basis of preparation and presentation
t 3FTPVSDF BMMPDBUJPO UIF PSHBOJTBUJPO IBT QMBOOFE UP BDIJFWF t ͳF SFQPSU TIPVME EJTDMPTF IPX UIF SFQPSU XBT QSFQBSFE
the objectives. t ͳF CBTJT GPS EFUFSNJOJOH NBUFSJBMJUZ SFQPSUJOH CPVOEBSZ
t -JOL UIF TUSBUFHJD PCKFDUJWFT XJUI SFTPVSDF BMMPDBUJPO QMBOT summary of significant framework and methods.
ability to adapt to change in the external environment.
t %JTDVTTJPO BCPVU XIBU HJWFT UIF PSHBOJTBUJPO JUT DPNQFUJUJWF Conclusion
advantage: innovation, development and use of intellectual
capital, environmental and social considerations that give it Investors well informed about the organisation’s business
the competitive edge. operations can take mature decisions that will improve the financial
environment and the economy as a whole. Organisations that
6. Performance are profitable, by taking along their stakeholders in their success
t ͳF SFQPSU NBZ DPOUBJO RVBMJUBUJWF BOE RVBOUJUBUJWF stories, will always be rewarded. Also, organisations that talk about
information about the performance of the organisation. the risks the business faces improve transparency of corporate
t *ODMVEF RVBOUJUBUJWF JOEJDBUPST DPNQBSJOH BDUVBM QFSGPSNBODF report. With multiple scandals rocking the investment world,
with targets explaining their significance and importance. there is a need to improve the integrity of corporate reporting.
t *ODMVEF B OBSSBUJWF PG UIF PSHBOJTBUJPOT FĉFDUT CPUI QPTJUJWF The Integrated Report aims to fulfill that needs.
and negative), connecting financial performance with regard
to other capital.
Case Study projects are also benefitted by way of augmentation in generation at

no additional cost to them. Concerned home state also gets 15% of
The basic objective of the case study is to allow the students to apply generated power as free. The total expenditure for this project was
ideas and insights from theory to the real life issues and problems. USD 1 billion. Since 2007-08, which was the first year of operation,
VHDCL has been a profit making company.
Case Study - Triple Bottom Line The Vidyut Dam has been the object of protests by environmental
A preliminary investigation for organisations and local people of the region. The protest was
VIDYUT DAM PROJECT the Vidyut Dam Project was against the displacement of town inhabitants and environmental
completed in 1962 in a South- consequences of the weak ecosystem. “We don’t want the dam. The
Asian country (here-in-after dam is the mountain’s end” was the prominent slogan.
referred as country) and its design The relocation of nearly 1.5 lakh people or may be even more, from
was completed in 1973 with a the area has led to protracted legal battles over resettlement rights
600 MW capacity power plant. and, ultimately, resulted in the project’s delayed completion despite
Construction began in 1979, but the fact that land acquisition was started in 1980. There is no master
was delayed due to economic, plan for rehabilitation nor even a clear estimate of the number of
environmental and social impacts. people affected. According to the 2003 status report of the public
In year 1987, technical and financial assistance was provided by the work department of Chapala town, the Dam replaced 15,550 families.
neighbouring country to said country after signing of MoU, but this This estimate excludes a large number of people who lost their lands
was interrupted just a year later with political instability. Hence, said but have not been officially recognised as project-affected. Among
country was forced to take control of the project and at the first, it was those officially recognised, allotted with land of poor quality or with
placed under the direction of the irrigation department of concerned multiple ownership claims.
home state of said country. However, in July 1989 the Vidyut Hydro Near to year 2006, while filling of the reservoir has led to the reduced
Development Corporation Limited (VHDCL) was formed to manage flow of Karaka River’s water from the normal 1,000 cu ft/s (28 m3/s)
1,900 MW Vidyut Hydro Power Complex; wherein 75% stake held to a mere 220 cu ft/s (6.3 m3/s). This reduction has been central to
by union government and remaining 25% stake by concerned local protest against the dam, since the Karaka River is considered
home state government. The 1,900 MW Vidyut Hydro Power sacred river whose waters are crucial to religious beliefs.
Complex comprises of Vidyut Dam and 1,000 MW Vidyut Hydro Old Chapala town shifted and named as New Chapala Town (NCT)
Power Plant (250MW×4), Beejuree HEP (400 MW), and Vidyut which is semi-ultra-modern hill station at height of 1,555-1,855
PSP (500 MW). m above MSL, with better road network and district head quarter
The Vidyut Dam is a 260.61 m (855 ft) multi-purpose high rock and (shifted to NCT, earlier about 65 kms away from Chapala). NCT
earth-fill embankment dam on the Karaka River near Chapala town. equipped with better health (got 80 bed modern hospital against 25
Its length is 574.85 m (1,886 ft), crest width 20.11 m (66 ft), and base bed hospital in old Chapala, and also got 5 primary health centres
width 1,128.06 m (3,701 ft). The dam creates a reservoir of 4.0 cubic with additional 75 bed facility in total) and education facilities (hostel
kilometres (a32,00,000 acre ft). facility of 900 students, degree college with university campus which
The 1,000 MW Vidyut Hydro Power Plant (Vidyut HPP) was can accommodate 440 residential students and faculties, and against
commissioned in 2007-08 as a multipurpose project, with variable 1 inter college in old Chapala, 5 inter-college established (one in NCT
speed features which can optimise the round trip efficiency under and 4 in nearby villages). This all done at project cost.
varying water levels in its reservoirs. Power is distributed to 10 In addition to the human rights concerns, the project has spurred
northern states (including concerned home state) of said country. concerns about the environmental consequences of locating such a
The complex will afford irrigation to an area of 2,71,139 hectares large dam in the fragile ecosystem of the foothills of great mountain
(=6,70,000 acres), irrigation stabilisation to an area of 6,07,028 range. There are further concerns regarding the dam’s geological
hectares (=15,00,000 acres), and a supply of 270 million imperial stability. The Vidyut dam is in a major geologic fault zone. This
gallons (1.23×106 m3) of drinking water per day. 162 million gallons region was the site of a 6.7 magnitude earthquake in September 1992,
of drinking water for around 4 million people of the neighbouring with an epicentre 55 km (34 mi) from the dam. Dam proponents
state, apart from 108 million gallons of drinking water for around 3 claim that the complex is designed to withstand an earthquake of
million people of the concerned home state. Due to regulated releases 8.4 magnitude, but some seismologists say that earthquakes with
from the Vidyut storage reservoir, the existing downstream hydro a magnitude of 8.5 or more could occur in this region. Were such

a catastrophe to occur, the potentially resulting dam-break would (6.3 m3/s). Former concern is more significant than the later
submerge numerous towns downstream, whose populations total concern, because later was of short duration; it is obvious when
near half a million. the reservoir is filled to its maximum capacity, the flow of the
In spite of concerns and protestation, operation of the Vidyut Dam river will again become normal. Regarding the displacement, it
continues and is completed. But VHDCL was aware of these and is mentioned in the case itself that according to the 2003 status
tried to respond in a constructive way. The spirit of CSR initiative is report of the public work department, the Dam replaced 15,550
depicted by its CSR initiative title ‘VHDC Sahridaya’ (Corporate with families. Further, this estimate excludes a large number of people
a Human heart), wherein the focus areas are: who lost their lands but have not been officially recognised as
t Shiksha - Education Development project-affected. Even those officially recognised, allotted with
t Svasth - Nutritional Health and Sanitation and Drinking land of poor quality or with multiple ownership claims. This
Water Projects concern substantiates in absence of a full-proof master plan.
t Nipun - Livelihood Generation and Skill Development Initiatives It is not the case that local resident were/ are in complete
t Unnaati - Rural and Infrastructure Development distress, they were/are compensated with alternative and
t Yogy - Empowerment Initiatives better facilities and remedies as well that too at project cost,
t Srrishti - Environment Protection Initiatives which includes the:
Out of these ‘VHDC Srrishti’ has some special mentions, ‘Environment t %FWFMPQNFOU PG IJMM TUBUJPO UP BUUSBDUJPO GPS UPVSJTN o ͳF
Focussed Initiatives’ is working with three objectives Soil and Water New Chapala Town (NCT) is developed with semi-ultra-
Conservation, Green Energy Generation and Technology Promotions modern facility at height of 1,555-1,855 m above MSL as pre-
and Environment Protection and Promotion. planned hill station which will attract the tourist. By creation
To conserve soil and water VHDCL is working on water harvesting of lake due to the impoundment of the reservoir of Vidyut
and water harvesting tanks (capacity 3,000 litres each) were installed Dam, scope of water sports is there. Hotels, Guides and Tour
in the project affected villages for rainwater harvesting. Through and Travels will cause employment opportunities for locals.
this activity, beneficiaries were able to store almost 9 lakh litres of t #FUUFS SPBE OFUXPSL MFBET UP ease of living and improved
rainwater during monsoon. In addition, VHDCL under this program communication channels which also help in establishing
installed more than 730 LED based Solar Street Lights and more suitable industries according to environmental aspects.
than 180 LED based Solar High Mast Lights in near-by towns and t 4IJGUJOH PG EJTUSJDU IFBE RVBSUFS UP /$5 SFTVMUT JO SFEVDUJPO
villages in year 2019-20. Moreover, to promote plantation of different of distance of travel by town residents to reach to district
fruit, fodder, and medicinal plants, VHDCL planted 2,70,202 plants/ head quarter for any task by about 65 kms, hence life of locals
sampling till now. will be further eased.
VHDCL has won many awards in the last decade in different t Improved health facilities - NCT equipped with better health
categories including CSR domain, but most recent and relevant (for facilities. It got 80 bed modern hospital against a 25 bed
case study) among them areÆ hospital situated in old Chapala town. Apart from this also
t )3 1MBUJOVN "XBSE GPS 5SBJOJOH &YDFMMFODF JO got 5 primary health centres with additional 75 beds in total.
t /BUJPOBM $43 -FBEFSTIJQ "XBSE t Improved Education facilities in terms of hostel facility of 900
t $43 *OOPWBUJPO BOE -FBEFSTIJQ "XBSE students and increase in number of inter-colleges.
It has not only gained recognition in term of awards, VHDCL has Not only the local resident (directly affected), other too got
obtained following Certifications: benefit from project, such as 250 cusecs (a162 million gallons
t *40 $FSUJmDBUJPO 2VBMJUZ .BOBHFNFOU 4ZTUFN
per day) of water supply to neighbouring state, which will meet
t ISO 14001:2015 Certification (Environment Management drinking water need of around 4 million people, apart from
System). 167 cusecs (a108 million gallons per day) of water supply to
t 0)4"4 $FSUJmDBUJPO 0DDVQBUJPOBM )FBMUI BOE concerned home state, which will meet the drinking water
Safety Management System). need of around 3 million people. Power is also distributed
Required to 10 northern states (including concerned home state) of
said country.
As part of the policy initiative, if VHDCL is willing to implement
the Triple Bottom Line (TBL) reporting initiative; then ADVISE VHDCL showed social commitment through Shiksha, Svasth,
the management regarding dimensions of TBL, and what are Nipun, Unnaati, and Yogy as part of their CSR initiative.
perspectives composed by different dimensions of TBL. Also, (ii) Planet, the environmental bottom line measures the impact on
enumerate the challenges, expected benefits, and initiatives resources, such as air, water, ground and emissions to determine
under each dimension in context of Vidyut Dam and Vidyut the environmental impact and ecological footprints.
Hydroelectric Power Plant (1,000 MW).
The project has spurred concerns about the environmental
Solution consequences of locating such a large dam in the fragile
British business author John Brett Elkington in year 1994 coined the ecosystem of the foothills of great mountain range, which will
term TBL. Every business needs to be sustainable, rather than only result in weak ecosystem and concerns over a catastrophe to
profitable. A business is said to be sustainable, when management occur (due to earthquake - the potential dam-break). Regarding
makes sustainable business decisions. To consider sustainability of the later concern, it is also mentioned in the case that the Vidyut
business decision there are three bottom lines i.e. People, Planet dam is in a major geologic fault zone. This region was the site of a
and Profit (also known as dimensions of TBL), instead of single 6.7 magnitude earthquake in September 1992, with an epicentre
bottom line (i.e. Profit). 55 km from the dam. In response to which the Dam proponents
Here-in VHDCL, shows strong commitment for CSR through the claim that the complex is designed to withstand an earthquake
certification (regarding quality, environment and safety) they of 8.4 magnitude, but some seismologists say that earthquakes
obtained and also through the awards they won (in the domain of with a magnitude of 8.5 or more could occur in this region.
CSR and Training). Were such a catastrophe to occur, the potentially resulting dam-
break would submerge numerous towns downstream, whose
Dimensions (sets) of TBL populations total near half a million.
(i) People, the social equity bottom line relates to corporate The major environmental benefit is generation of 1,000
governance, motivation, incentives, health and safety, human MW (3,532 MU of Annual Energy) of environment friendly
capital development, human rights and ethical behaviour. peaking power.
The project has major concerns about the displacement of In order to leave improved environment footprint and to trade-
town inhabitants, followed by reduction in flow of Karaka River off the environmental loss caused during construction, VHDCL
from the normal 1,000 cu ft/s (28 m3/s) to a mere 220 cu ft/s through initiative ‘VHDC Srrishti’ working on:

t Rainwater Harvesting – It has installed the necessary concerned home state government. The total expenditure for
infrastructure in the affected areas to harvest almost 9 lakh this project was USD 1 billion. Since 2007-08, which was the first
litres of rainwater during monsoon. year of operation, VHDCL is a profit making company.
t Green Energy Generation and Technology Promotions The initiative includes the feature of variable speed, the 1,000
through installing LED based Solar Street Lights and LED MW Vidyut HPP has variable speed features which can optimise
based Solar High Mast Lights. the round trip efficiency under varying water levels in its
t Environment Protection and Promotion through plantation reservoirs to keep the cost of operation low.
of 2,70,202 samplings so far, of different fruit, fodder, and The quantifiable economic benefits include:
medicinal plants. t ͳF HFOFSBUJPO PG .8 .6 PG "OOVBM &OFSHZ
(iii) Profit, the economic bottom line refers to measures of environment friendly peaking power. This will no
maintaining or improving the company’s success in terms of doubt lead to industrial and agricultural growth in the
adding value to shareholders. northern region.
It is an inherent feature (rather project specific concern) of t PG HFOFSBUFE QPXFS XJMM CF HJWFO GSFF UP UIF DPODFSOFE
hydro power projects that the duration of construction is quite home state, apart from power as per their share, where the
lengthy and huge capital outlay is involved. In case of Vidyut distress is caused due setting up of the project. Hence, the
Dam too, Construction began in 1979, but was delayed due to state has economic benefit from the project too.
economic impact apart from social and environmental pressure. t *SSJHBUJPO PG MBLIT IFDUBSFT PG BSFB CFTJEF JSSJHBUJPO
In 1987, technical and financial assistance was provided by the stabilisation of 6.07 lakhs hectares. Hence, supporting other
neighbouring country, but this was interrupted years later with economic activities as well indirectly.
political instability. Project then placed under the direction To conclude, the project largely seems sustainable as running
of the irrigation department of concerned home state of said in profit since it was operational, leaving minimal and positive
country. However, in July 1989 the Vidyut Hydro Development environmental footprint, and also payback society (especially
Corporation Limited (VHDCL) was formed to manage such directly affected local population) with alternate better facilities
1,900 MW Vidyut Hydro Power Complex; wherein 75% and compensation (may be with few minor exceptions or
stake held by union government and remaining 25% stake by irregularity on case to case basis).
Case Scenario of defects. Six-Sigma seeks to improve the quality of process by

Case Scenarios, as opposed to Case Studies, are short cases. Written identifying and removing the cause of defects (defect can be anything,
in a more compact style with an appealing narrative, the Case which lead to customer dissatisfaction). Six Sigma uses quality
Scenario’s focus is on covering more depth in a specific area. management and statistical methods with special infrastructure of
people. Six-Sigma can be implemented through two methodologies;
Case Scenario – Six Sigma 1) DMAIC (Define, Measure, Analyse, Improve and Control) -
Smooth Connect Telecom (SCT) is the Improve existing business process (remove defect).
SCT private sector telecom company. SCT is 2) DMADV (Define, Measure, Analyse, Design and Verify) -
second largest player in telecom sector of Create new business process (defect free).
country, with subscriber base of more than
10 million. SCT achieved this magnificent DMAIC methodology of Six Sigma implementation at SCT
growth by acquiring competitor in recent
years. SCT deals in fixed line telephone
services, corporate services and mobile
(cellular) services. SCT is meeting all the requirements from
regulator in efficient and timely manner.
SCT is known for continuous innovation in its services, with changing
pace of technology and business need like wise use of Optical Fiber
Wire and VoLTE (Voice over Long-Term Evolution) etc. This helps
the SCT in acquisition of many corporate clients.
The largest player in telecom industry is Voice Telecom, which is Define – Define the improvement area
resulting company out of corporate restructuring of state-owned
Define includes definition of customer requirement or problem faced
telecom corporation. Voice Telecom still own largest market share
by customer.
due infrastructural advantage over other players in the market. SCT
is also facing tough competition from Voice Telecom on pricing and First and foremost, requirement of is to ensure customer must be
customer volume. billed correctly, because wrong billing may lead to either of;
Majority of telecom operators, including SCT and Voice Telecom, a. Delayed revenue – due to litigation for wrong billing
usually criticised by customers for poor customer services, b. Loss of revenue – due to porting to alternate telecom
misallocation of call duration and call drop; but majority of operator by customer
complaints are on account of; Customer care executives need to be trained, so that they can guide
a. Calculating wrong tariff, and the customer in most appropriate way and ensure lowest possible
b. Dull and delayed response from customer care executives. wait time to solve customer complaint.
Hence, by focussing on customer services, if SCT improves its billing Measure – Existing process for comparison
process and handles the customer complaints wisely; then SCT Existing performance needs to be measured
can gain competitive advantage over other players including Voice Since performance need to be measured specially in two domains
Telecom. In order to improve the quality of customer services, SCT ‘billing processes’ and ‘customer complaint handling’, hence
decide to practice Six Sigma initiative. SCT needs to have a system through which it can collect reliable
information (likewise number of complaints as percentage of
Required
total customers, similarly wrongly billed customers against total
Enumerate the modus operandi that ‘how SCT can APPLY customers; is there any process of reissue the correct bill? – if yes
DMAIC method to implement Six Sigma’. –than in how many cases it is issued? and average time to solve
complaints) in order to measure existing performance.
Solution
Performance is required to be measured against each of critical
Six Sigma was first used by Mr Bill Smith of Motorola Corporation
success factors (which will create value for customer).
in 1986 for improvement of manufacturing process and elimination

Analyse – Cause effect relationship between factors of process Mr Sodhi, Head Workshop and Repairs agrees that the repair issues
Existing process needs to be mapped in order to determine the root in case of recently sold vehicle have been increased.
cause of problem Mr Murthy, VP Production and Operations who recently joined the
SCT should further analyse the information collected in second SAL replied, firstly large percentage of worker are unskilled; secondly
point (measure) above for determining the performance, in order to due to large amount and categories of raw materials, dumped by store
reach to root cause of customer complaints and wrong billing; So that at production floor; that’s too well prior to need. These two reasons
necessary preventive and corrective steps then can be taken. cause worker fails to differentiate among parts which appear similar.
Improve – Plan improvement on basis of analysis He also mentioned entire business process, especially production
Existing process need to be improved in order to mitigate the root process is quite old and contains certain activities which are purely
cause threats unnecessary, he also highlight importance of industry 4.0 and give
stress on business re-engineering through artificial intelligence,
Once the SCT done with the analysis, it has to identify the possible
machine learning, etc.
solution to root causes, in order to improve the performance.
Mr Naidu, VP Purchases immediately responded about economics
Any improvement, which is so ever is suggested; needs to be both
of discount involved behind purchase of large quantity and also
feasible from SCT prospective and valuable from customers’
mentioned buying too less may lead to stock-out situation.
perspective.
Improvement can be done by reissue of bill where it was wrongly Required
issued earlier, if already process of revision of bill is in existence than You were also presented at meeting as deputy to Mr Reddy. Post
wait time for reissue need to be curtailed. meeting you came back to your desk and start working. Mr Reddy
Control – Continuous control to identify and correct the called to you to his cabin, on reach to his cabin; he asked you to
process variance prepare draft of report (ADVISE) seek by CEO; and meet him
Improved processes need to be controlled continually in order to with copy of draft after half an hour from now.
assure enhanced performance shall be maintained
Solution
Post improvement in process (issue of bill and handling of customer
complaints), the manager who is responsible for such process at Report
SCT need to assure continuous control over the process, so that Addressed to;
customer services should create same value for customer and keep Office of CEO,
them satisfied. Shakti Automobiles Limited (SAL).
Dated – 19th Jan 2021
For monitoring, KPI against CSFs can be established and reported on
daily basis, likewise number of complaints (especially which remain Report on underlying reasons behind current performance and
unresolved at day end) and wrong billing cases. These KPI will also Lean Management, Cost Management tools
act as early signal to Line Manager or Senior Management.
In order to implement Six Sigma as per DMAIC method, SCT need
to form a team of line managers from different processes which
are need to be improved (or critical from prospective of customer
services). Team and implementation project should lead by some
senior management person (may be CEO him-self ).
Case Scenario – Performance Measurement
Shakti Automobiles Limited (SAL) is a leading battery based (i) First reason behind weak financial performance is highlighted by
e-rickshaw manufacturing firm, under brand ‘Shah Swaari’ in three Mr. Swami i.e. Price of SAL’s Product Shah Swaari is much higher
models – Super, Star, and Speed. SAL started this business around 5 than price offered by all the competitors in market. Quality and
years back when it was only manufacturer of such e-rickshaw. SAL features of other products are also similar.
manufactures all assembly components themselves, irrespective Target Costing as cost management technique can be applied.
of fact that these components can be acquired from market at a Since market condition are stiff and bargaining power of customers
cheaper rate. Major component of total costs in manufacturing of is high due to multiple competitors, and these competitors are
such e-rickshaw is variable in nature. Company was performing selling the product at price lesser then price offered by SAL.
well, earning reasonable and enjoyed large market share up-till two Hence, price offered by such vendors should be considered as
year ago majorly due to first mover advantage. But due to increasing ‘Target Price’ and after reducing ‘Target Profit’ from same ‘Target
competition as new entrant coming into market and rough macro Cost’ can be identified. Production, operations facilities along with
economic conditions, market share starts shrinking; resultantly product need to be reengineered to achieve such ‘Target Cost’.
profit starts declining. If no major steps taken, then company may
(ii) Second reason is that SAL manufactures all assembly components
run into red in year to come.
themselves, irrespective of fact that these components can be
Mr Pillai, CEO attended some workshop last week, where he learned acquired from market at a cheaper rate.
about the lean management and techniques of cost management.
Relevant cost of both, ‘Make or Buy’ needs to be compared. As
He asked Mr Reddy, Chief Management Accountant to report on
mentioned that major component of total costs in manufacturing
underlying reasons behind current performance with available set of
of such e-rickshaw is variable in nature, hence, such major
possible solution. Mr Reddy immediately convened a meeting of top
component of costs can be controlled if SAL buy the all the
ranked officers, which is chaired by CEO, at meeting;
components instead of Making them.
Mr Swami, VP Marketing mentioned that it is difficult to maintain
Only those products need to be made in house whose variable
same level of sales in upcoming years because price of Shah Swaari
cost of manufacturing is less then market price and vice versa.
is much higher than price offered by all the competitors in market.
Quality and features of other are also similar. (iii) Third and major reason is popularity of their product is
declining, this is evident from declining in market share and
Mr Dutta, Customer Relation Officer also supported Mr Swami
lot of complaints from buyers in e-mails and tele-calls for
and said that the popularity of their product is declining, he quoted
manufacturing defects.
that he receives lot of complaints from buyers in e-mails and tele-
calls due to manufacturing defects; which arise in product within Since these defects arise in product within month period of
a month period of purchase and frequency of such calls and emails purchase. Hence, product needs to be looked at. Further, some
have increased in recent years. He also mentioned that in some cases, of cases customer reported that assembled part is not belonging
customer reported that assembled part did not belong to model to model they purchased and some customers say assembly is
they purchased, and some customers say, assembly is not as per not as per specification provided. Hence, quality is needed to be
specification provided. ensured in the product delivered.

One of way to look at ‘Quality’ is conformance to need of resultantly less/no material lying over in store or production floor.
customer, to ensure same Total Productivity Management/ Total Note - Takt time is the maximum time to meet the demands of the
Quality Management supported by Six Sigma need to be applied customer, this will help to decide the speed of/at manufacturing
as part of Lean System Management. facility. Heijunka can be applied in order to reduce variation
Total Quality Management is management of entire process, between takt times over the production.
including planning process, to meet customer’s requirements. Cost benefit analysis of ‘reduction in storage cost along with
PRAISE analysis can be used in order to achieve improve quality. opportunity cost saved’ and ‘increase in ordering cost, purchase
Using DMAIC (Define, Measure, Analyse, Improve and Control) cost along with stock-out cost’ need to be made.
methodology of Six Sigma, existing business process can be (vi) Sixth reason for low performance is old established businesses
improved to ensure customer satisfaction, reducing cycle time processes, especially production processes and contains certain
and reduction in waste also. activities which are purely unnecessary.
(iv) Fourth reason being, large percentage of worker are unskilled. Value Analysis is need to be applied in order to ensure maximum
Each worker should be provided with requisite training. value to customer by eliminating activities which are not value
Though Kaizen, workers should be involved into improvement generating, this will control cost also, that’s too strategically.
of existing process so that they become able to address small Process Innovation and Business Process Re-engineering can
problems or improve a process. also be applied. Re-engineering is rethinking and radical design
(v) Fifth and second major reason is large amount and categories of business process in order to achieve improvement. It will
of raw materials, dumped by store at production floor; that’s help the SAL to keep them at par with changing technology by
too well prior to need. This reason may be root cause of one synchronisation along with redesign, retool the business process.
of complaint by customer that assembled part is not belong to Further details can be tabled on requisition basis.
model they purchased.
JIT can be implemented as part of lean system. JIT is pull system
Closure of Report
of production, with single piece flow after considering takt
time. In JIT, production facility is need to be integrated with
vendor system for signal (Kanban) based automatic supply which Mr Reddy,
depends upon demand based consumption. Under JIT system Chief Management Accountant
of inventory storage cost is at lowest level due to direct issue of (For Management Accounting Division)
material to production department as and when required and Shakti Automobiles Limited
Skill Assessment Based Questions Note- You can ignore taxes but need to consider the time value of
money; decimal accuracy up-to two digits is expected.
The questions at this level are based on skill assessment. An
illustrative list of the verbs that appear in a question requirement for Answer
each question is given in November 2019 issue. It is important that Statement of the Comparable Life Cycle Cost
students answer the question according to the definition of the verb.
Particulars Automatic Semi-
Question 1 Automatic
(R) (R)
About Problem Target Verb/(s)
Acquisition Cost 10,00,000 5,60,000
Life Cycle Costing Advise
PV of Entire Life Cash 2,16,000 5,76,000
Royal Bakers is famous for cakes and cookies. Mr Das the owner Operating Cost (W.N.2)
at Royal Bakers is interested in offering affordable products to PV of Salvage Value (W.N.3) (49,700) (14,200)
their customers, hence keen to capture the small scope of cost- Total Cost of the Oven over the 11,66,300 11,21,800
effectiveness. Royal Bakers located in the centre of the city where life cycle
space has a huge cost and royal baker is running out of space during
peak hour causing loss of sale. Most of the customers are regular to Note – Hurdle rate of 12% (marginal cost of capital rate) is considered,
Royal Bakers. Royal Bakers is known for fast service, Mr Das wish to for purpose of application of time value of money.
be true to the tagline ‘Close your eyes to wish and open them to find it
cooked for you’. The hurdle rate is 12%. Working Note 1 – Depreciation (R)
Non-availability of skilled workers and high attrition rate of Particulars Automatic Semi-
workers including chefs is the cause of worry for Mr Das. In order Automatic
to retain workers, Royal Bakers is paying a higher salary than Acquisition Cost 10,00,000 5,60,000
industry standards. The raw material is easily available as and Salvage Value 70,000 20,000
when required. Royal Bakers is considering two different models of Depreciable Value 9,30,000 5,40,000
baking oven machine to replace its old oven. The baking capacity of both
Useful life in a number of years 3 3
machines are the same and both will occupy a similar amount of space.
Depreciation on SLM basis 3,10,000 1,80,000
The first model is the automatic oven which will cost about
R10,00,000. Another model is the semi-automatic oven which will Working Note 2 – Present Value of Entire Life Cash Operating Cost
cost at R5,60,000. The annual operating cost (including depreciation)
Particulars Automatic Semi-
is 40% of the acquisition cost and R4,20,000 in case of automatic and
Automatic
semi-automatic oven respectively. After 3 years of use, the automatic
oven can be salvage at R70,000, whereas semi-automatic oven will Annual Operating Cost 4,00,000 4,20,000
fetch R20,000 only. The automatic oven is more advanced and Depreciation (see W.N. 1) 3,10,000 1,80,000
equipped with latest technologies to speed up the baking, because Annual Cash Operating Cost 90,000 2,40,000
only ingredient need to be inserted in right proportion and mix. Cumulative PV factor @ 12% 2.40 2.40
Whereas in semi-automatic machine some part of the process needs for 3 years
to be performed manually by the workers. PV of Entire Life Cash 2,16,000 5,76,000
Required Operating Cost (R)
ADVISE which oven shall royal baker acquire. *Annual operating cost is 4,00,000 i.e., 40% of 10 Lakhs, in case of
automatic machine.

Working Note 3 – Present Value of salvage value reprocessing is hardly possible, even if possible then at a huge cost;
hence, it is essential to keep vigil control over quality and detection
Particulars Automatic Semi- of defect at the earliest stage. In the semi-automatic oven, there is
Automatic the scope of reviewing the material after stage/s and improvisation
Salvage Value 70,000 20,000 can be done.
PV Factor @ 12% for 3rd year 0.71 0.71 Overall, Royal Bakers should take the decision only after due and
careful consideration of above factors.
PV of Salvage Value (R) 49,700 14,200
Advise Question 2
Based upon life cycle cost, Royal Bakers are advised to acquire semi-
automatic oven, because it causes a saving of R44,500. The cost has About Problem Target Verb/(s)
qualitative implications too, apart from quantitative or monetary Theory of Constraints Calculate, Interpret, Apply
implications. Similarly, a management decision is also impacted by
qualitative and non-monetary quantitative factors. Hence, decision Ajanta Digital Solutions (ADS) is a renowned name for
taken in part a above may differ if Royal Bakers consider- manufacturing a wide variety of digital stationery products for office
and academic use. The ‘Abacus division’ of ADS is engaged in the
Finishing of bake products – the look and taste production of basic calculators, capable of academic and commercial
It is obvious the presence, which one important feature for bakery use. Presently Abacus is manufacturing only three models,
product in order look delicious and tempting; will be way different if named C-100, C-125, and C-500. These calculators are sold to
cooked in the automatic and semi-automatic machine. The taste may customers through wide-spread retailers and distributors’ network
also be different, which is more critical from prospective of customer across the country.
retention because a large number of the customers are regular to
the royal baker, hence maintaining the principal customer is maybe During manufacturing process, each calculator needs to pass
a key consideration. This factor may go in favour of any of version through various steps, before it gets ready. PC-IA is the essential step
oven. If look goes in favour of automatic oven, then taste may be in and performed manually, where processing chip is being installed,
semi-automatic due to corrections by the worker during baking and activated, and tested. The production capacity of Abacus is constraint
relatively authentic preparation. by PC-IA. The basic information pertaining to top-line and the prime
cost is as follows (Amount in R)-
Manpower
Availability of skilled workers and retention of workers is the cause Particulars C-100 C-125 C-500
of worry presently. In order to operate an automatic oven obviously Sale price per unit 140 200 450
fewer workers are required; hence money can be saved by cutting Material cost per unit 72 104 200
down recruitment cost and excess salary paid to the worker in order
to retain them. On the other hand, skilled workers are already in Labour cost per unit 30 52.5 75
scarcity, automatic machine obviously requires a more technically All the process and division at ADS are operating for a single shift
competent operator. But largely this factor moves in favour of of 8 hours in a day. Conversion cost per hour (including labour
automatic machine despite is costlier. cost) is R5,600. The standard output for PC-IA during a day is the
Space processing of either 800 units of C-100 or 560 units of C-125, or
320 units of C-500. ADS is capable of sale more than, what they are
Royal Bakers located in the centre of the city where space has a huge cost presently capable to produce in all range of models. The CEO of
and Royal Bakers is running out of space during peak hour causing loss of ADS recently attended a science fair, Robo-tech 4.0; where he saw a
sale. Although the size of both the ovens are same, the number of worker Robot developed by Synergy Robotics Limited, capable to assembly
and space required for them surely be less in case of the automatic oven. including installation of processing chip to any sort of device.
Hence, this factor again moves in favour of automatic oven.
Required
Power consumption and availability Management hired you as cost consultant, advice on the
Although the power consumption cost is presumed to already following aspectsÆ
include in annual operating cost hence considered as a monetary (i) On a random day if 480 units, 140 units and 120 units of
factor but need and availability of power is a very important factor; C-100, C-125, and C-500 respectively are produced and sold,
in order to ensure uninterrupted baking. In the absence of stand-by CALCULATE at what efficiency level current constraint
power back-up, power cut may lead to downtime. It will complete (bottleneck) is operational. INTERPRET the same. COMPUTE
downtime for the automatic oven and to a certain extent in the case profit earned during such day.
of semi-automatic (because the manual process will keep going on). (ii) FIND production of which model is more beneficial, considering
Stand-by power back-up will also have an additional cost. the ranking (based upon throughput performance ratio).
Customisation (iii) APPLY Goldratt’s five steps to remove the bottleneck at Abacus.
In case of cookies, it may be ok to produce the standard product; but Answer
the cake needs to base upon the order of the customer, who may seek
customisation. Scope of customisation needs to evaluate. In the case (i) Efficiency level can be measured with help of Efficiency Ratio,
of the semi-automatic oven, the scope of customisation and ethnicity which is one among the control ratios.
will be relatively high. Efficiency ratio indicates the degree of efficiency attained
in production. It is expressed in term of standard hours for
Speed actual production as a percentage of the actual hours spent in
Royal Bakers is known for fast service, and Mr Das wish to be true to producing that work.
tagline ‘Close your eyes to wish and open them to find it cooked for Standard hours for actual production u 100
you’. The automatic oven is more advanced and equipped with latest
technologies to speed up the production. Hence, this factor moves in Actual hours worked
favour of automatic oven. = (9.8/8) × 100
Detection of the defect = 122.5%
If speed thrills, then it kills too. In case of the bakery, rework and

Working Note – Standard hour required for actual production 1. Identifying the System Bottlenecks – At Abacus division of
ADS, PC-IA is bottleneck.
Product Actual Standard Standard Standard
output Daily Hourly Hour 2. Exploit the Bottlenecks – Bottleneck activities’ capacity
(Units) Output Output Required must be fully utilised. Although the efficiency of bottleneck
(a) (Units) (Units) (c) (a)/(c) activity is already 122.5% but further attention on the
(b) (b)/8 possibility to enhance the flow of products from bottleneck
activity is needful.
C-100 480 800 100 4.8
3. Non-bottleneck activities are subordinate – Bottleneck
C-125 140 560 70 2
activity should setup the pace for non-bottleneck activities.
C-500 120 320 40 3 Abacus shall plan its production keeping PC-IA at the centre
Standard Time Required (in hours) 9.8 point, because even if the efficiency of other activities which
Interpretation – 122.5% signifies that efficiency (usage) of are non-bottleneck enhanced beyond current level; the
exploiting bottle-neck activity is 22.5% better than the standard output can be maximum possible by PC-IA.
use. PC-IA is producing out-put which require 9.8 hours, in 4. Elevate the bottleneck – Eliminate the bottleneck by
8 hours. enhancing the capacity and efficiency. Major change (business
reengineering) or continuous minor change (Kaizen) may do.
Profit earned during the day In the case of Abacus, the introduction of the robot may be a
Particulars Amount in (R) way to elevate the bottleneck.
Revenue 1,49,200 Note – There will always be one bottleneck in the system, if
[(480×140) + (140×200) + (120×450)] such bottleneck is eliminated then a new constraint emerges
Less: Material Cost 73,120 as a bottleneck. Hence, this process continues. Ultimately
[(480×72) + (140×104) + (120×200)] improvement is a never-ending continues process.
Less: Conversion Cost 44,800 5. Repeat the process – Apply step 1 to new bottleneck activity
(including labour cost) [5,600 × 8hrs.] which emerges at Abacus and repeat the process.
Profit 31,280
Question 3
(ii) Statement of ranking, based upon throughput performance
ratio (using throughput contribution) About Problem Target Verb/(s)
Particulars C-100 C-125 C-500
Target Costing Explain, Calculate, Evaluate
Sale price per units R140 R200 R450
…(a) Venice Light Works (VLW) manufactures multicolour glow bulb
Material cost per unit R72 R104 R200 (MCG-10) used for lighting and decoration. MCG-10 considered as
…(b) reliable product in market due to zero-defect. VLW sells MCG-10
Throughput contribution per R68 R96 R250 through retail-chains and individual shopkeeper apart from factory
unit …(c) = (a) – (b) outlet. MCG-10 has demand throughout the year but there is high
Maximum possible production 800 560 320 demand during festival seasons especially ahead of Diwali. Company
…(d) follows the lot purchase system and manufacture the product ahead
Maximum possible throughput R54,400 R53,760 R80,000 of peak season of festivals. Presently the VLW is working at 80% of
contribution …(e)= (c)×(d) capacity and manufacture 4,00,000 bulbs annually, at following per
Conversion cost (including R44,800 R44,800 R44,800 unit cost:
labour cost) (5,600×8hrs) …(f ) Particulars Behaviour Amount (R)
Throughput performance ratio 1.21 1.20 1.78 Direct Material Variable 22
...(e)/(f ) Direct Labour Variable 6
Ranking II III I Factory Overhead
Considering the throughput performance ratio (or TA ratio) 1. Engineering Cost Fixed 10
and ranking above most beneficial model to produce is C-500 2. Machining Cost Fixed 5
followed by C-100 and C-125. 3. Inspection Cost Variable 5
Throughput contribution Administration Overheads Fixed 12
TA Ratio =
Conversion cost Selling and Distribution Fixed 12
t ͳSPVHIQVU BDDPVOUJOH EFWFMPQFE CZ (BMMPXBZ BOE Overheads
Waldron which use the term factory cost and completely Total Cost 72
relay upon the Goldratt’s theory of constraints which use the Recently the competition in decorative lights and electronic markets
term operating expenses, but the meaning of factory cost has escalated, due to goods imported from Chinese manufactures at
and operating expenses used at both places are identical. cheap rates. Such imported light bulbs are also sold through same
t ͳFPSZ PG DPOTUSBJOUT DPOTJEFS short-run time horizons and shops at which MCG-10 is available for sale. Due cheaper in rate
assume other current operating cost to be fixed costs. customer prefer imported light bulb rather MCG-10.
t )JHIFS UIF UISPVHIQVU QFSGPSNBODF SBUJP PS 5" SBUJP
JT To be competitive in market, the marketing department of VLW
better and beneficial. conducted applied research and suggested that price should be 12.5%
lower than the current prices. VLW during last three financial years
t "MM UIF QSPEVDUT NPEFMT XIJDI IBWF UISPVHIQVU and during current year records the pre-tax profit @ 10% rate of sale,
performance ratio (or TA ratio) more than one may management of VLW wish to earn the same rate of profit (margin) in
be produced/ continued to produce, depending upon upcoming years too.
constraint function.
Production and operation manager is of opinion that cost reduction,
(iii) Application of Goldratt’s five steps to remove the bottleneck in order to be competitive in market may result in reduction in
at Abacus quality, whereas Manager - Quality control suggests, if number of
Goldratt’s theory of constraints describes the following inspection staff increased, then inspection can be performed at each
mentioned five steps process of identifying and taking steps to stage and defect can be curtailed at the earliest stage to eliminate
remove the bottlenecks that restrict output. rework cost.

Management accountant is of the opinion that since MCG-10 is Under proportionate reduction plan cost for each category
mature product, hence majority of cost associated in production is proportionately reduced in proportion of existing weight.
of MCG-10 are committed in nature, price cutting seems difficult; Here, a presumption is needed to be taken that all the cost are
it may hit the top line and bottom line adversely. In response to avoidable in nature, where as in case of every business; there
him, Chief engineer suggest product (MCG-10) can be redesigned; are some of cost categories which are true sense unavoidable
but marketing manager shown his resistance on the suggestion of and committed in such a way that, these continue to occur
redesigning of product because according to him ‘existing product even in shut down situation (e.g. salary to guard, minimum
appearance and features are key reasons for popularity of product in rental for electricity and water meter etc.); same is pointed by
market and leads to sale’. Management Accountant, that product is matured in nature
(means not in designing or research phase) hence committed
Required cost may be unavoidable in nature.
(i) CALCULATE the price suggested by marketing department.
Note
(ii) COMPUTE the target cost and new margin, appraise percentage
Students must note that fixed costs are not as same as
decline in margin.
unavoidable cost. Fixed cost may be avoidable in nature.
(iii) If proportionate cost reduction plan is applied, then
(a) CALCULATE planned cost reduction for each cost (iv) Possibility of cost reduction and Suggested course of action
category. for VLW
(b) EXPLAIN proportionate cost reduction plan. Target costing comprises four stages. First being determining
(iv) Based upon discussion taken place among the functional the product target price, quality, and functionality; second
manger, EVALUATE the possibility of cost reduction in order determine the target cost; thirdly designing the product and
to analyse the possibility of application of target costing. Also production process to achieve the target costing, and fourth
suggest course of action to adopt. use pilot project to evaluated feasibility. Based upon discussion
Answer taken place among the functional managers, it is evidential that
VLW is presently moving towards third stage.
(i) Price suggested by marketing department (Target Price)
Current cost per unit – R72 per unit As stated by management accountant that product MCG-10 is
mature nature hence majority of cost are of committed nature,
Profit (Margin) @10% of sale price
hence may be unavoidable in nature. Product MCG-10 is
Sale Price = R72 + 10% of Sale Price
material-oriented product and raw material cost is around 30%
So, let presume sale price is ‘X’
of total cost. So, if gain sharing arrangement can be entered with
X = R72 + 10% of X
vendor then surely VLW can save some portion of material cost.
X = R72 + 0.1X
As said by production and operation manager, cost reduction may
X - 0.1X = R72
lead to compromise with quality. He may be right, but he needs to
0.9X = R72
look for scientific way to reduce the cost of operations like change
X = R72/ 0.9
in batch size (if required can shift to JIT) or outsource some part
X = R80
of operations; scientific management can also be applied in order
New price will be 12.5% less than current price to curtail motion time and reduction in labour cost.
R80 – 12.5% of 80
Quality Manager is of opinion with extra inspection staff,
R80 – R10 = R70
quality can be assured, but appointment of additional inspector
(ii) Target cost and new margin and supervisor will also lead to increase in cost; hence effective
Target Price – Margin (i.e. 10% of sale price) = Target Cost way to ensure quality while reducing cost of application of
Target Cost = R70 – 10% of 70 practice of TQM and Kaizen. Kaizen costing will be great help
R70 – R7 = R63 to management of VLW to cut the cost, with support and
New Margin (under target costing) is R7 participation from worker.
Percentage decline in margin Chief engineer suggestion is appreciable, because target costing
is most beneficial in those case where the product is in designing
Existing Margin – New Margin (under target costing)
u 100 and planning phase. As per research around 70-80% of cost is
Existing Margin committed at stage of designing of product. It is important
8-7 to note that the word ‘committed’ is used as ‘not incurred’;
= u 100
8 therefore, cost being committed (i.e., not incurred cost) will
= 12.5% be incurred when it became due in course of production. But
Note redesigning is not feasible from the prospects of marketing of
There is decline in margin in absolute term, whereas in relative product as per the statement made by marketing manager.
term the margin remains same i.e. 10% of sale price. Marketing manager can conduct applied research in order to
develop understanding the temperament of customer of MCG-
10, whether they are price sensitive or conformance to need
(iii) Planned cost reduction for each cost category under
is their priority. If customer found price sensitive (existing
proportionate reduction plan
recommendation of marketing team shows high possibility of
Amount in R this, because marketing team feels customers can be retained is
Particulars Existing Cost Target Cost price is reduced by 12.5%) then product redesign may opted. But
Direct Material 22 19.25 if conformance to need is their (customers) priority, then value
chain analysis can be used to identify the activities which creates
Direct Labour 6 5.25
value to customer and other than these activities (which are not
Factory Overhead creating the value) can be eliminated in order to reduce the cost.
1. Engineering Cost 10 8.75
So, there are possibility to reduce the cost, even if not in all the
2. Machining Cost 5 4.375
cost category then surely in some of categories; so that target
3. Inspection Cost 5 4.375
cost can be achieved.
Administration Overheads 12 10.5
Selling and Distribution 12 10.5 “Every effort has been made to include all possible elucidations
Overheads for a given case/ question aided by outline and well-chosen
Total Cost 72 63 photographs for quick industry/ concept reference”.

“Strategy is about making choices and trade-offs; it’s about

deliberately choosing to be different”
– Michael Porter
Strategic Role of Management Accounting- An Overview
External Porter’s Five Value Chain Industry Industry

Analysis Forces/ PESTLE and Firm's Life Cycle Critical
Position Success Factors
Performance
Measurement
Models
Value
Aligning Vision,
Creation &
Mission, Goals
Innovation
Control Through
Budgets and
Variance
Analysis
Product, Costing, Revenue Product/ Service
Selection
Service, Measurement & Critical Success
and Implementation
and Market Forecasting Factors
Evaluation
Development
Linking CSFs
to KPIs
Cost Benefit
Ethical Analysis
Consideration Risk
Assessment
Performance
Reports
Assessing Current
Performance- Profitability
Understanding Competitive
Internal Balanced BCG Products Analysis -
Stakeholders' Advantage &
Analysis Scorecard, Matrix Customers,
Needs Generic Strategy
Benchmarking, Products, etc.
etc.

CASE STUDY ITB Hotels

ITB hotels are known for state of art
The basic objective of the case study is to allow the students to apply ITB
amenities and great hospitality. The

ideas and insights from theory to the real life issues and problems.
occupancy rate ranges from 70% to 80%
on average, but for few metropolitan
Pricing Strategy locations, the occupancy touches to 90%
ITB is a multi-brand diversified conglomerate corporation that to 100%. ITB hotels follow tariff policy,
deals in a wide range of industries, from hotels to FMCG; from wherein tariff is based upon the cost of
paper to tobacco; from IT solutions to agro/agri (AGRO) business living of individual city (wherein hotel
through its different divisions and departments, which are working is located) and occupancy rate (of the
independently. Managers of some of these divisions are accountable individual hotel) when customer check-
for their cost and revenue, while in others they are additionally in. Dr. Angel Gupta who is a regular guest at ITB in Mumbai (due to
accountable for the capital employed too. ITB is still diversifying its her medical conferences) surprised to see the variation between the
business. tariffs. She was charged R5,400 per night when her stay during the
trip falls on weekdays and R8,000 when it falls on weekends.
FMCG Division
Required
In the recent quarter, the FMCG
Division of ITB launched (i) COMMENT on the ITB’s organisational structure and its
east
moonfeast dream cream biscuits, Moonf appropriateness.
which are flavoured twin cream (ii) DEFINE responsibility accounting and responsibility centre.
biscuits. These biscuits are available (iii) EXPLAIN profit centre and investment centre.
in two different sizes of packing -
(iv) IDENTIFY the nature of FMCG and AGRO Divisions from the
price R5 for 35 grams and R10 for 80 grams. Division decided the
preview of responsibility accounting.
price considering the cost it incurred and a preferred margin. The
margin stipulated by manager for two years period. (v) EVALUATE the pricing strategies adopted (along with
appropriateness, and set of advice where it seems inappropriate)
The market segment relevant to such cream biscuits is highly by–
competitive and hostile, customers are price sensitive too, but the a) FMCG Division
segment has a turnover value of nearly R4.5 crores during such recent b) AGRO Division
quarter. Response to moonfeast dream cream biscuits is merely c) ITB Hotels
reasonable. The Division is looking forward to launching a range of [Support your answer with facts and figures (calculation thereof )
flavours. A report containing investment requirements regarding the given in the case]
new flavours sent to corporate head office for approval. As per market
research report of a trade association, during the same quarter total
of around 375 MT biscuit was sold in the relevant segment. Solution
(i) Organisational Structure outlines the roles of individuals in
AGRO Division the organisation and decides the way in which authority and
responsibility are allocated among them and how they are
A high-yield variety of hybrid maize seed HY-10 was developed after coordinating with each other to attain organisational objectives.
incurring the huge R&D cost, nearly R2.35 crores by AGRO Division. ITB is following the divisional structure wherein various
Maize is largely a Rabi crop and seed rate depends upon the factors divisions operating autonomously. Since divisions are operating
like purpose, seed size, season, plant type, sowing method (For independently hence may be termed as strategic business units
winter and spring maize seed rate of 8-10 kg/acre is desired, whereas (SBUs). Due to high autonomy, the decision-making process is
for sweet corn, baby corn, and pop-corn seed rate of 8, 16, and 7 usually decentralized.
kg/acre is respectively desired). HY-10 committed and provide high
This type of organisation structure is fit for growing companies
yield and big-deep grains; also reduces the seed rate requirements to
that are diversifying because it’s easy to bolt on another division.
80%-90% of aforementioned. CP-555 was a prominent seller prior to
Since ITB is a multi-brand diversified conglomerate corporation
the lunch of HY-10 and its 4 kg packing was sold for in the range of
that deals in a wide range of industries and still diversifying
R1,450-1,500 generally. Other players are also working on developing
its business hence the divisional form of organisational
HYV maize seeds.
structure best fits ITB.
AGRO Division has lined up many such more development Mind it, in divisional structure too, some functional departments
projects which are duly approved by the divisional head, and some are working horizontally throughout the organisation and
are in pipeline. HY-10 approved by the regulator and government known as corporate function or shared/support services, such
authorities three seasons ago and available for commercial sale as Accounts and HR & Payroll, etc.
thereafter in the market. HY-10 sold in a pack of 2, 10, and 25 kgs
only. Figures pertaining to these three seasons are tabled below– (ii) Responsibility accounting is that type of management
accounting that collects and reports planned actual accounting
information in terms of responsibility centers. A responsibility
centre is a specific unit of an organisation assigned to a manager
who is held responsible for its operation and resources. The
Season Revenue Volume division can be designate as either of cost, profit, revenue,
(thousand of sale or investment centre depending upon the responsibility
R) (quintal) (accountability) assigned to its manager (s)/ divisional manager.
First 7,460 149.2 (iii) Profit Centre and Investment Centre.
HY-10
Wherein the manager of division is accountable for the cost
Second 13,185 293.0 and revenue of division, it shall be categorised as profit centre.
Third 12,460 311.5 Thus, the performance of such division shall be measured in
terms of the difference between the revenues and costs (the
absolute amount of profit).
But wherein manager is additionally (apart from cost and
revenue) accountable for the capital employed too –categories

as investment centre. The performance of an investment

centre can be measured by appraising profit/return in relation Season Revenue (in Volume Volume Price per
to the investment base of centre, ROI, RI, and EVA are some thousand R) of sale (in of sale kg (in R)
prominent financial performance measures. quintal) (in kg)
(iv) FMCG Division is a profit centre because it decides its own First 7,460 149.2 14,920 500
prices as well as a cost but for investment, it has to take the Second 13,185 293.0 29,300 450
approval of the head office, as it is mentioned in the case that
a report containing investment requirement regarding the new Third 12,460 311.5 31,150 400
flavours sent to corporate head office for approval. Moreover,
the desired margin, which is used to determine the price also Price skimming seems an appropriate strategy for the
stipulated by the manager only. AGRO Division because HY-10 was developed after incurring
AGRO Division is an investment centre because it takes the huge R&D cost (nearly R2.35 crores), that need to be
investment decisions on its own, without the intervention of recovered in few early years because some other players
head office, as it is mentioned in the case that AGRO Division are also working on developing HYV maize seeds; if once
has lined up many such more development projects which are they developed HYV maize seeds then ITB may not be in a
duly approved by the divisional head, and some are in pipeline. position to charge the high price to recover its R&D cost from
the product.
(v) FMCG Division
Customer (formers) might not mind paying a high price for HY-
FMCG Division determines the prices based upon the cost it 10 because it committed and actually provide high yield and
incurred and desired margin stipulated by manager. Hence, big-deep grains and also reduce the seed rate requirements to
pricing strategy (hence the decision) adopted is the cost-plus 80%-90% of normal requirement.
margin approach.
Hotels
The tariff charged by ITB hotels is based upon the cost of
Concept Insight living of an individual city (wherein the hotel is located) and
occupancy rate (of the individual hotel) when customers check-
It is important to note the limitations of cost-plus margin
in. It means ITB is relying upon the strategy of differential
approach:
pricing.
– It ignores the price charged by the competitors,
One of the factors that determine the price in the case of
– It also ignores the price which customer ready to pay, and ITB hotels is occupancy rate. It means ITB considers the
– Enterprise not looking towards cost control and management. importance of capacity constraints. The practice of charging
FMCG Division determines the two different prices of a higher price for the same product or service when the
moonfeast dream cream biscuits; R5 for 35 grams and demand for it approaches the physical limit of the capacity
R10 for 80 grams; hence the price ranges from R125 to to produce that product or service is known as peak-
R142.86 per kg in comparison to an average price of R120 load pricing.
per kg only (see the working note below) charged by other The pricing strategy seems appropriate largely, but for regular
players in the relevant segment. guests like Dr. Gupta, it may be annoying.
It is mentioned in the case that the market segment relevant to Peak–load pricing, on one hand, generates high profit for ITB
such cream biscuits is highly competitive and hostile, customers at the same time it brings equilibrium in demand and supply.
are price sensitive too; hence selling them product at a premium But guests like Dr. Gupta, who is a regular guest of ITB may
price (which more than the average price) is not a good strategy not be happy with differential pricing (tariff R5,400 per night
to penetrate into the market and acquire market share. This is the on weekdays and R8,000 per night on weekends) on account
reason that response to moonfeast dream cream biscuits is merely of the peak load factor. The impact of peak-load pricing will be
reasonable. more likely to be seen in those metropolitan locations when the
Hence it is advisable for divisional managers of the FMCG occupancy rate touches 90% to 100%
Division to pick the penetration strategy, which means keep
the prices low initially (in comparison to average market price
or near rival) to gain the market share (and product acceptance), CASE SCENARIO
once market share reach a reasonable level then prices can be Case Scenarios, as opposed to Case Studies, are short cases. Written
reinstated to normal level (the average market price). in a more compact style with an appealing narrative, the Case
Scenario’s focus is on covering more depth in a specific area.
Note – FMCG Division can practice techniques like Target
costing, Kaizen to bring the cost down to reduce the price and 3URÀWDELOLW\$QDO\VLV
sell the product at or lower than market-led prices. “A” is a mid-size bank with a loan asset portfolio that primarily
Working note– Determination of price charge by other players comprises of housing loans and commercial loans. Efforts are
in the relevant segment during the said quarter. underway to identify business opportunities that can contribute
Turnover – R4.5 crores positively to the bank’s bottom line. As a management analyst, you are
Quantity sold – 375 MT (Metric Ton) - since 1 MT is equal to analyzing the interest income from loan portfolios, the main income
1,000 kg hence 3,75,000 kg biscuits were sold during the said portfolio for any bank. You notice interest income from two types
quarter. of loan portfolios – student education loans and consumer durable
loans. These loan portfolios have not been focused upon until date
Average price per kg – R4.5 crores / 3,75,000 kg = R120 per kg. since the loans form a minor portion of the entire loan portfolio, each
AGRO Division less than 1% of the total loan portfolio. Consequently, the interest
The price charged by the AGRO Division for HY-10 during income generated is also minor in terms of the entire interest income
three previous sessions are tabled below, which depicts AGRO of the bank. The primary focus has always been on housing loans and
Division use the strategy of price skimming in the case of commercial loans, which form a major portion of the loan segment.
HY-10 because the prices were initially high (R500 per kg) and Following is some information you have about the interest on the
continually decline thereafter (R450 then R400 per kg). The student education loan segment and the interest on consumer
price initially charged for HY-10 was much more than the price durable loan segment:
range of R362.5-375 per kg that CP-555 charged which was a Interest income earned on student education loan segment and
prominent seller prior to lunch of HY-10. consumer durable loan segment.

(R in Lakhs) Student Education Loans:

Particulars Year 1 Year 2 Year 3 Year 4 Year 5 It can be seen that interest income from student education loans
have increased steadily from R15 Lakh in Year 1 to about R35 Lakh
Interest earned in Year 5. This shows that the volume in this loan segment has been
on Student 15 18 21 28 35 steadily growing in the recent years. It could be a potential area to
Education Loans explore to expand our loan offering. Currently, “A” recognizes 150
Interest earned educational institutions for the purpose of providing education loan
on Consumer 30 28 22 16 12 to students in need of financing but each bank in peer bank group
Durable Loans on an average recognizes 450 such institutes for the same purpose.
The number of courses “A” recognizes for which a loan is extended
Other information available to you: is 25 courses, mostly courses that are undertaken to earn a higher
qualification like post-graduation degree. However, peers on the
other hand each recognizes, a broader variety of 100 courses, both
Student Education Loans: graduate and post-graduate degree for which they are willing to
The bank recognizes around 150 finance students. Therefore, it seems that “A” can expand the range
educational institutions for the purpose of courses for which it provides student education loans. “A” can
of providing educational loans to also recognize more educational institutions to expand its potential
students who need financing. These market volume. However, this comes at the risk of default. Currently
are premier institutes that are well “A”’s approach to this segment has been conservative, limiting loans
recognized for their academic rigor. only to institutes and courses that enable the student with a very high
Due to the quality of their courses, possibility of finding a job immediately after qualifying. These may
100% of the students get job placements be courses that are sought out by potential job recruiters. Hence,
immediately after graduation. Due to students to whom loans were provided by “A”, have not defaulted on
this the loan default on these loans has been very negligible, if any. any of the loan repayments. Its loan default rate in almost negligible.
Also, the bank has identified around 25 courses, predominantly post “A”’s peer banks have a much broader market reach, but at the same
graduate courses, for which it has been extending education loans time, immediately after graduation only 80% of the students to
to students. whom loan financing was provided, have been able to find jobs. The
On the other hand, information from peer group banks shows that on job recruiters may not immediately require the some of the courses
an average each bank recognizes around 450 educational institutions. that some of the institutions offer. This increases the risk of loan
The number of courses recognized are both graduate and post default.
graduate degrees, almost 100 courses. Not all institute are premier. It is recommended to study the student education loan market
The recognition of these degrees in the market varies. Therefore, segment more carefully. “A”’s strategy can be then laid out based
only around 80% of the graduates to whom peer bank group offers on our internal benchmark requirements and risk profile.
financing, find job placements immediately after graduation.
Consumer Durable Loans:
Consumer Durable Loans: The consumer durable loan segment has seen a steady decline in
The bank provides unsecured consumer durable loans for limited interest income from R30 Lakh in Year 1 to R12 Lakh in Year 5.
product purchase such as TVs, Refrigerators, mobile phones etc. It “A” provides financing to customers to purchase from a list of 15
has a list of 15 products for which it provides loans to customers who consumer durable products that it has identified including TVs,
need financing. The loan disbursement procedure is routed through refrigerators, mobile phones. These are disbursed through its sales
sales personnel who are present in select branches of stores with personnel present in the select stores with whom it has tie up for this
whom the bank has tie up for such loans. Loan processing takes few purpose. Due to due diligence procedures, the loan default rate has
days with due diligence done based on the loan application documents been very low.
that the customer submits. Again, due to this due diligence, default On the other hand, peer bank group have a much broader range
rates have been negligible. of products, on an average of 45 products for which financing can
On the other hand, information from peer banks suggests that that be provided. There is no restriction on where the product is being
on an average each bank recognizes about 45 products for which purchased from. This widens the market range. Also, their customers
they provide customers financing when they want to purchase the can apply for these loans online. Disbursement of loan in immediate.
consumer durable item. Also, loan processing is done online, with This provides for hassle free shopping experience.
the help of the respective bank’s inbuilt loan application system. It is recommended to study “A”’s loan disbursement procedures
Loan disbursement is immediate. The consumer durable can be further in order to increase the loan volume for consumer
purchased from any store, not just from recognized stores that have durables. Currently, it is restricted to purchases for specific products
a tie up with the respective bank. This enables hassle free shopping from select stores. Loan is being disbursed only after due diligence
experience to many. procedures, which have a time lag of few days. Increasing the range
of products for which financing is offered and a dedicated bank
Required system where the customer can apply for these loans may ramp up its
Put forward your inputs (recommend) based on the information volumes. At the same time, the downside risk to be addressed is the
provided above, to find business opportunities that can help Bank risk of fraud due to immediate loan disbursement or extending loans
“A” grow its lending portfolio and interest income. to customers whose credit worthiness might be lower. This would
increase the risk of default.
Solution
Conclusion- By expanding customer base “A” has the advantage of
Student Education loans and Consumer Durable loans have been a tapping these customers for future cross selling of its home loan and
very minor part of “A”’s business operations, each being less than 1% commercial loan products. “A”’s current customer base especially
of entire loan portfolio. At the same time, these maybe segments that from the home loan portfolio can also be researched to identify
can potentially grow our lending portfolio and increase our interest potential customers who may need either student education loans
income earning capacity. or consumer durable loans. Hence, the two customer segments may
be considered for future expansion purpose. “A” needs to tailor its
strategy based on internal benchmarks and risk profile capacity.

For Your Conceptual Understanding

SKILL ASSESSMENT BASED QUESTIONS
The basis objective of the case study is to allow the students to apply Sale price Demand in Sale Variable Contribution
ideas and insights from theory to the real life issues and problems. per unit units revenue in R cost in R in R
in R (@ R6 per
unit)
Question 1 40 - - - -
39 2,000 78,000 12,000 66,000
About Problem Target Verb/ (s)
38 4,000 1,52,000 24,000 1,28,000
Pricing Strategy Calculate, Elucidate 37 6,000 2,22,000 36,000 1,86,000
36 8,000 2,88,000 48,000 2,40,000
“Zinc” a brand of Zink Pen and Plastic Limited (ZPPL), is a
household name for stationery products. The R&D Division of “Zinc” 35 10,000 3,50,000 60,000 2,90,000
developed a new pen A;FOUPOJD with assorted ink colours with the 34 12,000 4,08,000 72,000 3,36,000
tagline ‘give your writing a Zen energy’. 33 14,000 4,62,000 84,000 3,78,000
“Zinc” has used market research/ studies to determine that if price 32 16,000 5,12,000 96,000 4,16,000
of R40 is charged for pen, demand will be NIL. It has also been
established that demand will rise or fall by 2,000 units for every R1 31 18,000 5,58,000 1,08,000 4,50,000
fall/ rise in the selling price. The further information is also available 30 20,000 6,00,000 1,20,000 4,80,000
in Annexure as a result of these studies. 29 22,000 6,38,000 1,32,000 5,06,000
The Board members in presence of functional heads at ZPPL are 28 24,000 6,72,000 1,44,000 5,28,000
discussing the different pricing strategies that can be adopted in 27 26,000 7,02,000 1,56,000 5,46,000
context to ‘Zentonic’.
26 28,000 7,28,000 1,68,000 5,60,000
Dissension is clearly visible between the marketing head and the
finance head. The marketing head is striving to keep the price as 25 30,000 7,50,000 1,80,000 5,70,000
low as possible to capture the commercial space and maximise the 24 32,000 7,68,000 1,92,000 5,76,000
revenue, whereas the finance head argued in favour of keeping the 23 34,000 7,82,000 2,04,000 5,78,000
price high to maximise the profit because the design and R&D of
22 36,000 7,92,000 2,16,000 5,76,000
‘Zentonic’ will not be matched by the competitors currently. The
distinct parameters (revenue and profit) of performance linked 21 38,000 7,98,000 2,28,000 5,70,000
pay seem to be the major reason for contradiction between two 20 40,000 8,00,000 2,40,000 5,60,000
functional heads. Board members consider both the thoughts and 19 42,000 7,98,000 2,52,000 5,46,000
instruct you (management accountant) to drive the price(s).
18 44,000 7,92,000 2,64,000 5,28,000
ZPPL diversifies itself into the online learning space and starts
a web-based platform A;FO;JDL which offers quality videos for 17 46,000 7,82,000 2,76,000 5,06,000
competitive and professional exams such as JEE, NEET, UPSC, KVPY 16 48,000 7,68,000 2,88,000 4,80,000
and etc. In order to attract the viewer, ‘ZenZick’ offers few lectures on 15 50,000 7,50,000 3,00,000 4,50,000
fundamental concepts of curriculum after registration at the website
14 52,000 7,28,000 3,12,000 4,16,000
without any cost, but for complete access, candidates need to have
paid account. 13 54,000 7,02,000 3,24,000 3,78,000
12 56,000 6,72,000 3,36,000 3,36,000
Required 11 58,000 6,38,000 3,48,000 2,90,000
(i) CALCULATE the unit selling price of A;FOUPOJD that will 10 60,000 6,00,000 3,60,000 2,40,000
maximise revenue and maximise profit. 9 62,000 5,58,000 3,72,000 1,86,000
(ii) ELUCIDATE the pricing strategy advocated by marketing 8 64,000 5,12,000 3,84,000 1,28,000
head and finance head for A;FOUPOJD and pricing strategy
adopted for A;FO;JDL’ 7 66,000 4,62,000 3,96,000 66,000
6 68,000 4,08,000 4,08,000 -
Annexure 5 70,000 3,50,000 4,20,000 -70,000
4 72,000 2,88,000 4,32,000 -1,44,000
3 74,000 2,22,000 4,44,000 -2,22,000
2 76,000 1,52,000 4,56,000 -3,04,000
Sale revenue ContribuƟon
9,00,000 1 78,000 78,000 4,68,000 -3,90,000
40,000 , 8,00,000
8,00,000
0 80,000 - 4,80,000 -4,80,000
AMOUNT IN INR
7,00,000
34,000 , 5,78,000
6,00,000
5,00,000 Answer
4,00,000
3,00,000 (i) The unit selling price of A;FOUPOJD that will maximise revenue
2,00,000 and maximise p rofit can be easily derived through demand
1,00,000 function. The graph shows sales revenue is maximised at 40,000
0
-1,00,000 0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000 units and contribution (so profit) is maximised at 34,000 units.
-2,00,000
-3,00,000
Note – Fixed cost will be fixed irrespective of the level of
-4,00,000 activity (presuming fixed cost does not hold feature of step
-5,00,000 cost).
-6,00,000
DEMAND IN UNITS
To calculate the selling price for these two levels of output, we
can insert the number of units into the equation for the demand
function.

Demand function q = 80,000 – 2,000p or p = 40 – 0.0005q Service level agreement (SLA) was duly entered and service level
Whereas p represents selling price and q represents level of (SL) of 90/20 has been prescribed to keep a check on service
output. quality. Invoice will be generated monthly, and SL will also be
Revenue will be maximum when the selling price will be observed on monthly basis. For the first month along with the
R20. invoice, KIBS provide the following details to RSL–
t 5PUBM DBMMT PĉFSFE
When q is 40,000 units of Zentonic pens,
t $BMMT BOTXFSFE XJUIJO UISFTIPME UJNF
B 40,000 = 80,000 – 2,000p
t 4IPSU PS "CBOEPO DBMMT XJUIJO UISFTIPME UJNF
B 2,000p = 40,000
CFO while authorising the payment queues generated by the account
B Then p will be R20
executive in ERP, come across the KIBS payment; he immediately
Profit will be maximum when the selling price will be R23 seeks a copy of SLA from legal but not able to understand the technical
When q is 34,000 units of Zentonic pens, aspects hence he decided to calls you (management accountant) to
B 34000 = 80,000 – 2,000p EXPLAIN few terms (including SL) and certain COMPUTATIONS.
B 2,000p = 46000,
B Then p will be R23 Required
Accordingly, sales revenue at profit maximisation level would (i) What is the SLA threshold and what is the threshold time in
be R7,82,000 (R23 × 34,000 units) and the expected profit at this case?
this level is already given i.e., 5,78,000 (refer graph). Therefore, (ii) Explain the significance of 90/20 SL.
variable cost will be R2,04,000 or R6 per unit. [not required (iii) Compute the SL level for the first month.
in question]
(iv) Whether KIBS attained the SL level to full the terms of SLA?
(ii) The marketing head is striving to keep the price low as possible (v) For how many calls KIBS can bill to RSL?
to make capture the commercial space and maximise the
revenue. The pricing strategy advocated by him is penetration
pricing. It includes setting the price low with the goals of Answer
attracting customers and gaining market share. The price will (i) A service-level agreement (SLA) threshold is the activity
be raised later once this market share is gained. response time specified in a service level agreement. In the
The finance head argued in favour of keeping the price high to current case, the SLA threshold is the number of seconds within
maximise the profit because the design and R&D of Zentonic which a call shall be responded to by a tele-caller at KIBS. The
will not be matched by the competitors currently. The pricing threshold time, in this case, is 20 seconds it is represented by a
strategy advocated by him is price skimming. Under price service level (SL) of 90/20.
skimming, high prices are set when a new product is launched (ii) A service-level agreement (SLA) defines the level of service
so that fewer sales are needed to break even and to reimburse you expect from a vendor, laying out the metrics by which service
the cost of investment of the original research into the product. is measured. Service level basically measures the performance.
Since it involves selling a product at a high price, sacrificing Service level (SL) of 90/20 signifies that 90% of the calls shall be
high sales to gain a high profit is therefore called "skimming" the answered within 20 seconds.
market. Price dropped to increase demand once the customers
who are willing to pay more have been 'skimmed off'.
The pricing strategy adopted for A;FO;JDL is freemium, Concept Insight
freemium is a revenue model that works by offering a product SLA is the document that outlines the wider service
or service free of charge (typically digital offerings such as agreements between a service provider and its customer,
software) while charging a premium for advanced features, whereas SL is the acceptable level of service performance
functionality, or related products and services. The word regarding which agreement has been entered.
"freemium" is a portmanteau combining the two aspects of Mind it, both the SLA and SL are not the same.
the business model i.e., "free" and "premium".
(iii) Service Level (SL) measure the performance and can be
Question 2 computed for voice calling BPO services using the following
formula–
About Problem Target Verb/ (s) Total calls answered within threshold time
SL=
Service Level Agreement Compute, Explain (Total calls offered-Short or abondon calls
within threshold time)
Red Star Limited (RSL) is the largest manufacturer of Air- SL = 4,850/ (5,120 - 115)
Conditioners. RSL is not good at attending the customer calls due SL = 4,850/ 5,005
to lack of capabilities, but it is an important activity from the aspect
of the value chain. Hence, in order to improve customer experience SL = 96.90%
(downstream supply chain), RSL decided to hire Krishna Infotech (iv) Against the expected service level of 90%, KIBS attain the service
& BPO Services (KIBS) for attending the calls of their existing and level of 96.90% which means out of each 100 calls nearly 97 class
prospective customer. are answered within 20 seconds (threshold time), whereas the
requirement was minimum requirement is 90%; hence KIBS
attain the SL level to full the terms of SLA.
(v) No, doubt SL used for measuring the performance which relies
upon the calls answered within the threshold time, but the calls
answered beyond threshold time also cause costs and resources
at end of the BPO vendor (KIBS in this case) hence billing
shall be for total calls responded/answered (rather only
those which are answered in threshold time). Hence, in a given
case, the KIBS can raise an invoice for 5,005 calls i.e., 5,120
(total calls offered) – 115 (short or abandon calls within
threshold time).

Question 3 Product Inspection Costs increased by R40,000 from 2020 to

2021. This appraisal cost checks for conformity of the product with
About Problem Target Verb/ (s) accepted standards of production. Quality checks on the production
line is important to detect defects at the earliest. Product inspections
Cost of Quality Analyse during the manufacturing process (in-line product inspection) help
in detecting defects while the product is being made. Defects can be
NZ Ltd. implemented a quality improvement programme and had corrected / rectified, or the unit produced can be scrapped.
the following results: Pre-shipment product inspection ensures that the product conforms
with the specifications agreed with the customer. This control
2020 2021 prevents defective units / non-conforming units from reaching
Particulars
(Figures in R
customers, an external quality failure. External quality failure has
Sales 6,000 6,000 costs in the form of product returns, warranty expenses etc. Product
Warranty expenses reduced significantly by R1,50,000 from the year
Scrap 600 300 2020 to 2021. This improvement can be attributed to better quality
Rework 500 400 production and increased product inspection.
Production Inspection 200 240 External quality failure has hidden costs in the form of shrinkage
Product Warranty 300 150 of market share, negative impact on brand image etc. Quality
reassurance ensures that the goodwill of the company is maintained
Quality Training 75 150 and there is no negative impact on the company’s future business
Materials Inspection 80 60 prospects.
Required Workings
ANALYSE the quality costs Figures in R'000
Answer Sr. Particulars 2020 2021 Savings /

No (extra spend)
Analysis 1. Prevention Costs
(a) Quality Training 75 150 (75)
2. Internal Failure Costs
(a) Scrap 600 300 300
(b) Rework 500 400 100
Total 1,100 700 400
3. Appraisal Costs
(a) Product Inspection 200 240 (40)
(b) Materials Inspection 80 60 20
Total 280 300 (20)
4. External Failure Costs
The total cost of quality in the year 2020 was R17,55,000. The total (a) Product Warranty 300 150 150
cost of quality in the year 2021 was R13,00,000. Therefore, over all Total (1+2+3+4) 1,755 1,300 455
the cost of quality decreased by R4,55,000 from 2020 to 2021. Given
the same scale of operations in both years (annual turnover being
60,00,000), the profits therefore would have increased by R4,55,000. Question 4
The break-up is summarized in the table (refer workings).
In the year 2021, more emphasis was given to Quality Training, the About Problem Target Verb/ (s)
spend increased by 75,000 p.a. Quality training is a preventive cost
that is aimed at improving the quality of output / performance of the Make or Buy Comment, Assess
employees. The benefit of this spend can be seen in the reduction of
internal failure costs (scrap and rework costs). Mr. Venkatesh, who recently joined the Tirupati Casting and Forge
The total internal failure costs of Scrap and Rework was R11,00,000 Limited (TCFL) as assistant manager in the management accounting
in the year 2020 that reduced to just R7,00,000 in the year 2021, this division is collecting, estimating, and arranging the information
reduction of R4,00,000 per year is directly on account of the quality required for make vs. buy decision and pricing decision; using
training given to employees. Better quality output resulted in reduced which chief management accountant can consider the best way to go
scrap and need for rework. while taking uncertainties into account and advise the management
accordingly.
Material Inspection Costs decreased by R20,000 from 2020
and 2021. Appraisal costs check for conformance with accepted X-104
standards for production. The reduction in material inspection
costs could be due to better understanding with the vendors about Balaji Enterprises (BE) ready to deliver product X-104 (in a semi-
material requirements needed for production, better quality of furnished state) for R40 under a continuous supply agreement. TCFL
materials procured etc. When the input material is of good quality insists on inserting a stable price clause in the supply agreement, to
and conforms with the production requirements, material inspection which BE responds that variation will be pass on to TCFL. Finally,
costs can be reduced substantially. it was decided if the agreement entered then the price (which is
currently R40/-) shall be subject to periodical (after each quarter)
Better quality input material may also be a reason for the drastic review.
reduction in rework and scrap costs highlighted above.

Y-29 Comparable Contribution

TCFL is producing the product Y-29 (at full capacity) and able to sell Particulars If sold If sold through
the entire production through a network of distributors (and through through E-retail
retailers, in those areas where there is no distributor appointed). distributors platform
TCFL contacted by an e-retail platform, with a proposal; wherein the
platform shows interest in offering the product Y-29 to its customers Selling price for TCFL 1,225 1,200
(members/ subscribers). The E-retail platform has two types of Less- Variable costs 870 870
customers, “the plus” category and others. The E-retail platform Contribution 355 330
will charge R1,300/- from “plus” category and R1,350/- from others,
E-retail platform has the policy to keep margin (to meet its cost and Sensitivity of the decision on the proposal by E-retail
earn a profit) of 8.33% and 12.50% on the procurement cost for the platform
sale made to “plus” category and other customers respectively. In the If the contribution from each unit of Y-29 sold to the E-retail
proposal, the E-retail platform also states the price which it can pay platform increased to 355 and beyond then TCFL will be
to TCFL; according to the requirements stated above. indifferent, among the distributors and E-retail platform. Thus,
Mr. Venkatesh compiled the following tables, for product X-104 the price stated by the E-retail platform needs to increase by
and Y-29 respectively on a per unit basis– R25 per unit (from R1,200 to R1,225) i.e., 25/1,200 which come
out to be 0.02083 or 2.083% (25/1,200×100)
X-104 Hence, if the price stated by the E-retail platform in the
proposal increase by more than 2.083% then the original
Particulars In-house Purchased from decision would be reversed (because beyond that point selling
production BE, there-after through the E-retail platform will become more profitable for
furnishing and re- TCFL).
labelling at TCFL
(ii) Make vs. Buy Decision & Sensitivity Analysis
Selling price of product 115 112 Make vs. Buy Decision – Since the contribution is R47 when
Variable costs 73 25 the product X-104 is purchased from BE and then furnishing
Fixed costs 18 18 and re-labelling done at TCFL, in comparison to R42 when it
External purchase cost NA 40 is produced in-house (see the calculation below); hence it is
beneficial to buy the product X-104.
Y-29 Comparable Contribution
Particulars Amount in R Particulars In-house Purchased from

production BE, there-after
List Price 1,400 furnishing and
Price charge from distributors 1,225 re-labelling at
Variable cost incurred by TCFL 870 TCFL
Selling price of product 115 112
Less- Variable costs 73 25
Required Less- External purchase - 40
(i) COMMENT how TCFL should respond to the proposal of cost
the e-retail platform regarding product Y-29 and ASSESS the Contribution 42 47
sensitivity of such decision.
(ii) COMMENT on the make vs. buy decision regarding product Sensitivity to the external purchase price
X-104 and ASSESS the sensitivity of such decision to the To be indifferent, among the in-house production and buying
external purchase price. from BE, the contribution from the product X-104 when it
is purchased from BE needs to fall to R42 per unit. Thus, the
Answer external purchase cost needs to increase by R5 per unit (from
R40 to R45) i.e., 5/40 which come out to be 0.125 or 12.5%
(i) Pricing (Decision on the proposal by E-retail platform) &
(5/40×100). Hence, if the external purchase price increased
Sensitivity by more than 12.5% the original decision would be reversed
Decision on the proposal by E-retail platform – Since the (because beyond that point buying from BE will not remain
TCFL is producing the product Y-29 at full capacity and able beneficial).
to sell entire production through a network of distributors
at R1,225 (results in a contribution of R355), hence shall not
accept the proposal of the E-retail platform at the stated
price of R1,200 (results in a contribution of R330) (see the Concept Insight
statements below for the calculations). Sensitivity analysis is capable to incorporate uncertainty
into decision making (by taking each uncertain factor in
Price stated by E-retail platform turn), and also calculates the change (percentage change
– relative measure hence comparison of importance among
Particulars Plus Others factors become easy) that is minimally required in factor(s)
Customer before the original decision is reversed.
Sale price 1,300 1,350 Since sensitivity analysis considers uncertainly related to
each factor in turn, hence where multiple factors changing
Less- margin kept on the 100 (i.e.8.33%) 150 simultaneously; it has no utility. Apart from this, sensitivity
procurement cost (12.5%) analysis only calculates the change that is minimally
Procurement cost (price stated 1,200 required in factor before the decision is reversed; but it does
by E-retail platform) not consider or calculates the probability of such a change.

Question 5 revenue based on current market conditions, not constraining

the “departmental profit center approach” towards operations.
About Problem Target Verb/ (s) Division B on the other hand can record the transfer price at
the marginal cost of production for Division A. The marginal
Transfer Pricing Comment, Recommend cost for Division A is R1,200 per unit. If Division B is allowed to
record the transfer price at R1,200 unit per sub-assembly unit
AB Cycles Ltd. has 2 divisions, A and B which manufacture bicycle. purchased from Division A, it would show a profit of R300 per
Division A produces bicycle frame and Division B assembles rest of unit of bicycle sold.
the bicycle on the frame. There is a market for sub-assembly and the
final product. Each division has been treated as a profit centre. The R
transfer price has been set at the long-run average market price. The Sell at the final product stage 3,000
following data are available to each division: Less: Transfer Price for each sub assembly 1,200
R purchased from Division A
Estimated selling price of final product 3,000 p.u. Less: Incremental cost for Division B to process 1,500
Long run average market price of sub-assembly 2,000 p.u. further
Incremental cost of completing sub-assembly in 1,500 p.u. Contribution 300
division B The problem with Dual transfer pricing system is that it can
Incremental cost in Division A 1,200 p.u. complicate the records since Division A records the transfer
price at R2,000 per sub-assembly unit transferred to Division B.
Required Division B records its transfer price at R1,200 per sub assembly
(i) If Division A’s maximum capacity is 1,000 p.m. and sales to the unit it purchases from Division A. This can lead to errors in the
intermediate are now 800 units, should 200 units be transferred company’s overall records.
to B on long-term average price basis? COMMENT. (iii) Both Divison A and the Company make higher contribution by
(ii) What would be the transfer price, if manager of Division B should selling to intermediate market. If the market demand increases
be kept motivated? Substantiate your RECOMMENDATIONS to 1,000 units, the full quantity should be sold outside as
with suitable reasons. intermediary and nothing should be transferred to Divison B.
(iii) If outside market increases to 1,000 units, should Division
A continue to transfer 200 units to Division B or sell entire Question 6
production to outside market? COMMENT.
Answer Transfer Pricing Discuss
(i) In this case there are two options available –
Option A R A manufacturer of Cell Phones has many operating units within its
Sell at the sub assembly stage (after 2,000 organization structure. The ‘assembly plant’ that assembles parts to
completion of Division A) make the final product. The others are mainly units that manufacture
‘component parts’ for the cell phone. The management promotes
Less: Incremental cost in Division A 1,200 decentralized system of working, where the manager of each unit has
Contribution 800 the power to take decisions independently. The management only
oversees that the impact of major operating decisions such that they
Option B R promote “goal-congruence” that will benefit or not adversely impact
Sell at the final product stage 3,000 the company.
Less: Cost at Division A and Division B 2,700 ‘Max’ is the head of the ‘battery manufacturing’ division. The division
(R1,200 + R1,500)
Contribution 300
Therefore it is profitable to sell at the subassembly stage

because of higher contribution, provided there is a market.
Hence, if there is market at intermediate stage, first priority is
to sell intermediary (sub assembly).Therefore, 800 units should
be sold as sale of intermediary.
The balance capacity available of (1,000 – 800) = 200 units
should be transferred to B and B should complete the assembly
and sell as final product, since the company can earn R300 per
unit for each unit of such sale.
(ii) Recommendation
sells most of its output to its final ‘assembling plant’ division headed
If B Div. receives the subassembly at market price of R2,000, by ‘Ruby’. Battery is an important component of a cell phone. The
plus its own incremental cost of R1,500 will give total cost of company has an overall mission to sell only products that are of
R3,500, thereby yielding a loss of R3,500 – R3,000 = R500 per good quality, for which long lasting life of the battery component
unit, whereas the company makes a profit of R300 per unit. is critical. In March this year, the engineers of both the previously
The loss of R500 per unit would demotivate the manager mentioned divisions created an innovative design to improve battery
of Division B. This would impact the company as inhouse life. These newly designed batteries will be used in a new range of cell
production of the bicycle does yield a positive result, a profit phones that the company plans to produce. The ‘battery’ division had
of R300 per unit. In order to keep the manager of Div. B spent R50 lakhs developing a suitable prototype that was acceptable
motivated, the company can adopt a dual rate transfer pricing to the engineers from the ‘assembly plant’ division. The managers
policy. Division A can record the transfer price at the long are discussing a suitable transfer price for these newly developed
run average market price of R2,000 per unit for each bicycle batteries.
transferred to Division B. This lets Division A show reasonable

As mentioned before, part of the sales from the ‘battery’ division is Answer
also to external customers. However, at the current levels the ‘battery’ J
*NQBDU PO UIF DPNQBOZT mOBODJBMT
division is operating only at 60% capacity producing 60,000 units Amount in R
annually. Its annual capacity is 1,00,000 units. The annual demand
for the newly developed batteries would be an additional 40,000 Department Case a: Case b:
units. By accepting this internal order, the entire annual capacity of Batteries Batteries
the ‘battery’ division can be utilized. procured from procured in
outside at house at R300
It is now close to the year end for the company. A very important
R275 per unit per unit
metric to determine the payout is the division’s financial performance.
Therefore, there is intense pressure to sell more and cut costs. Each ‘Battery’ Division --- 28,00,000
division maintains separate accounting records. ‘Assembly Plant’ Division (1,16,20,000) (1,20,00,000)
‘Max’ wants to charge a transfer price of R300 per unit of battery. Overall Company (1,16,20,000) (92,00,000)
Total manufacturing cost is R250 per unit of battery while the
variable cost is R230 per unit. Case a: Batteries procured from outside at R275 per unit
‘Ruby’, the manager of the ‘assembly plant’ has been trying to convince Cost outflow to the company, incurred by the ‘assembly
‘Max’ to reduce the transfer price to R275 per unit. ‘Ruby’ argues that plant’ division would be R1.162 crores. This comprises of the
the additional production for the new range of cell phones would following:
help utilize unused capacity. In line with the current arrangement, 1. Procurement cost: 40,000 units procured at R275 per unit =
she wishes to get all her batteries from the in-house department R1.1 crores.
due to their higher quality level. However, she finds the cost of R300 2. Additional quality inspection cost: R5 lakhs or R0.05
per unit very high. She shares quotes from other vendors for similar crores.
quality batteries where the average market price is R275 per unit. She 3. Cost of replacement of defective units at a defect rate of
wishes ‘Max’ to provide her the batteries at this rate, which she feels 0.1% of annual sales
is a more competitive price. = 40,000 units × 0.1% × R3,000 per unit = R1.2 lakh or
As per the company’s policy, if a cell phone is found defective within 1 R0.012 crores
year from date of sale, it will be completely replaced by a new phone. Total outflow = R1.1 crore + R0.05 crore + R0.012 crore =
Cost of replacement of a cell phone is R3,000 per cell phone. The R1.162 crores.
annual demand for the newly developed cell phone range is expected When batteries are procured from outside, ‘battery’ division
to be 40,000 units per year. Batteries procured from outside vendors will not incur any cost outflow. However, the unit has unused /
could result in 0.1% of sales becoming defective. These will require excess capacity. Since currently the opportunity cost of unused
replacement of the entire cell phone by the company. ‘Ruby’ argues capacity is zero, this is a non-quantifiable waste. The company
that this is a miniscule portion of the annual sales. All the same, to may have to consider scaling down capacity / activities in this
keep this at a minimum threshold, quality inspection procedures division by shutting down some of its machines. However,
are in place that costs the company R5,00,000 per year. Batteries since it is given that the cell phone industry is in the cusp
manufactured in-house have always met the required quality of a growth phase, it is possible to bring in orders from the
standards. It would not result in any defective products. external market, to utilize the balance 40% unused annual
‘Max’, the manager of the ‘battery’ division justifies the internal capacity.
transfer price rate of R300 per unit on these counts: The company should however be cautious since the ‘battery’
division would be catering to its rival cell phone manufacturers.
1. The quality of in-house batteries is superior compared to the While the ‘assembly plant’ would be procuring batteries
external market providers. They will not result in any sale returns externally from the battery unit’s rivals. It could lead to a
due to defective batteries. situation where the company is working against itself for the
2. Sales policy of the ‘battery’ division for both external and internal sake of maintaining profitability of its individual units. This
sales is – goes against the concept of goal congruence that could affect
Selling price / transfer price = Total Cost + 20% mark up. the company’s ability to sustain business in the long run. This
Therefore, based on a total cost of R250 per unit, the transfer would be a separate study that would need inputs from other
price is arrived as R300 per unit. senior management executives.
3. The division has spent R50 lakhs to develop prototype as per the
Case b: Batteries procured in house at R300 per unit
assembly line requirements. Being a profit center ‘Max’ insists
that this cost be recouped by charging a higher rate. Net cost outflow to the company will be R92 lakhs.
The ‘battery’ division would earn a revenue of R300 per unit
Both ‘Max’ and ‘Ruby’ decide to approach senior management whom
while incurring a variable cost of R230 per unit. Total cost of
they report to in order to resolve their dispute by examine in detail.
production is R250 per unit, that includes a fixed cost of R20
Assume that currently the opportunity cost of excess capacity is zero.
per unit. However, this has been ignored since it is a sunk cost.
There are no pending sales orders that help utilize the excess capacity.
Therefore, each internal sale to the assembly plant division
Also given, that the demand for cell phones has been increasing, so
would net revenue of R70 per unit. The total additional revenue
the industry is in the cusp of a growth phase.
earned from this internal transfer would be 40,000 units ×
Required R70 per unit = R28 lakhs. This comes with the additional
(i) Impact on the company’s financials if (i) Batteries are procured benefit, that the unit is operating at full capacity, producing
at R275 each from external market and (ii) Batteries are high quality component for another unit within the company.
procured in-house at R300 each. Thereby, aiding goal congruence.
(ii) As a member of the senior management committee, with the The ‘assembly plant’ division would incur a cost outflow of R1.2
idea of goal congruence of the divisions and the company as a crores because of the internal transfer. (40,000 units × R300 per
whole: unit). Although this is costlier than the option of procuring from
(a) How would you convince ‘Ruby’ to buy the batteries from the external vendors, it comes with high quality assurance. Sale
the in-house division? of defective cell phones can be avoided, thereby improving the
(b) How would you convince ‘Max’ to reduce his transfer price DPNQBOZT CSBOE JNBHF BOE DVTUPNFS MPZBMUZ.
from R300 for each battery? Net outflow to the company = cost to the ‘assembly plant’
division – additional revenue for ‘battery’ division = R1.2
Hint: For examine in detail use verb ‘DISCUSS’. crores - R0.28 crores = R0.92 crores or R92 lakhs.

At the overall company level, this can also be simply calculated It is given that the opportunity cost for excess capacity is nil.
as the marginal cost of producing additional 40,000 batteries Therefore, the unit’s excess capacity is waste. Therefore, for
= 40,000 units × R230 per unit = R92 lakhs. Fixed cost of determining the transfer price, ‘Max’ should consider only the
manufacture, a sunk cost, is ignored. marginal cost of producing a battery unit rather than following
Conclusion: It is better to manufacture the batteries in- a cost-plus mark-up pricing policy. As explained above, fixed
house due to the following reasons– cost is again a sunk cost to the company.
1. External procurement cost is R275 per unit while the Therefore, as a senior management committee member,
marginal cost of manufacturing a battery is only R230 ‘Max’ has to reasoned out in reducing the transfer price from
internally. R300 per unit. Ideally, the transfer price should include only
the marginal cost of production of R230 per unit. Given the
2. Quality of in-house production is higher, requiring no
decentralized working of the organization, leverage can be
additional quality control checks.
given for ‘Max’ to charge a premium for the quality of his
3. Promotes goal congruence, where each division will work products. Overall, it would not affect the company’s financials.
towards sustaining the company’s business growth. However, there has to be a check on how reasonable this
premium is since it could lead to decisions that are detrimental
(ii) Negotiating with managers of individual units: to the company. Also, performance evaluation should
Negotiating with ‘Ruby’, the manager of ‘assembly plant’ also include non-financial metrics like quality of products
division: produced, innovative designs and production techniques that
Ruby argues in favor of procuring similar batteries from the are factors that will sustain business in the long run.
external market at a price of R275 per unit that is much lower
than the internal transfer price quote of R300 per unit. Overall Question 7
it costs R1.162 crore per year to procure the components as
against her division bearing an internal transfer cost of R1.2 About Problem Target Verb/ (s)
crore. However, by using external batteries, replacement of
defective units would be 0.1% out an annual sale of 40,000 Relevant Cost Concepts Analysis
units that is 40 units need to be replaced. ‘Ruby’ may argue
that this is a miniscule portion of the annual sales. However, An apparel manufacturing company has raw material inventory
the company’s image of providing quality products may take of polyester fabric bales that was initially procured to be used in
a hit. For the company, procurement cost, along with the cost manufacture of shirts. Later, keeping in mind the current fashion
of replacement and additional quality inspection cost makes it trend, the design department suggested manufacture of cotton shirts
costlier than producing the batteries in-house. instead. Therefore, the bales of polyester fabric are now not required.
It was procured at R1,00,000 few months back, the scrap value if sold
Cost of external procurement = R1.162 crore / 40,000 units =
in the external market would be R45,000 (alternative 1). The fabric
R290.50 per unit.
has alternative uses:
Cost of manufacturing in-house = marginal cost of production
= R230 per unit. Alternative 2:
The fact internal transfer is the better option has to be reasoned The material can be used to make polyester jackets. This would
out with ‘Ruby’. She in turn should be given the assurance, the require the following additional work and materials:
company would give importance to other non-financial
metrics while evaluating her unit’s performance for bonus Material A 500 bales of material
payouts. One of these could be the number of successful
innovative designs collaborated along with other departments Material B 1,000 units
such as the ‘battery’ division. This would have a more positive Direct Labor 3,000 hours unskilled
impact on the employee morale. Excessive emphasis on
2,000 hours semi-skilled
financial metrics could lead to decisions that may benefit the
unit but may be detrimental to the company. 1,000 hours highly skilled
Extra selling and delivery expenses R50,000
Negotiating with 'Max', the manager of the ‘battery’ division:
Extra advertising R25,000
The ‘battery’ division is currently operating at 60% capacity.
With the additional order to produce 40,000 units, the capacity This conversion can produce 1,000 units of polyester jackets that can
can be utilized completely. This avoids wastage of resources. be sold at R400 each. Material A is already in stock and widely used
Quality of components is another positive feature that the within the company. Although present stock will be sufficient to meet
company should give credit to ‘Max’s’ division. Therefore, he is normal production requirements, extra material used to facilitate
justified in charging a premium for quality. At the same time, alternative will need to be replaced immediately. This will avoid any
the following points need to be reasoned out with him: loss due to stock out of Material A for the products under regular
Development cost of new design of R50 lakh is a sunk cost for production. Material B is an imported dye item, which cannot be
the company. It need not be passed onto the ‘assembly plant’ very easily procured due to import restrictions. At present Material
division. Instead during performance appraisal, ‘Max’ can B is used in the production of high-end fashion clothing that on an
highlight this as an investment that has paid off in the form average gives a gross contribution of R750 per unit of such clothing
a successful design for the new range of products that the (without the cost of Material B). Each unit high-end fashion clothing
company is planning to manufacture. Such project initiative requires 5 units of Material B.
outflows need to viewed investments and not as costs against
the unit. During performance appraisal for bonus payout, Material A Material B
the management can consider the payoffs from such project Acquisition cost at the time of R87 per bale R75 per unit
initiatives, how successful they have been and how many did purchase
not yield any result. This is Research and Development that is Net realizable value R85 per bale R45 per unit
important for the long-term sustainability of the company.
Replacement cost R90 per bale ---

Alternative 3: To make a decision, the company has to consider the relevant cost
The company also manufactures curtains for which it uses polyester for each option, along with any additional expenses that need to be
fabric of a different variety and texture. The bale of polyester fabric incurred. The alternative that yields the highest cash contribution/
currently lying as obsolete inventory can also be used as a substitute benefit should be chosen.
to the regular polyester material that is used to make curtains. For
this, certain modifications to the texture are required to be done along Alternative 1: If obsolete bale of polyester fabric is sold as scrap in
with certain other procedures that will make the material suitable for the external market it would yield cash return of R45,000. The original
utilization in curtain production. procurement cost is a sunk cost that needs to be ignored.
The substitute will contribute towards production of about ~10%
of the monthly curtain production. The following would be the Alternative 2: Utilize the obsolete polyester fabric to make jackets.
additional work and material required: In addition to the polyester material, Material A and B would be
added to the production process. It would also require the work of
Material C 1,000 units additional labor.
Direct Labor 1,500 hours unskilled Calculation of net cash contribution from Alternative 2:
500 hours semi-skilled Particulars Amount (R)

500 hours highly skilled Sales Proceeds (1,000 jackets × R400 each) 4,00,000
In a month, 15,000 bales of regular polyester fabric used for curtain Material A (note 2.1) 45,000
production is procured at a rate of R80 per bale. This month, due to Material B (note 2.2) 1,50,000
the substitution, only 13,000 bales of regular polyester fabric would
be required. With reduced procurement for the current month, the Direct Labor - unskilled (note 2.3) 15,000
supplier will reduce the bulk discount given on regular purchases. Direct Labor - semi skilled (note 2.4) -
Accordingly, the procurement rate of regular polyester fabric will be
at a rate of R85 per bale for the current month. Direct Labor - highly skilled (note 2.5) 24,000
Material C has to be made in-house since it cannot be procured Variable Overhead (note 2.6) 6,000
as such from the external market. The standard cost per unit of Extra selling and delivery 50,000
Material C would be as follows:
Extra advertising 25,000
Direct labor, 2 hours unskilled labor R10
Net contribution 85,000
Raw materials R09
Variable overhead: 1 hours at R1 per hour R01 Note 2.1: Material A is already in stock and widely used within the
company. However, if this is used to make jackets as per alternative
Fixed overhead: 1 hours at R3 per hour R03
2, it has to be replaced immediately so that other normal production
Total standard cost of production R23 activities are not impacted. Therefore, the relevant cost for Material
A would be its current replacement cost at R90 per bale. Alternative
The wage rate and overhead recover rates for the company are 2 uses 500 bales of Material A. Therefore, relevant cost = 500 bales ×
as follows: R90 per bale = R45,000.
Variable overhead R1 per direct labor hour Note 2.2: Material B is a scarce material due to import restrictions.
Fixed overhead R2 per direct labor hour It can alternatively be used to make high-end fashion apparel.
Unskilled labor R5 per direct labor hour Gross contribution from high-end apparel clothing is R750 per unit
sold. Each unit requires 5 units of Material B. Therefore, the gross
Semi-skilled labor R10 per direct labor hour contribution per unit of Material B would be R750 / 5 = R150.
Skilled labor R15 per direct labor hour Alternative 2 uses 1,000 units of Material B. Therefore, relevant cost =
1,000 units × R150 per unit of Material B = R1,50,000.
The unskilled labor can be procured on contract basis to meet the
exact production requirements. The contract expires once the Note 2.3: Unskilled labor is hired on contract basis to meet exact
work is done. Semi-skilled labor is part of the permanent labor production requirements. The contract expires once the work is
force, but the company has excess supply of this type of labor at done. Relevant cost = payment made to labor hired specially for this
the present time. Highly skilled labor is in short supply and cannot purpose = 3,000 hours × R5 per hour = R15,000.
be increased significantly in the short term. This labor force is
presently engaged in the manufacture of upholstery. Each unit of Note 2.4: Semi-skilled labor is part of the permanent labor force, but
upholstery requires 4 hours of highly skilled labor. The contribution the company has excess supply of this type of labor at the present
from sale of each unit of upholstery is R36. To cater Alternative 2 or time. This means that there is spare capacity within this workforce,
3, they need to discontinue production of upholstery until the work their idle time can be used towards making jackets as per Alternative
is completed. 2. Therefore, there is no additional cost incurred for the 2,000 hours
of work needed for Alternative 2. Therefore, relevant cost = nil.
Required
Present cost information by giving detailed ANALYSIS whether Note 2.5: Skilled labor is a scarce resource, additional labor cannot be
the obsolete bale of polyester fabric should be sold (Alternative1), hired easily in the short term. Therefore, relevant cost will include the
used production of jackets (Alternative2) or used as a substitute for payment made for the current work plus opportunity cost incurred
curtain cloth production (Alternative 3). due to diverting this scarce resource. Each unit of upholstery requires
4 hours of highly skilled labor. The contribution from sale of each unit
of upholstery is R36. Therefore, the contribution per hour of highly
Answer skilled labor is R36 / 4 = R9 per hour of skilled labor. Alternative 2
The textile company has to take a decision whether to– requires 1,000 hours of skilled labor. Therefore, opportunity cost =
(i) sell the bale of obsolete polyester fabric; 1,000 hours × R9 per hour = R9,000. In addition, the skilled labor is
(ii) produce jackets by using this obsolete polyester fabric; or paid R15 per hour, the pay for making jackets as per alternative 2 =
(iii) use obsolete polyester fabric as substitute for curtain cloth 1,000 hours × R15 per hour = R15,000. Relevant cost = opportunity
production. cost + pay = R9,000 + R15,000 = R24,000.

Note 2.6: Variable overhead cost will be R1 per direct labor hour. Therefore, for analysis, the in-house cost of production of Material C
Direct labor hours will equal the hours spent by unskilled, semi- would be R20 per unit. Alternative 3 requires 1,000 units of Material
skilled and highly skilled labor = 3,000 + 2,000 + 1,000 hours = 6,000 C. Therefore, the cost of Material C = 1,000 units × R20 per unit =
hours. Therefore, variable overhead cost = 6,000 hours × R1 per hour R20,000.
= R6,000.
Note 3.3: Unskilled labor is hired on contract basis to meet exact
Alternative 3: Use the obsolete bales of polyester fabric as a substitute production requirements. The contract expires once the work is
to make curtain cloth material. done. Relevant cost = payment made to labor hired specially for this
In addition to the obsolete bales of polyester fabric, this would require purpose = 1,500 hours × R5 per hour = R7,500.
in-house manufacture of Material C, in addition to extra labor. The
change in procurement rate of input regular polyester material should Note 3.4: As explained in note 2.4 above, there is no additional cost
also be considered. in the utilization of semi-skilled labor force. Their idle time is used
towards this extra production as per Alternative 2 or Alternative 3.
Calculation of net cash contribution from Alternative 3: Therefore, there is no additional cost incurred for the 500 hours of
work needed for Alternative 3. Therefore, relevant cost = nil.
Particulars Amount (R)
Net savings in procurement cost for the 95,000 Note 3.5: As explained in note 2.5 above, skilled labor is paid at R15
current month (note 3.1) per hour for this work. The opportunity cost of diverting this scarce
Material C (note 3.2) 20,000 resource from regular production of upholstery material is R9 per
hour. Therefore, relevant cost for alternative 3 = 500 hours × (R15 +
Direct Labor - unskilled (note 3.3) 7,500 R9) per hour = 500 × R24 per hour = R12,000.
Direct Labor - semi skilled (note 3.4) -
Note 3.6: Variable overhead cost will be R1 per direct labor hour.
Direct Labor - highly skilled (note 3.5) 12,000
Direct labor hours will equal the hours spent by unskilled, semi-
Variable Overhead (note 3.6) 2,500 skilled and highly skilled labor = 1,500 + 500 + 500 hours = 2,500
Net contribution 53,000 hours. Therefore, variable overhead cost = 2,500 hours × R1 per hour
= R2,500.
Note 3.1: In a month, 15,000 bales of regular polyester fabric used for
curtain production are procured at a rate of R80 per bale. This month, To summarize the net cash contribution from various alternatives:
due to the substitution, only 13,000 bales of regular polyester fabric Alternative 1: sell as scrap R45,000.
would be procured at a higher procurement rate of R85 per bale for
the current month. Alternative 2: Make of 1,000 jackets R85,000
The original cost of procurement = 15,000 bales × R80 per bale = Alternative 3: Substitute in curtain cloth production R53,000.
R12,00,000 Conclusion: Alternative 2 yields the highest net cash contribution.
Cost of procurement for current month = 13,000 × R85 per bale = Therefore, the obsolete inventory should be used to make polyester
R1,05,000 jackets.
Therefore, savings in procurement cost due to substitution = R95,000
“Every effort has been made to include all possible elucidations for a
Note 3.2: Cost of in-house production of Material C. Material C given case/ question aided by outline and well chosen photographs
costs R23 per unit to be produced internally. Fixed overhead cost of for quick industry reference / concept reference.”
R3 per unit has to be ignored since it is a sunk cost for this decision.

“If all you’re trying to do is essentially the same thing as your rivals, then it’s
unlikely that you’ll be very successful.”
– Michael Porter
ways have their own importance at Sanjivini Hospital in order to

&$6(678'< respond to MUDA (waste).
The basis objective of the case study is to allow the students to apply In favour of the Kaizen initiatives that can be clubbed with 5S, the
ideas and insights from theory to the real life issues and problems. CMD argues “these are quick and easy and helps to eliminate or
Case Study- KAIZEN (with integration to 5S and PDCA) reduce waste”. The HR (executive director) head supports the CMD
by stating that “it promotes personal growth of employees and the
At Sanjivini Hospital, stores recently organization and also act a barometer of leadership”. The finance
complete the exercise of numbering head (who is also an executive director) supported the CMD by
the patient files to keep the record in to stating that “these ideas (small changes) can be implemented by the
shorten retrieve, because the reception worker him/herself with very little investment of time”.
desk finds it cumbersome to locate the The finance head also quoted a reference of the report that was
file in case of revisiting patients. The published in The New Indian Express recently, stating that private
different departments (OPD, IPD, and hospitals spend 50 percent of operational costs on salaries of medical
OT) of Sanjivini Hospital uses some staff, including doctors. The analysis says that hospitals spend 28-
of the surgical items, out of common 32 percent on drugs and consumables and maintaining a bed in a
inventory pool; hence visual control is super-specialty hospital takes about `15,000-25,000 every day.
used to prevent stock-out situation or improve inventory control. Then he (finance head) presented the following facts and figures in
“If someone asked me to suggest a basic procedure for solving problems front of the board–
scientifically, rationally, efficiently, and effectively by removing During the previous period (t-1), at Sanjivini Hospital the average bed
the barriers and reducing the wastes – KAIZEN may be the best capacity was 350 and the average overall actual operation cost for a
possible answer”. This is the opening remark of the CMD of Sanjivini week of seven working days was `4,59,37,500 against the standard
Hospitals at the recent board meeting, after which a clear split in the cost of `18,500 per bed per day.
viewpoint of directors over the utility of Kaizen is visible; some of During the period just ended (to) with the Kaizen initiatives the goal of
the directors favour the organisation-wide innovations wherein top cost reduction was 8%. The average bed capacity increased by 10% and
management’s active involvement is essential; whereas some others the average overall actual operation cost for a week of seven working days
believe performing those improvement initiatives which can be was `4,63,54,000 against the standard cost of `17,020 per bed per day.
applied through an operational level workforce with the little amount
of resources are essential. Required
The executive director responsible for planning and operation read (i) Assist the management of Sanjivini Hospital to CALCULATE
an executive summary followed by a presentation wherein the facts the following, using Kaizen Costing –
and figures related to operations were highlighted. In response to a a. Cost base for the period just ended (t0)
question raised by the independent director regarding the proper
b. Kaizen Cost reduction target during the period just ended
disposal of surgical wastes, he mentioned that during the year
(t0) in amount
(just completed) colour coding was used throughout where it was
possible, after considering a suggestion letter from a nurse, and this c. Cost base for the period just started (t1)
significantly prevent mix-up of medical wastes, which make disposal (ii) ASSESS the performance of Sanjivini Hospital for the period
easy and cheap. The head of housekeeping division added, on the just ended (t0) from the perspective of Kaizen Costing.
feedback from ward boy, all switches were labelled to save energy (iii) After briefly explaining Kaizen and the 5S and IDENTIFY
and cost on the environment day. at-least three practices adopted by Sanjivini Hospital
CEO, gave stress upon the clarifying ideal situation because he feels wherein Kaizen overlaps with 5S activities.
it is useful to identify problems in your working place, because the (iv) ADVISE the management at Sanjivini Hospital, how it can
gap between ‘desired ideal status’ and ‘actual current situation’ is track the Kaizen suggestions.
‘problem/(s)’. He further added, – “if the problems are complex and (v) After stating the Kaizen process, do synthesis of the
composite then the Kaizen process with help of the PDCA cycle needs relationship between the Kaizen process and PDCA Cycle.
to be practiced; if the problem is simple and relates to operations then (vi) LIST at-least three practices that can help Sanjivini Hospitals
Kaizen initiatives can be clubbed with 5S”. He mentioned both the to foster the Kaizen culture.

Solution
(i) Kaizen Costing
t Cost base for the period just ended (t0) = `4,59,37,500 / (7 days
× 350 beds) = `18,750 per bed per day.
Note – Cost base for Kaizen Costing purpose shall always be
calculated in per-unit basis to equalise the change in capacity
level. 5S represents a scientific way of workplace management so that
t The Kaizen Cost reduction target during the period just ended work can be performed effectively, efficiently, and safely. 5S acts
(t0) in amount will be 8% of the cost base for the period just as the foundation of eight pillars of TPM and represents;
ended (t0) i.e., actual cost = 8% of cost base i.e., 8% of `18,750
t Seiri means Sorting
per bed per day. This comes out to be `1,500.
t Seiton means Set in Order
Note – Here 8% is the Kaizen Cost reduction rate and `1,500 t Seiso means Shine
is the Kaizen Cost reduction target. t Sieketsu means Standardization
t Cost base for the period just started (t1) = `4,63,54,000 / (7 t Shitsuke means Sustain
days × 385 beds) = `17,200 per bed per day.
Working Note – Average bed capacity i.e., 350 + 10% of 350 = 385 beds.
Concept Insight
It is important to understand the difference between the Standard
Cost and Kaizen Costing, so refer the table of differentiation below–
Standard Costing Kaizen Costing

It is a cost control technique. It is a cost reduction
At Sanjivini Hospital, the following Kaizen initiatives can be
technique.
linked with 5S–
It assumes current work It assumes continuous t Colour coding of the waste bin to prevent mix-up of medical
condition will remain same. improving conditions. wastes.
t To save energy, switches were labelled.
Meet cost performance standard. Achieve cost reduction target. t Visual control to prevent stock-out situation or improve
For larger period usually six For relatively short span – inventory control.
or twelve months. e.g., monthly or quarterly. t Proper numbering of the patient files to shorten retrieve time.
For variance analysis Gap between actual cost and
Note – the Kaizen initiative taken place at Sanjivini largely
comparison is among the kaizen target cost identified.
covered by second ‘S’ Seiton i.e., set in order.
actual & standard cost.
Variances need to be Reasons for missing kaizen (iv) Tracking of Kaizen suggestions can easily be practiced at Sanjivini
reported and addressed. target cost need to be Hospital by maintaining a Kaizen suggestion board that generally
addressed. comprises–
Kaizen Suggestions To Do Doing Done
(ii) Performance of period just ended (t0) from the perspective of Kaizen
Costing is appreciable because during the years the Kaizen Cost
reduction target was `1,500, means through Kaizen initiatives it
has to reduce the cost from `18,750 per bed per day to `17,250 per
bed per day; whereas Sanjivini Hospital attains the actual average
operating cost of `17,200 per bed per day, means a reduction of Sanjivini Hospitals can use the KAIZEN suggestion board in the
`1,550 (i.e., more than Kaizen Cost reduction target was `1,500). following way (steps)–
In other words, one can say rather than reducing the cost by t Write the idea on a paper and stick it when you come- up with
8% Kaizen initiatives helps to reduce case by 8.27%; hence ideas for improvement.
performance is acceptable and appreciable. t Move the paper to “TO DO” when a supervisor or work
For better understanding on questions i and ii, refer the table below– improvement team are discussing.
t Move the paper to “Doing” when you are practicing the ideas
Period Actual Standard Kaizen Kaizen Cost Kaizen after agreement from the supervisor or work improvement team.
Cost Cost* Cost Reduction Cost
Base Target Target t Move the paper to “Done” when you complete the ideas.
t-1 18,750 18,500 Note – If Sanjivini hospital willing then can collaborate with 5S
t0 17,200 17,020 18,750 1,500 (i.e., 8%) 17,250 initiatives as an extension to the Kaizen suggestion board.
t1 17,200 (v) The relationship between the Kaizen process and PDCA cycle
Cost 1,500 Kaizen is solving problems process at working place, to improve
Reduction 1,550
(desired situation and condition, whereas PDCA (also known as Deming
during t0 (attained) i.e., 8%) Cycle) is an iterative four-step management method used
* Irreverent for KAIZEN costing. in business for the control and continuous improvement of
(iii) KAI means change and ZEN means improvement, hence processes and products. PDCA stands for the plan–do–check–
‘KAIZEN’ represents a change for the better. ‘KAIZEN’ is a lean act. The PDCA Cycle provides a framework and structure for
process that continuously strives for problem-solving to achieve identifying improvement opportunities. The seven steps of the
Total Quality Management. ,BJ[FO QSPDFTT BSF

decade ago. The plant was originally built on a 65-acre area with another
Plan 155 acres allocated for a vendor cluster. The production unit spread out
in 40,000 square meters and is operated by 600 line engineers.
4UFQ 4FMFDUJPO PG ,BJ[FO
Theme In the plant, safety became a critical issue. This is also evident
from the report of the review committee, which was submitted to
4UFQ 4JUVBUJPO "OBMZTJT the board of directors recently. Report details all those incidences
4UFQ 3PPU $BVTF "OBMZTJT (that occurred in the last couple of years) when safety norms were
breached or safety measures in operation were failed and result in
4UFQ *EFOUJîDBUJPO PG incident or accident.
Countermeasure
Total such incidences are 54, out of which major are 11. Results of
detailed investigation show that 14 such incidences were taken place
Act Do due to sheer negligence of workers (it was also identified that 4 of
such incidences occurred while the concerned worker was during
4UFQ
PDCA 4UFQ overtime hours), whereas 37 incidences taken place due to poor
Cycle and Implementation workplace management and the remaining 3 are due to power failure.
Standardization
of effective
KAIZEN of the identified
Process Countermeasures Out of 37 incidences that took place due to poor workplace
Countermeasures management, 19 were due to using either the wrong tool (tool required
either misplaced or non-accessible due to any reason) or hazardous/
toxic elements were not handled properly including failure to keep the
process within the control limits (2 were serious, but no causality); 5
were due to breakdown or failure of machines (4 were serious, and the
Check one incident resulted in a fire resulting in two casualties and injuries
4UFQ $IFDL to many). It was also identified that all the 5 machines involved were
effectiveness of not regularly cleaned and even regarding one of such machines a
the complaint (that it sparks some time) was also registered by the operator
Countermeasure with maintenance staff (same remain unresolved). The remaining 13
were due to cluttered production floor (1 among them were serious,
involving one casualty and injuries to some others).
VP Finance after reading the report sent a letter to the board, wherein
Note – immediate action is requested. He included the adverse monetary
The important point that needs to keep in mind is ‘the effect of such incidences in the letter.
continuous nature of improvements’. Don’t stop after Act, During the next board meeting, wherein you (management
do plan further on. accountant) are also present; an independent director who is an
HR professional said ‘the consequences of such incidences include
(vi) The practices that Sanjivini Hospital needs to stress upon in defame and low employee morale (apart from litigation and pressure
order to foster the culture of Kaizen. from employee unions), hence resolution shall be prompt and apt.
t Promote the culture of sharing of ideas – Best practices The CEO responded ‘BSC (balanced scorecard) is already in practice
can be evolved within the hospital through sharing and at Santnagar plant of Mijaj, which includes Internal Process,
discussing the idea (change) that can solve the problem and Learning & Growth, the score is also acceptable in both the
causing a gap in existing and ideal position. Such practices perspective’. A question was posed related to accidents due to
shall be adopted in every vertical of the hospital. employee negligence are they (employees) learned enough? CEO
t Do whatever best can be done with existing resources – while responding to question referred report from the HR head,
Reach to the level of optimum utilization and remember wherein it was mentioned that during such two years 27 training
there always scope for improvement. programs were organised and average attendance turned out nearly
t Foster esprit-de-corps culture – A culture in which no 80%. Every employee who works on the production/assembly line has
blaming other’s opinions, instead of this they support in to undergo 3 months of training at the time of joining.
implementation after the agreement from the supervisor or The MD expresses his concern over the number of such incidences and
work improvement team. surprised to know that BSC is failed to deliver. MD prior to this board
t Integrate everyone's image – To have overall perspective meeting, attended a CPE meet wherein he comes to know about 5S,
while evaluating any individual initiative (suggested change). red tag, and marking; but not sure whether these will help or not. MD
ordered you to prepare documents showing the application of 5S to
Case Study- 5S the Mijaj’s Santnagar plant, apart from preparing the precise checklist
and list of benefits owning to different ‘S’. It was decided a task force of
the director and top executives shall be formed to respond to the issue.
Required
(i) EXPLAIN the 5S briefly followed by a piece of information
to the task force on ‘is the root causes of incidences that took
place due to poor workplace management are connected with
the scope of 5Ss?’ Support your answer by correlating the facts
given in the case and highlight how 5S can be helpful to Mijaj.
(ii) You prepared the document as desired by MD and gave it
to the computer operator to punch in, but she merged the
checklist and list of benefits as follows–
a. Working out the procedures defining the course of
Mijaj is the leading household name in the nation for electronics and processes.
automobiles. Mijaj inaugurated its two-wheeler plant at Santnagar with
a planned capacity of one million motorcycles per annum, more than a b. Are lines, pipes, etc. clean, will they demand repairing?

c. Quick informing about damages (potential sources of Description Reason Can be overcome
damages.
13 incidences Cluttered Seiri (sorting)
d. Do tools or remainders of materials to production lie on production floor
the floor (in the workplace)? (1 were serious, Use red and yellow
involving one tags with store and
e. Has the floor any irregularity, cracks, or causes other
casualty) designated holding
difficulties for the operator’s movement?
area
f. Are the oil’s stains, dust, or remains of metal found
around the position, machine, on the floor? 19 incidences Using either wrong Seiton (set in
tool (tool required order)
g. Better usage of the working area. (2 were serious,
either misplaced
h. Are pipe outlets of oils not clogged by some dirt? but no causality) Use of label, signs,
or non-accessible
colour code, line
i. Shortening of the time of seeking necessary things. due to any reason)
marking, tool form,
or hazardous/toxic
j. Is attention given to keeping the workplace neat and or shadowing
elements were not
clean?
handled properly
k. Decreasing of mistakes quantity resulting from the including failure to
inattention. keep the process
l. Is the position (location) of the main passages and places within the control
of storing clearly marked? limits
m. Are all transport palettes stored on the proper heights? 5 incidences Breakdown or Seiso (Shine)
You are also required to CLASSIFY (and re-arrange) in failure of machines,
(4 were serious, The operator
relevant categories of 5S. because they
involving two shall assume the
were not regularly
(iii) LIST, why do balanced scorecard fails to deliver in all casualties) role of cleaner.
cleaned and
the cases? Critically ASSESS the CEO’s response to the Cleaning shall
repaired (even the
question posed. involve inspection
repair request/
(iv) EXPLAIN taskforce, for what purpose red-card/tag of all aspects of the
complaints remain
is meant? How is it used? Are there any other colours machine – front,
unresolved)
tag too? rear, left-right, top
and bottom
Solution If first 3S (sorting, set in order, and shine) become the standard
(i) 5S represents a scientific way of workplace management so that which is adopted by organisation sustainably then the probability
work can be performed effectively, efficiently, and safely. 5S first of incidences which took place due to unattended-ness of worker
developed by Hiroyuki Hirano and was come into practice as part shall also be reduced. At the Santnagar plant of Mijaj, there were
of the Toyota Production System. 5S is usually considered as an 14 such incidences in the previous two years. Hence, 5S practice
essential component of Lean manufacturing, and the foundation can really help the Mijaj in reducing the probability of more than
of eight pillars of TPM. 5S are as follows– 90% of incidence to promote safety.
t Seiri means sorting, aiming to remove all unwanted, (ii) Classification of checklist items and benefits in relevant
unnecessary, and unrelated materials at the workplace. categories of 5S
t Seiton means set-in-order that consists of putting
Description of item Checklist/ Category
everything in an assigned place so that it can be accessed
Benefit
or retrieved quickly as well as returned in that same
place quickly. a. Working out the procedures Benefit Seiketsu
defining the course of processes. (Standardize)
t Seiso means shine. The shining process consists of cleaning
up the workplace, keeping it neat, and giving it a 'shine'. b. Are lines, pipes, etc. clean, Checklist Seiso
t Seiketsu means standardization, which involves defining the will they demand repairing? (Shine)
standards by which personnel must measure and maintain c. Quick informing about Benefit Seiso
cleanliness. damages (potential sources of (Shine)
t Shitsuke means Sustain. Sustaining the discipline, which damages.
helps in It maintain orderliness and to practice the first 4 S as d. Do tools or remainders of Checklist Seiso
a way of life materials to production lie on (Shine)
Note – Practice of 5S is a sequential process. the floor (in the workplace)?
Yes, the root causes of incidences that took place due to poor e. Has the floor any irregularity, Checklist Seiri
workplace management at the Santnagar plant of Mijaj are highly cracks, or causes other (Sort)
connected with the scope of 5Ss. difficulties for the operator’s
movement?
The incidences that took place were largely due to items at
the workplace are either not properly sorted or not in order. f. Are the oil’s stains, dust, Checklist Seiso
Lake of maintenance of the machines in term of cleaning or remains of metal found (Shine)
and repair also another major reason for same. around the position, machine,
on the floor?
Total of 37 incidences took place due to poor workplace
management at the Santnagar plant of Mijaj, which represent g. Better usage of the working Benefit Seiri
more than 2/3 incidence of the last two years. area. (Sort)
h. Are pipe outlets of oils not Checklist Seiso
clogged by some dirt? (Shine)

The processes at SEL were traditionally designed and hardly modified

i. Shortening of the time of Benefit Seiton since its inception. Accounts payable function (process) is also not
seeking necessary things. (Set-in- an exception and requires rationalization. It’s not only the obsession
order) of managers but also the fear of workers; that hinders the SEL from
j. Is attention given to keeping Checklist Seiketsu revamped even to make minor changes.
the workplace neat and clean (Standardize) The CEO, who joined SEL recently, presided over a meeting where
(SoPs)? all the functional heads (including finance, marketing, and store,
etc.) were present. Highlighting the concern of vendors, the CEO
k. Decreasing of mistakes quantity Benefit Shitsuke
remarked ‘If managers have the vision, re-engineering will provide
resulting from the inattention. (Sustain)
the way’. Many functional heads were unable to understand what the
l. Is the position (location) of the Checklist Seiton CEO intended to say, especially ‘what he meant from the word re-
main passages and places of (Set-in- engineering? Is this meant by improvement or innovation?’
storing clearly marked? order) Currently, the accounts payable department receives a duplicate
hard copy of the purchase order (from the purchasing department),
m. Are all transport palettes stored Checklist Seiton
a duplicate of good receipt note (from gate/store), and invoice (from
on the proper heights? (Set-in-order)
vendor); then match the particulars in all three and only if matched
Note- Alternate Classification may also be possible. proceed for payment. Managing accounts payables (including
processing vendor’s invoices) as part of working capital management
(iii) The prominent reasons for the failure of a balanced is KRA of CFO. He mentioned ‘we are thinking to completely
scorecard to deliver in all the cases are– automate the process, to speed up the invoice processing’. To which
t Managers mistakenly think mere use of non–financial the CEO responded ‘Don’t automate, do obliterate’. Further CEO
measures and Balanced Scorecard is meant for reporting said ‘why only accounts payable, why not others or all?’
purposes only. VP-Production and Operations raised his concern over the
t In case senior executives delegate the responsibility of the identification criteria for processes to be rationalised. VP-HR and
implementation to middle-level managers. Payroll jumped into the discussion with the plausible conflicts and
challenges out of the changes, SEL aiming at. CEO stressed the
t If companies, try to copy measures and strategies used by the
importance of ‘breaking away from the old rules’.
best companies rather than developing their own measures
suited for the environment under which they function. Required
Mere draw down the BSC and compute the score is no guarantee You were also present in the meeting (as management accountant),
that things can’t go wrong. An in-depth evaluation is required. hence required to
The KPIs established may be outdated or irrelevant. Targets (i) CEO stressed the ‘breaking away from the old rules’ and
may be understated, and performance may be overstated. mentioned ‘don’t automate, do obliterate’. Synthesis of both the
CEO's remark includes a reference to report from the HR statements in the context of BPR. Also ADVISE how account
head, wherein it was mentioned that during such two years 27 payable function (process) can be re-engineered at SEL.
training program was organised and average attendance turned (ii) Improvement, Redesign, and Re-engineering are not the same.
out nearly 80%. Since learning is something more than training; Briefly COMPARE the terms to help the functional heads, who
hence conducting training program will not be enough, if unable to understand the CEO’s remark.
participation and learning of worker are not assured. Physical (iii) LIST, set of criteria that can be applied to identify the processes
attendance will not ensure the learning, for this worker need to suitable for re-engineering.
be engaged and they shall be motivated to practice what they
(iv) LIST the plausible conflicts which SEL may face along with
learn during training.
possible the way-out.
Note - Positive motivation is better than negative motivation
(v) CEO said ‘why only accounts payable why not others or all’.
to build a constructive culture, hence do link incentive for
STATE the steps involved in Business Process Reengineering
compliance rather than charging penalty for not following
Life Cycle?
what asked for.
(iv) Red tags help to identify objects that need to be removed from Solution
the workplace, in the process of sorting.
How it works - While sorting, place a red tag on the undecided
items. This lets everyone know this item needs to be evaluated.
Notate on the tag whenever item used afterward that, this will
help in deciding the frequency of use and take the decision to
leave the item where it was originally placed, relocate the item,
or dispose of the item.
Note - Until determining their value, such red-tagged items
are placed in the Red Tag Holding Area.
Yes, apart from the red tag, another tag that can be used is
the yellow tag. A yellow tag contains detailed information
(including expected use, dates, etc.) of needful items, which are
useful but not required currently, hence usually kept in store.
Case Study – Business Proceess Reengineering
Sim-tech Electronics Limited (SEL) deals in a wide range of (i) Business Process Re-engineering (BPR) is a fundamental
electronic products for domestic and commercial use. SEL was rethinking and radical redesign of business process to achieve
established around 40 years back and famous for completely dramatic improvement in critical contemporary measures of
indigenous products. Raw materials including assembly components performance, such as cost, quality, service, cycle time, etc. Frederick
are procured from registered vendors only. Delayed processing of Winslow Taylor said to develop a science for each element of a
invoices by SEL is the major concern of vendors. Even a few vendors man’s work, whereas Micheal Hammer thinks differently hence
deny the further supply of material. ESBTUJDBMMZ EFWJBUF GSPN 5BZMPS JO UIF GPMMPXJOH NBOOFS

– Hammer looks at processes as a whole not just as a collection t That can be broken into the parts.
of parts; because only then you can decide on the best way to t Those which are behaving like constraints (Bottleneck).
do the whole process and redesign it radically. t Feasible to make the change.
– Hammer wrote an article titled ‘Re-engineering work: t Cross-functional and cross-organisational.
Don’t automate, obliterate’, wherein he said don’t use t Core processes that have high impact – the business
IT just to make existing processes faster; be prepared to process which capable to add value substantially. One can
design a completely new process. Basically, Hammer favours use a value chain to identify high-level processes.
breaking away from the old rules. t Front-line customer serving - Business processes that are
customer-facing used by front-end employees.
Hence in both the statement CEO advocates for BPR.
(iv) Challenges in employing BPR
Re-engineering of accounts payable at SEL
Business Process Re-engineering results in radical changes in
Currently, the accounts payable department receives 3 the process and may involve automation (or further automation)
documents in physical hard copy and then matches the same to hence challenges pertaining to change is expected, SEL can expect
proceed for payment to the vendor. the following plausible challenges which they need to respond–
Out of these three documents (duplicate hard copy of purchase t Decreased employee morale – Since BPR starts with
order, a duplicate of good receipt note, and invoice) accounts a mindset that the existing process is not perfect,
payable department can skip invoice and it can proceed for improvement can be made; means what employees are
payment based upon auto-matching of good receipt note with performing is not of optimal worth. Changes in role and
purchase order. responsibility are expected after BPR, with which employees
Further, a real-time ERP solution (maybe cloud-based or SEL’s may not be comfortable and may lose job satisfaction. The
server-based) can put into place to automate the process of staff of the accounts payable department of SEL may be
matching the purchase order and goods receipt note (because transferred to some other department.
both the document either created or hosted on the ERP). This t Reduced staff (Layout) – Automation leads to reduction of the
also results in saving time, earlier spent in punching the data (at workforce, hence job security is a cause of worry. In the accounts
end of account payable department), and physical movement of payable department of SEL too, many may lose the job.
documents from one department from others.
t Incomplete impact analysis – Processes may be complex,
Maintaining records and generating reports become easy hence BPR may result in either indirect effect or effect
and cheap, Such ERP will also auto-check the invoice details on an invisible element that can’t be predicted with the
whenever punched into the system. acute degree.
(ii) Difference between Process Improvement, Process t All or nothing methodology – BPR is all about radical
Redesign, and Process Re-engineering change and looks at processes as a whole not just as
Process Improvement targets to tap incremental improvements, a collection of parts, hence either complete change or
while keeping the process stable (in relative term to process nothing to change.
redesign and process re-engineering), whereas Process Re- Overcoming BPR challenges
engineering involves radical redesigning of core processes.
The challenges are due to change and rection of people who
Process Redesign is the middle path to both the extremes will be impacted by change if change management is applied
(Process Improvement and Process Re-engineering). properly then SEL can easily overcome the majority of
Refer to the diagram to understand the difference in scope challenges posed above.
and outcome of Process improvement, Process redesign, and t Focus on all change management impacts – People,
Process re-engineering– Process, and Systems.
Strategic t Communicate early and often.
opportunities or t Practice continues improvement.
Process (v) Business Process Re-engineering Life Cycle
environmental
Re-
threat (process Business process re-engineering life cycle involves seven steps
engineering
need to be out of which first two are enterprise-wide and the remaining
re-vamped) five are process specific. Refer to the diagram below–
The process has
big problems Process Visioning - Define corporate vision and business goals
Enterprise
and needs to Redesign wide
change Identifying - Identify business processes to be engineering
reengineered
Process is Process
stable Improvement
Analysing - Analyse and measure an existing process
Core
Mid-
Smaller processes Redesigning - Identify enabling IT & generate
sized
sub-process (using value alternate process redesign
processes
chain)
(iii) Criteria to identify the processes Evaluating - Evaluate and select a process redesign Process
The processes for re-engineering shall be selected with the specific
utmost care by a cross-functional team of managers considering engineering
Implementing - Implement the reengineered process
the vision and business goals from a holistic view. SEL shall
consider the following points to identify the processes –
Improving - Continuous improvement of the process

Skill Assessment Based Questions revisited once every year since it is not possible to do more dynamic
costing due to the 35 different types of cartons being produced.
The basis objective of the case study is to allow the students to apply
This is acceptable both to the production manager and the senior
ideas and insights from theory to the real life issues and problems.
management of the company. Accordingly, the total standard cost
Question 1 computed from the above inputs is acceptable for evaluation of the
manufacturing performance.
Storage
Target Costing Calculate, Assess, PX-2 receives and stores raw material within factory premises.
Advise, Comment It has a warehouse located 20 kms from its factory where finished
corrugated cardboard sheets (cartons) are stored. Shipment of goods
PX-2 manufactures cartons primarily for the use of manufacturers from factory to warehouse is made using trucks that the company
of electronic products. Cartons are customized for each brand owns. Later, based on the demand, shipments are made from the
that individual manufacturers produce. Cartons for each brand are warehouse to electronic product/(s) manufacturers all over India.
unique, having specific scheme of instructions, bar code, information, Stacking, dispatching, and shipping of goods is done manually.
and pictures. Presently, PX-2 produces at least 35 different types of
cartons for each brand and has a market share of 40% in this segment. Financial Performance
The market for electronic products is expected to grow exponentially PX-2 sells each ton of carton at `1,40,000. In addition to the
in India. This has attracted not just more electronic products NBOVGBDUVSJOH DPTUT EFUBJMFE BCPWF GPMMPXJOH DPTUT BSF JODVSSFE
manufacturers but also suppliers of similar cartons to cater to the t Shipping of goods to the warehouse 20 kms away is `6,000 per ton.
demand from such manufacturers. Therefore, an electronic product
t Warehouse maintenance expense is `30,000 per ton.
manufacturer can procure customized cartons for its product/(s)
from multiple carton manufacturers. PX-2 has been in this business t Required profit margin of finished corrugated cardboard sheets
for many decades. It is a family run business. (cartons) is `5,000 per ton.
Production Process A back-of-the-envelope calculation indicates that the cost of
operations is actually higher than this sales price. Since the market
Kraft paper is the primary raw material required to make corrugated
is highly competitive, PX-2 does not have the flexibility to increase
cartons. PX-2 buys this from external suppliers. The Kraft paper
its sale price.
is loaded into machines called corrugators. Corrugator machines
processes this into cardboard sheets. These sheets are then Problem at hand
printed upon with unique colour along with information relevant A close competitor of PX-2 is able to sell similar cartons at `1,10,000
to the electronic product for which it is being made and cut into per ton. There is not much product differentiation between the
appropriate size. Batches of finished cartons are packed together goods. A “competitor-study” indicates that the competitor is making
and shipped to the warehouse. In the recent years, awareness about reasonable return even at this price. Likewise new entrants are eating
corporate social responsibility has led manufacturers of cartons to into PX-2’s market share.
use recycled paper as raw material to make cartons. Recyclable paper
On the production side, the production management team is
material is procured from scrap paper dealers. Raw material needed
convinced that they have the best practices in place and that the
for production is stored within the factory premises.
costs being incurred are reasonable. The loss making financial
performance, in their opinion is due to market pricing of the product.
On the other hand, the sales manager is of the opinion that given the
market competition, the product cannot be sold at any higher price.
Hence, the loss cannot be addressed by increasing the sale price.
Required
As a newly employed management accountant you have been
requested to suggest possible solutions to improve profitability.
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Following is the information available about the production plan and (i) CALCULATE the current cost of operations to produce 1 ton
TUBOEBSE DPTUT CBTFE PO CVEHFUT of cartons. Given the current sale price of `1,40,000 per ton,
t 1SPEVDU .JY ͳF JOQVU NJY UP QSPEVDF DPSSVHBUFE DBSECPBSE what is the profit or loss being incurred?
TIFFUT JT BT CFMPX (ii) Intense market competition and the ability of a competitor to
sell a similar product at a much lower price, requires you to
Material Product Mix Market Price use target costing methodology to solve the problem. Taking
per ton (`) the competitor’s sale price of `1,10,000 per ton CALCULATE
the target manufacturing cost.
Kraft paper 80% 50,000
(iii) In the current set-up, CALCULATE ideal manufacturing
Recyclable paper 20% 20,000 cost considering most efficient use of resources. Ideal
manufacturing cost is when there is no wastage of current
t *OQVU 0VUQVU :JFME " UPO PG SBX NBUFSJBM QSPDFTTFE JO UIF resources.
corrugators yields half ton of cardboard sheets (corrugated).
(iv) What conclusions would you draw when you the target
t 0QFSBUJOH $PTUT " DPSSVHBUPS NBDIJOF DBO QSPDFTT UPOT NBOVGBDUVSJOH DPTU BOE UIF JEFBM NBOVGBDUVSJOH DPTU <)JOU
of cardboard sheets during an hour long production run. ADVISE].
Operating cost of the machine for one hour is `30,000.
(v) ASSESS whether the company return improve its profitability
t 1SJOUJOH $PTUT $PTU PG QSJOUJOH DVTUPNJ[FE JOGPSNBUJPO BOE XIFO UIF GPMMPXJOH BDUJPOT BSF UBLFO
colour/ design costs `5,000 per ton of cardboard sheet.
(a) The product input mix is changed as kraft paper 55% and
t Other costs required to complete the manufacturing process recyclable paper 45%. Market price per ton of kraft paper
(Inc. glue, dyes, and wax) is `20,000 per ton of cardboard sheet. is now `51,000 and of recyclable paper is `15,000.
These standards represent “best practices” for the company that (b) Input output yield improves to 85% from the current level
have been followed for the past many years. Standard costs are of 50%.

(c) Storage of finished goods at the warehouse is being (iii) Ideal manufacturing cost of production per ton of corrugated
improved. The company is moving to a smaller warehouse cardboard sheet. Ideal manufacturing cost would be the cost
within the same vicinity. Automation of stacking and incurred when the resources are used in the most efficient
dispatch operations will be done using forklifts. Storage manner. In the given problem, the input-output yield of 50%
space is being optimized by stacking the goods on racks that is the only sub-optimized resource. Hence, the ideal cost of
can store more volume within the same floor space. This can production, without wastage of resources would be when the
reduce warehouse operating costs by `5,000 per ton. input-output yield is 100%.
(d) Trucks used for shipping are being replaced by more When Yield is 100%, only one ton of raw material is needed to produce
fuel efficient, larger ones. This would save the company one ton of corrugated cardboard sheets. As calculated in Note 1 of
`2,000 per ton. question 1, the material procurement cost per ton is `44,000.
(vi) COMMENT on how the above target costing study has made Therefore, the ideal manufacturing cost would be–
PX-2 environmentally responsible.
Particulars `
Answer
Raw material cost (yield 100%) 44,000
(i) Current cost of producing 1 ton of finished corrugated
Add: Operating cost (corrugator machine) 6,000
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Add: Printing costs 5,000
Particulars `
Add: Other costs 20,000
Raw material cost (refer note 1 below) 88,000
Ideal manufacturing cost (per ton) 75,000
Add: Operating cost (corrugator machine) 6,000
(iv) Conclusions drawn from target manufacturing cost and ideal
Add: Printing costs 5,000 manufacturing cost. Target manufacturing cost is `69,000 per
Add: Other costs 20,000 ton while ideal manufacturing cost is `75,000 per ton of output.
Hence, it can be concluded that even with the most efficient use
Current manufacturing cost per ton 1,19,000 of resources, the target manufacturing cost cannot be achieved.
Add: Shipping of goods to the warehouse 6,000 As mentioned in the problem, the “competitor-study” indicates
that the competitor selling at `1,10,000 per ton is able to earn a
Add: Warehouse maintenance expense 30,000 reasonable return even at such lower price.
Total cost of operations per ton 1,55,000 Therefore, it can be concluded that the presumption that
production is based on “best-practices” is wrong. Unlike the
At the current sale price of `1,40,000 per ton, the company is opinion of the production team, the cost being incurred is not
incurring a loss of `15,000 per ton of cartons produced. reasonable. Competitors have a more cost efficient production
process that is yielding them profits even at lower sale prices.
Note 1: Material Cost Therefore, production personnel have to undertake study of
more recent advancements in the production process that
Material Product Market price Procurement
the new entrants are able to implement. Such a study would
Mix per ton (`) Price per ton include value analysis and value engineering practices. Study
of Input (`) of the input-output yield, which is currently at 50% may result
Kraft paper 80% 50,000 40,000 in same savings through streamlining production activities.
Similarly, the production can revisit the product mix. If cheaper
Recyclable paper 20% 20,000 4,000 recyclable paper can be used to in more quantity to produce
Total procurement price per ton of raw material 44,000 the same quality of cardboard sheets, significant savings in
cost can be achieved. Efforts can also be taken by the senior
With a yield of 50%, the input raw material needed to produce a management to identify areas that can have a favourable impact
ton of corrugated cardboard sheet is 1 ton/50% = 2 tons of raw on cost. For example, upgrading facilities in the production line
material. Hence the raw material cost for production of one ton or storage areas could lead to cost savings.
corrugated sheets is 2 tons of raw material × `44,000 per ton = (v) Assessment of profitability given certain parameters that
`88,000. can be implemented by the company.
Note 2: Corrugator Machine Given the implementation of parameters in requirement (v) of
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In one hour, the corrugator can produce 5 tons of cardboard
sheet. Operating cost for one hour is `30,000. Hence operating Particulars `
cost per ton is `6,000.
Raw material cost (refer note 1 below) 40,941
(ii) Target Manufacturing Cost when with sale price of `1,10,000 per ton.
Target Manufacturing Cost = Sale price – Required profit Add: Operating cost (corrugator 6,000
margin – Non-manufacturing expense machine)
Add: Printing costs 5,000
Particulars `
Add: Other costs 20,000
Competitive selling price 1,10,000
Current manufacturing cost (per ton) 71,941
Less: Profit margin and
non-manufacturing expenses Add: Shipping of goods to the warehouse 4,000
Shipping of goods to the warehouse 6,000 Add: Warehouse maintenance expense 25,000
Warehouse maintenance expenses 30,000 Total cost of operations (per ton) 1,00,941
Required profit margin 5,000 Add: Required margin 5,000
Target manufacturing cost (per ton) 69,000 Sales price per ton of output 1,05,941

Note 1: Material Cost (with increase in usage of recyclable Question 2

material in product mix)
Material Product Market price Procurement
Mix per ton (`) Price per ton Competitive Advantage, Advise
TOC, COQ
of Input (`)
Kraft paper 55% 51,000 28,050 Gupta Surgical Products Limited (GSPL) is a renowned company for
the manufacturing of a wide range of affordable surgical products. GSPL
Recyclable paper 45% 15,000 6,750 is promoted by Dr. Pooja Gupta who is a professor of medicine. GSPL is
Total procurement price per ton of raw material 34,800 only privilege surgical equipment company which has its chain of own
exclusive stores, which are selling products of GSPL, apart from a tie-
Change in the product mix, to include cheaper recyclable paper, up with the medical and chemist shops across the nation for the sale of
without compromising on quality has reduced procurement their products. Although GSPL being an early mover of the industry was
cost from `44,000 to `34,800 per ton of raw material. Since established around 25 years back when hardly two or three players exist
recyclable paper component increased substantially, the in the market, but the growth phase of the industry is still continuing.
company used its bargaining power with its suppliers to get a Both the top and bottom line has an increasing trend, but the growth rate
better rate. This is mildly offset by an increase in the rate for of the bottom line is relatively less than the rate in case of the top line, the
kraft paper. Yet, the savings are substantial. possible reason is increasing competition. This results in the high cost of
advertisement and marketing to keep market share intact. GSPL thinking
In addition, it is given in the problem that due to value analysis
to enhance the capacity of its plant and other facilities, but availability of
and re-engineering, the yield has improved from 50% to 85%.
fund is a critical issue; since the contraction in margin rate is witnessed
Therefore, instead of 2 tons of input only 1.17647…… ton of
for the last couple of years due to stiff competition, despite an increase
input is required (1 ton output / 85%). Consequently, the raw
in absolute amount; GSPL is not ready to commit incremental financial
material cost has reduced from `88,000 per ton of output to
charge on an account of enhanced financial leverage, due to additional
just `40,941 per ton of output (1.17647… tons of raw material ×
borrowing. Hence, GSPL fund their requirements internally.
`34,800 per ton).
Note 2: Shipping cost to warehouse improved through the In order to response proactively to the unfortunate possibility of
usage of better transportation facilities. wide-spread of Novel Corona Virus (COVID-19) in the country, the
Note 3: Operational cost of warehouse has reduced through use ministry of public health and welfare appeals all the surgical product
of better technology and optimization of space. Cost savings are manufacturers to scale-up and speed-up the production of surgical
`5,000 per ton of output. products which are useful for protection from contamination and
useful for medical professionals.
Conclusion: If PX-2 is able to implement these parameters, it GSPL is the oldest manufacturer of surgical gloves and face masks.
can easily turnaround and become profitable. The output can GSPL is manufacturing only KN95 virus protection face mask
be priced at `1,05,941 per ton in order to get a profit of `5,000 (KN95) with particulate filtration efficiency more than 95%, which
per ton. This is lower than it nearest competitors offering of is approved by the regulator and ISO certified. KN-95 masks also
`1,10,000 per ton. Hence not only can PX-2 become profitable, recommended by WHO as standard equipment for safeguard. GSPL
it can also regain, if not expand its market share. decided to charge the price of `90 for KN95 which is on the lower
side to average price charged by other competitors ranging between
(vi) How has implementation of recommendations from the `100-105. The cheaper face masks (blue colour, 3 layers at `5-10)
target costing study made PX-2 more environmentally are also available for the customer but they are not with the feature
responsible? which KN95 provides.
PX-2 has become more environmentally responsible by through
UIF GPMMPXJOH NFBTVSFT
(a) Improving the product input – output yield from 50% to
85% has reduced wastage of raw material. The quantum of
Kraft paper/recyclable paper needed for production has
reduced from 2 tons to 1.17647…… tons. Since paper is a
product made from trees, it contributes towards reduction
of cutting down trees / deforestation.
(b) Changing the product mix to include more paper that Marketing division used to highlight the following features of KN-
is recyclable contributes towards better utilization of 95 produced by GSPL, but these features more or less similar to
scrap. Otherwise, such scarp discarded in landfills competitor’s product –
becomes unusable. Landfills require huge land resources, t Flat fold design for easy storage.
since waste has to be buried. Hence, better utility t Excellent filtration performance (clinically tested that filtration
of recyclable products protects the environment, efficiency is more than 95%).
places lesser pressure on landfill resources and at the
same time reduces cost of operations for the company. By t Made of high quality thick 5-layer material.
changing the product mix, PX-2 has substantially reduced t With exhalation valve.
raw material cost from `88,000 to `40,941 per ton, a t Washable (every mask manufacturer in the market claims
50% saving! this feature, but fiber significantly fell weak after wash which
(c) Use of efficient transportation facilities reduces fuel deteriorates efficiency. KN-95 has clinically proven result in its
emissions. This reduces the pressure for fuel that is derived favour that even after a wash, if dried in sunlight for 5 minutes it
from natural resources. will be resorted to using with the same efficiency as of new mask).
(d) Optimization of storage space conserves energy required t With adjustable nose clip & self-elasticated ear loops.
to operate the warehouse. Again, this reduces pressure on With passage of time, condition worsen than expected, hence government
resources like land and electricity. relies upon the import of surgical equipment, but COVID-19 related
These are areas where implementation of target costing study conditions within such countries (from where surgical equipment
made PX-2 more environmentally responsible. including masks are imported) also turns unfavourable hence they

impose a temporary ban on the export of surgical equipment including Required

mask. The government again urges domestic surgical equipment You are chief management accountant of GSPL. CEO asks you to
manufacturing companies to produce more and more such equipment. draft a report addressing her with ADVISE on–
In order to motivate these manufacturers, the Ministry of finance
came-up with schemes of easy credit, credit without guarantee, interest (i) Assessment of opportunities available for GSPL
subvention and moratorium, and exemption from statutory contribution (considering its current strategic position), while
and deferment of duties, and taxes. The government is promoting the countering the related threats.
use of a home-made mask too. (ii) Core competencies, which GSPL possess and can be
Dr. Angel Gupta who is CEO of GSPL called a meeting of division exploits as Critical Success Factors to gain competitive
heads, including ‘Face Mask Division (FMD)’ to look into opportunities advantage.
emerging out of the present PESTLE scenario, and what GSPL can do (iii) Viability of each option available with her based upon ideas
to seize them with the purpose of enlisting core-competencies require from division heads and innovation team. Consider each option
and currently possessed. FMD is equipped with the latest technology an independent scenario from others and presume defect is
and skilled staff who manufacture the KN-95 mask. identified at end of the cutting and spun bonding process.
In such a meeting division head of FMD proudly mention that (iv) The cost of poor quality in both the possible cases.
currently, they are producing one lac masks on monthly basis. He The supporting calculations shall be shown at relevant places in
mentioned it is needless to say, we can sale even if produce more report itself.
than this. He also briefs both the processes performed by FMD
which are – Solution
Cutting and spun bonding - Inner and outer fiber layers are Report
cut-down and spun bonding using nozzles blowing melted
threads of a thermoplastic polymer (polypropylene) to layer
Addressed to;
threads between 15-35 micrometres, which build up into cloth
Office of CEO,
performed.
Gupta Surgical Products Limited (GSPL).
Stitching and finishing - The outer and inner fiber layers are bonded Dated – 04th Jan 2023
with output of spun bonding process using thermal techniques and
then nose clip welded using mechanical techniques. Report to assist management decisions of strategic importance
He also furnished the below-mentioned information pertaining to regarding cost, pertaining to GSPL and FMD (in light of dynamics of
current operation aspects of these two processes – the business environment emerging due to outbreak of COVID-19)
Particulars Cutting and Stitching and (i) Opportunities and related threats
spun bonding finishing In order to assess the strategic position, one among the major
Monthly Capacity (in units) 1,15,000 1,00,000 analytical tools is SWOT analysis. Strengths and weaknesses
are internally generated, whereas opportunities and threats are
Material Cost Per Unit (in `) 40 - emerging from the business environment external to the business
Other Operating Cost (in `) 10,00,000 6,00,000 boundary. Opportunities and threats are systemic in nature, usually
uncontrollable, but can be responded. The length of opportunities
FMD follows throughput accounting, hence material cost incurred and threats depends upon an event (continuing or once-in-while)
during cutting and spun bonding operation is the only variable cost. and series of activities trailing to those events. The outbreak
of COVID-19 is also one such event which impact the GSPL
CEO wish to scale-up the level of capacity and production.
significantly because of the nature of business.
She collected a bunch of ideas from division heads and the
innovation team. She is from a medical background hence prior Enhanced market demand without the extra cost of
to furnishing a proposal to the board; She decided to check validity advertisement – GSPL is a growing company, but completion
and viability with help of expert opinion/advice on the following too. Amidst the stiff competition, GSPL can see out-break of
available options– COVID-19 as an opportunity to sell more and more products. No
doubt competitors will try hard to capture the significant share of
1. Installing a machine costing `2 lacs, which will auto-cut the fiber
enhanced market, but GSPL has the advantage of cost leadership
sheet into requisite space, it will enhance the monthly capacity of
which make their product affordable in the strategic segment in
cutting and spun bonding by 10% to the current level.
which they deal (KN-95, if we talk about mask specifically).
2. An automatic thermal bonding machine can be used which
One can say enhanced demand is not permanent and it possesses
is expected to enhance the monthly capacity of stitching and
severe threat, but see the option 2, 3, and 4 available, they all are
finishing operation by 20,000 units. Such a machine is available
such a nature where not capital cost involved. Machines are taken
as a monthly lease rental of `6 lacs.
on lease or task is outsourced (no doubt length of lease and out-
3. An outsourcing agency offer to perform the cutting and spun source agreement need to be decided carefully).
bonding at a rate of `6 per unit if the order size is less than 10,000
Another the threat which can be a highlight that the Government
units, and at a rate of `5 per unit of the order size is above 10,000
themselves is promoting the use of home-made mask too. KN-95
units. The maximum monthly order which such agency can serve
mask is approved by the regulator, ISO certified and recommended
is 20,000 units
by WHO, whereas such a home-made mask obviously not.
4. The same outsourcing agency also offers to perform stitching
Another threat, which can be considered that cheaper masks are
and finishing process but with a maximum limit of 12,000 units
also available despite that do not fall in segment (KN-95) in which
during months period. For this, they will charge a uniform rate of
GSPL deals, still apart from the counter the argument stated in the
`15 per unit.
above point; GSPL can build their market by advertising the feature
In the same meeting the Quality Head mentioned that 1,000 units of of ‘truly washable’ which make KN-95 actually reusable, and it's
KN-95 produced are found defective, which neither can be sold (even clinically proved. The reusable nature makes it further cheaper.
at subsidies rate) due to strict guidelines by the regulator nor can be
It’s important here to note the cost leadership is also limited to
reworked/ reprocessed. CEO is curious to know the loss if a defect is
relevant strategic segment not necessary to the entire market.
discovered at end of the cutting and spun bonding process/ at end of
the stitching and finishing process.

Easy availability of credit – GSPL is already considering the Automation Related

enhancement of capacity but finding it difficult due to the adverse Auto cutting of fiber sheet – The cutting and spun bonding
effect of borrowing on financial leverage. Announcement from the process is not bottleneck activity, thus has spare capacity of
the ministry of finance, regarding schemes of easy credit, 13,850 units after excluding defective products, it’s not making
credit without guarantee, interest subvention and moratorium, sense to automate the process to enhance capacity further.
exemption from statutory contribution, and deferment of Hence it not advised to install the machine.
duties and taxes for surgical equipment manufacturer are
opportunities and well in time because the problem of reducing Note – If defective units are 1,000 against the current
margin can also be addressed while enhancing the capacity production of 1,00,000 units, then against the production of
without any adverse leverage effect. It is important to consider 1,15,000 units, the defective units will be 1,150. Which means
the length and eligibility criteria of these benefits. units get through the cutting and spun bonding process are
1,13,850 (1,15,000-1,150).
(ii) Core competencies as Critical Success Factors – Core
Competency is a unique proposition which help firm to stand Automatic thermal bonding machine – Since the stitching and
ahead in the industry by serving value to its customers. Core finishing process is the bottleneck activity, and operational at full
Competency leads to either cost leadership or product capacity, hence any option to enhance capacity for which demand
differentiation, which is the primary source for a firm to gain is available in the market at price more than relevant cost to be
competitive advantage. incurred; must be accepted. Since there is net monetary benefit
of `92,500 (see table below), hence taking automatic thermal
The following are the core competencies which may help bonding machine on lease is highly advisable.
the GSPL to gain the cost leadership position (to cut down
cost where possible, because GSPL is charging `90 which Statement of Cost-Benefit
is on the lower side the rest of the competitors price which
Particulars `
ranges between `100 to 105) to attain competitive advantage
(enhanced market share). Incremental Revenue* × (13,850 @ `90) 12,46,500
t Latest technology – Division head of FMD said in the meeting Less: Incremental Cost (material cost)(13,850 @ `40) 5,54,000
itself the FMD (concerned division here) is equipped with the Less: Monthly Rental of Machine 6,00,000
latest technology in order to manufacture the KN-95 mask. Net Benefit 92,500
t Knowledge – Knowledge is a key resource. Being the initial *Presuming additional sale will take place at the same price.
players who start manufacturing of surgical equipment,
GSPL must have a wide knowledge of the industry. Being Since the capacity of the cutting and spun bonding process
the oldest manufacturer of KN-95, the mask also possesses is limited to 1,13,850 units (after considering defects), hence
certain knowledge about products which capable of putting enhancing the capacity of stitching and finishing process
them ahead of others. beyond such 1,13,850 units is not worth. So, the machine
will result in only 13,850 additional unit, if cutting and spun
t Well established marketing network and wider reach – bonding process, hold status quo.
GSPL is only privilege surgical equipment company which
has its chain of own exclusive stores, which are selling Outsourcing
products of GSPL; apart from a tie-up with the medical and Cutting and spun bonding process – The cutting and spun
chemist shops across the nation for sale of their products. bonding process is not a bottleneck activity, thus already has
t Professional management, who know the products well – spare capacity of 13,850 units, it’s not making sense to outsource
Be it promoter or current CEO, being medical professionals some of the unit to enhance to capacity further. Given become
are capable to understand the technical dimensions of the irrelevant in case. Hence it not advised to outsource.
product, which place them in a better position to make Stitching and finishing process – Since the stitching and
correct choices/decision. finishing process is the bottleneck activity, and currently
t Skilled workforce – Division head of FMD said in the operating at full capacity, hence any option to enhance capacity
meeting itself the FMD (concerned division here) is equipped for which demand is available in the market at a price more than
with skilled staff which manufactures the KN-95 mask. the relevant cost to be incurred; must be accepted. Since there
is net monetary benefit of `4,20,000 (see table below), hence
t Clinically tested that it ‘Truly Washable’ – The feature of outsourcing of 12,000 units for the stitching and finishing
being truly washable (that even after a wash, if dried in sunlight process is highly advisable. Non-monetary implication of
for 5 minutes it will be resorted to using with the same efficiency outsourcing can be considered.
as of new mask) is clinically proven in the case of GSPL only.
Statement of Cost-Benefit
Note – Availability of credit is not a core competency
because this benefit is available to all surgical equipment Particulars `
manufacturers. Similarly recommended by WHO is also not Incremental Revenue* (12,000 @ `90) 10,80,000
a core competency because, this is plus to all KN-95 mask Less: Incremental Cost (material cost) (12,000 @ `40) 4,80,000
manufacturers. (External factors are systemic in nature). Less: Cost pertaining to outsourcing (12,000 @ `15) 1,80,000
(iii) Viability of options available (based upon ideas from division heads Net Benefits 4,20,000
and innovation team) – the available options can be classified into two *Presuming additional sale will take place at the same price.
categories, options 1 and 2 are related to process re-engineering or (iv) Cost of poor quality – The cost of poor quality due to non-
automation; while options 3 and 4 are related to outsourcing. 1 and conformance to quality. This includes the cost of internal and
3 are related to cutting and spun bonding process, whereas 2 and 4 are external failures. The defect which can’t be repaired and sold
related to stitching and finishing process. at a reduced price is known as scrap and loss due to scrap
In order to access the viability of each such option the concept covered under internal failure cost.
of the bottleneck (theory of constraints) and throughput If the defect is discovered at the end of cutting and spun
contribution is relevant. Currently, the monthly production and bonding process
sale are one lac units against the monthly capacity of 1,15,000 units Against the 1,000 units of KN-95, which found defective at
(1,13,850 units after considering defective units) in the cutting end of cutting and spun bonding process, material required to
and spun bonding process and 1,00,000 units in the stitching and produce another 1,000 units of KN-95 shall be introduced to the
finishing process. Hence the stitching and finishing process is cutting and spun bonding process; because cutting and spun
bottleneck and operational at maximum possible capacity. bonding process has a spare capacity of 15,000 units beyond the

current level of production (Cutting and spun bonding process monthly basis can be processed in stitching and finishing process at
has a capacity of 1,15,000 units against the current production maximum, hence identification of defective (causing scrap, because
of 1,00,000). Hence additional 1,000 units can be processed but non-repairable and non capable of being sold at a reduced price)
this cause cost equal to material cost (the only variable cost). 1,000 units will result in only 99,000 units of KN-95 available for sale.
Hence in this way amount of loss will be `40,000/- i.e., (1,000 Hence, the amount of loss will be `90,000/- i.e. (1,000 units
units @ `40 each) @ `90 each (since cost of material (40) and throughput
If the defect is discovered at the end of stitching and finishing contribution (50) already included in this 90 hence become
process. irrelevant individually).
The 1,000 units of KN-95, which found defective at end of the Further details can be tabled on a requisition basis.
stitching and finishing process, will result in loss of revenue Closure of Report
(throughput contribution and cost of material); because the stitching
and finishing process is a bottleneck activity, which currently Chief Management Accountant,
operational at maximum capacity. Since only 1,00,000 units on Gupta Surgical Products Limited

SARANSH Last Mile Referencer for
COST MANAGEMENT
AND STRATEGIC
DECISION MAKING


ICAI Bhawan, A-29, Sector-62, Noida 201 309
Phone: 0120 - 3045930
www.icai.org | www.boslive.icai.org

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SARANSHLast Mile Referencer for

The Institute of Chartered

Board of Studies (Academic)

© 2023. The Institute of Chartered Accountants of India (Also referred to as ICAI)

Published in January 2023 by:

Message of Key ICAI Office Bearers

CA. (Dr.) Debashis Mitra

CA. Aniket S. Talati

CA. Dayaniwas Sharma

Saransh — Last Mile Referencer is a compilation of capsules on different subjects of

CA. Vishal Doshi

The Institute of Chartered

PART I: COST AND MANAGEMENT ACCOUNTING

Introduction To Cost and Management Accounting I. 2

Process And Operation Costing I. 12

Budget & Budgetary Control I. 19

Employee (Labour) Cost I. 22

Unit & Batch Costing I. 30

Job & Contract Costing I. 32

Activity Based Costing (ABC) I. 36

Joint Products & By-products I. 39

PART II: STRATEGIC COST MANAGEMENT

Subject Structure II. 3

Introduction to Strategic Cost Management II. 4

Modern Business Environment II. 6

Lean System and Innovation II. 10

Cost Management Techniques II. 13

Pricing Decision II. 15

Performance Measurement and Evaluation II. 17

Division Transfer Pricing II. 20

Budgetary Control II. 23

Case Study II. 25

Standard Costing II. 26

Decision Making II. 38

Framework for Reporting to External Stakeholders II. 44

Triple Bottom Line Reporting II. 45

Global Reporting Initiative II. 46

Integrated Reporting Framework II. 48

Case Study - Triple Bottom Line II. 52

Case Scenario – Six Sigma II. 54

Case Scenario – Performance Measurement II. 55

Skill Assessment Based Questions II. 56

Strategic Role of Management Accounting- An Overview II. 60

Case Study – Pricing Strategy II. 61

Case Scenario – Profitability Analysis II. 62

Skill Assessment Based Questions II. 64

Case Study- KAIZEN (with integration to 5S and PDCA) II. 73

Case Study- 5S II. 75

Case Study – Business Process Reengineering II. 77

Skill Assessment Based Questions II. 79

Cost and Management Accounting

Introduction to Cost and Management Accounting

Objectives of Cost Scope of Cost Role & Functions of Users of Cost

Cost Relationship of Cost and

Meaning of Terms used in Cost and Management Accounting

Cost Cost Management Cost

Objectives of Cost Accounting

Assisting management in decision making: Cost and Management accounting by providing

Scope of Cost Accounting Role and Functions of Cost and

Provide relevant Collection and

Users of Cost and Management Accounting Relationship of Cost Accounting,

Creditors and Financial Management

Essentials of a good Cost Accounting System

$POUSPMFUD Purchase Order"GUFS Purchase Requisition

4PNFPGUIFUFDIOJRVFTBSFEJTDVTTFEBTGPMMPXT Treatment of Loss of Material

Abnormal-ͳFDPTUPGBCOPSNBMTQPJMBHF JF BSJTJOH

Advantages of Marginal Costing %UHDN(YHQ$QDO\VLV

&RVW9ROXPH3URÀW&93$QDO\VLV Angle of Incidence