COST & MANAGEMENT

ACCOUNTING

Prof. Ranjan Kumar Bal

PP –
 COURSE OUTLINE
• Conceptual Knowledge
• Methods & Techniques
• Planning & Control Tools
• Managerial Decision Making
 What is Common?
 Lakshmi Niwas Mittal
 Kumar Mangalam Birla
 Indra Nooyi
 Osama Bin Laden
ACCOUNTING IS THE LANGUAGE OF BUSINESS.

• Serves as a means of communication

• Communicates / reports the events

Anthony & Reece:

“Accounting is not exactly a foreign
language; the problem of learning it is more
like that of an American learning to speak
English as it is spoken in Great Britain.”
 ACCOUNTING IS AN
INFORMATION SYSTEM.
INPUT (Raw Data)

SYSTEM PROCESSES (Men &

Equipment)
OUT PUT (Reports &
Information)
OUTPUTS OF ACCOUNTING

• Financial Statements
• Tax Returns
• Managerial Data and Reports
• Special Reports
CUSTOMERS OF ACCOUNTING

• External Customers
• Internal Customers

Customer is the king.

USERS OF ACCOUNTING INFORMATION
 Management
 Shareholders and Investors
 Lenders
 Creditors
 Employees
 Customers
 Govt. and Regulatory Agencies
 Others: General Public, Media, Consumer
Organizations, Researchers & Analysts
 WHY TO READ ?
• Personal Life
• Professional Life
• An Investment for Future
• Planning, Controlling & Decision
Making
• Business Strategy
 EVOLUTION OF ACCOUNTING

• Stewardship Accounting
• Financial Accounting
• Cost Accounting
• Management Accounting
 BALANCE SHEET
as at 31st March, 2005
LIABILITIES ASSETS
• Share Capital • Fixed Assets
• Reserve and Surplus • Investments
• Secured Loans • Current Assets And
• Unsecured Loans Loans & Advances
• Current Liabilities and • Miscellaneous
Provisions Expenditures
• Profit & Loss A/C
 BALANCE SHEET
as at 31st March, 2008
SOURCES OF FUNDS
• Shareholders’ Fund
• Loan Funds
APPLICATION OF FUNDS
• Fixed Assets
• Investments
• Current Assets, Loans & Advances
Less Current Liabilities & Provision
• Miscellaneous Expenditure
 PROFIT & LOSS A/C
for the year ending 31st March 2008.
I. Income
II. Expenditure
III. Profit before Tax
IV. Provision for Taxation
V. Profit after Tax
VI. Balance b/f from last year
VII. Profit available for appropriation
Appropriations
VIII. Balance transferred to Balance Sheet
 CASH FLOW STATEMENT
for the year ending 31st March,2008

• Cash flow from operating activities

• Cash flow from investing activities
• Cash flow from financing activities
• Net cash increase(decrease) in cash & CE
• Cash & CE at beginning of the period
• Cash & CE at the end of the period.
 F.A. - LIMITATIONS
• Focuses on reporting to external parties
• Based on GAAPs
• No emphasis on future; Postmortem Analysis
• No emphasis on influencing the behaviour of
the managers and employees
• Failed to meet the information needs of the
managers for planning, controlling, decision
making – No Detailed Information
 COST & MANAGEMENT ACCOUNTING
(COMA)
Provides information to managers for
planning, controlling & decision making.

The controller : The Chief Management Accountant

“The Controller is compared to a ship’s

navigator, with the President (CEO)
being the ship’s captain.”
 ROLE OF THE ACCOUNTANT
• TO MANAGE INFORMATION
• An Information Technologist

 SCORE – KEEPING
 ATTENTION DIRECTING
 PROBLEM SOLVING
 CUSTOMER – DRIVEN FOCUS IN
MANAGEMENT ACCOUNTING SYSTEM

VISION STATEMENT OF MANAGEMENT ACCOUNTING

GROUP AT JOHNSON & JOHNSON
 Delight our customers.
 Develop alternative measurement system.
 Keep it simple.
 Utilize 20% of time on Accounting & 80% on
analysis.
 Be the best.
 ABILITIES & SKILLS for
Management Accountants – A Survey
• Communication (oral, written &
presentation) skills
• Ability to work on a team
• Analytical / problem-solving skills
• Solid understanding of accounting
• Understanding of how a business functions.
• Computer skills
 THE MANAGEMENT ACCOUNTANT AND
STRATEGIC DECISIONS
The management accountant helps to formulate
strategy by answering questions such as :
• Who are our most important customers ?
• How sensitive are their purchases to prices, quality,
and service ?
• Who are our most important suppliers ?
• What substitute products exist in the market place,
and how do they differ from our product?
• Is the industry demand growing or shrinking ?
• Is there overcapacity ?
 IMPORTANCE OF COMA
 Helps in achieving the main objective of the
organization
Identifies unprofitable activities.
 Improves efficiency/Facilitates cost control.
 Helps in planning & preparation of budgets.
 Helps in inventory control.
 Facilitates decision making.
COMA Vs. FINANCIAL ACCOUNTING
Similarities
• Both are branches of Accounting.
• Are concerned with systematic recording and
presentation of financial data.
• Both follow same principles of Dr. and Cr.
• Both have the same source of recording
transactions.
• Both have the common goal of assisting the
organization they serve.
• Both are complementary to each other.
COMA Vs. FINANCIAL ACCOUNTING :
Differences
• Purpose
• Periodicity of reporting
• Customers served
• Audit
• Accounts prepared
• Tax assessment
• Actual and standard
• Profit and Loss
• Monetary and Non-monetary
• Relative efficiency
• Constrained by GAAP
 COST AND MANAGEMENT
INFORMATION SYSTEM
 COST ACCOUNTING INFORMATION SYSTEM
 OPERATIONAL CONTROL SYSTEM

OBJECTIVES OF CMIS:
• To provide information for costing out services,
products and other objects of interest to management.
• To provide information for decision making.
• To provide information for planning and control.
 COST MANAGEMENT
• Identifies, collects, measures,
classifies, & reports information
• Useful to managers in costing,
planning, controlling, & decision
making.
Cost Accounting : Evolving into Cost Mgt.
• It is associated with Mgt. Accounting
THE VALUE CHAIN OF THE BUSINESS FUNCTION
•
R&D
• Design
• Production
• Marketing
• Distribution
• Customer service

Accounting helps managers:

• To administer each of the business functions.
• To coordinate the functions of value chain.
ENHANCING THE VALUE OF COMA SYSTEM

• Customer Focus
• Value Chain & Supply Chain Analysis
• Key Success Factors –Cost & efficiency,
Quality, Time, Innovation, etc.
(Distinct or Extinct)
• Continuous Improvement (Kaizen) &
Benchmarking
“We are running harder
just to stand still.”

“If you’re not going forward,

you are going backward.”
 QUESTIONS
• “Management Accounting should not fit the
straightjacket of Financial Accounting.”
Explain.

• A leading management observer stated,

“The most successful companies are those that
have an obsession for their customers.”
Is this statement pertinent to management
accountants? Explain.
 CHANGE
Change is the only constant
in today’s world.
 MANAGEMENT AND COMA
– Provides adequate, timely and reliable information.
– Helps management in managing and controlling costs.
– Provides cost-benefit approach for resource allocation.
– Helps in decision making: Pricing
Product-mix
Profit-volume decisions
– Helps: Formulation & execution of budgets & standards.
– Helps in making special studies and investigations.
“ Without proper cost and management accounting,
decision would be like taking a jump in the dark.”
 COST TERMINOLOGY
• Cost : Resources sacrificed or
Amount of expenditure incurred
• Costing : Process of cost accumulation &
cost assignment
• Cost Object : Anything for which a measurement of
cost is desired.
• Cost Accumulation : Collection of cost data in some
organized way.
• Cost Assignment : Cost Tracing & Cost Allocation.
• Cost Tracing : Assigning direct cost.
• Cost Allocation : Assigning indirect costs.
• Cost Driver : A variable that causally affects /
influences costs over a given time span
 COST CLASSIFICATION

WHY ?
• To Achieve a Purpose / Objective
Control, Decision Making
• To Facilitate Communication /
Reporting
 COST CLASSIFICATION
 Behaviour
 Elements
 Control
 Decision Making
 Functions
 Nature
 ELEMENTS OF COST
• MATERIAL : Direct Vs. Indirect
• LABOUR : Direct Vs. Indirect
• EXPENSES : Direct Vs. Indirect

Direct cost of a cost object : Traced in an

economically feasible (cost effective) way.
 OVERHEADS
• Manufacturing or Factory
• Office & Administration
• Selling & Distribution
 OTHER CONCEPTS OF COST
• Fixed, Variable & Semi-variable
• Controllable & Uncontrollable
• Relevant & Irrelevant
• Incremental & Decremental
• Shutdown & Sunk cost
• Traceable & Untraceable
• Joint cost & Conversion cost
RELATIONSHIP OF COSTS
• Direct & Variable
• Direct & Fixed
• Indirect & Variable
• Indirect & Fixed
METHODS & TECHNIQUES
METHODS
- Job Costing
- Process Costing

TECHNIQUES
- Marginal Vs. Absorption Costing
- Standard Vs. Historical Costing
 COST ACCOUNTING
OBJECTIVES :
• To determine product costs
• To facilitate planning & control
• To supply information for decision
making
 “IN GOD WE TRUST,
EVERYBODY ELSE BRINGS DATA
TO THE TABLE.”

INFOSIS
 COST ESTIMATION
• Statement of Cost : For each cost object
or cost centre.
• Different Columns : Total cost / Cost per
unit / Previous period costs / Budgeted
costs / Variable & Fixed costs ……..
• Sources of Data : F.A. & C.A.
• Time Period : A month or week
 WHY A COST SHEET ?
• Fixing selling price
• Submitting quotations
• Planning & control of cost
• To know relative efficiency of products
• Decision making
 STATEMENT OF COST
COST SHEET
• Prime Costs or Direct Costs
DM + DL + DE = PC
• Production or Works or Factory Costs
PC + P. OH. = FC
• Office Costs or Cost of Production*
FC + O. OH. = COP
• Total Cost or Cost of Sales
COP + S. OH. = TC
*Assumption : Office & Admn. Overheads relate to production.
TREATMENT OF STOCK
 Raw Material
 WIP
 Finished Goods

Treatment of the amount realized from the

sale of scraps / wastes ?
ITEMS NOT AFFECTING COST SHEET
• Income Tax
• Dividends to Share Holders
• Interest on Loans
• Capital Loss
• Donations
• Capital Expenditure
• Discount on Shares & Debentures
• Underwriting Commission
• Writing off Goodwill
• Commission to MD
 ESTIMATED COST SHEET
• Considers all probable changes in cost
• Preparation :
- Prepare a “Cost Sheet”
- Establish relationship
- Estimate OH costs
- Prepare “Estimated Cost Sheet”
 CASE
The following information are obtained from the
records of AB cycles for the month of August:
Direct materials : Rs. 19, 80, 000
Direct labour : 18, 00, 000
Factory overheads : 5, 80, 000
Administrative overheads : 3, 90, 000
Outputs for the month : 2,000 cycles.
What price the company should quote for an order
of 100 cycles?
Note: Factory overheads are absorbed on the
basis of direct labour and administrative
overheads on the basis of works cost.
 THE FOLLOWING DATA RELATE TO A COMPANY:
Expected sales : 50,000 units
Direct material cost : Rs. 2.50 per unit
Direct labour cost : Rs. 2.00 per unit
Variable Overhead : Rs.1.50 per unit
Fixed cost : Rs. 1.50 per unit
Selling price : Rs.10 per unit

The firm expects to get a special export order for 10,000

units at a price of Rs. 7.25 per unit.
Advise whether the export order should be accepted or not.
The company has a capacity to produce 60,000 units.
 INFERENCES:
• An organization has different costs having
different nature.
Example: Fixed, Variable, Mixed Cost
• These costs behave differently to changes in
the level of business activity.
• Understanding this relationship helps in
planning, control and developing successful
business strategies.
 Cost of a product / process can be ascertained by :
1. Absorption costing
2. Marginal costing

ABSORPTION COSTING
Traditional or full cost method :
Cost of a product = V. C. + F. C.
 Variable costs are directly charged to the product.
 Fixed costs are apportioned on suitable basis.

DISADVANTAGES:
 It assumes that prices are simply a function of costs.
 It includes past costs which may not be relevant to the
pricing decision at hand.
 MARGINAL COSTING

- Direct Costing / Variable Costing

- A Technique of Costing
Meaning :
Ascertainment of marginal cost by differentiating
between F.C. and V.C. and of the effect on profit of
changes in volume or type of output.

Cost of a product : Only VCs are considered

: Product cost
FCs : Charged against the revenue of the period.
FC = Period costs
Valuation of inventory at M.C.

Contribution = C = S - V = F + P
Price = M.C. + Contribution
 MARGINAL COST

Economists : The cost of producing

one additional unit of output is the
marginal cost of production.
Include an element of FC

Accountants : MC is equal to the

increase in total VC.
 SEGREGATION OF SEMI-VARIABLE COSTS

 Levels of output compared to levels of expenditure Method :

The variable element in semi- vc = Change in amt. of exp.
Change in activity/qnty.

 High-low method (Range Method) : Similar to the previous

method

 Methods of least squares

Y = a + bx, where
Y = Semi-VC, a = FC, b = VC, x = Production in units
 ABSORPTION COSTING Vs. MARGINAL COSTING
1. Recovery of F.OH.
• Abs. Costing : Both F. OH. and V. OH. are charged
to production
• Mar. Costing : Only V. OH. is charged to production
and F.OH. transferred to P. & L. A/C.
2. Valuation of Closing Stock
• Abs. Costing : WIP at works cost and F. goods at
cost of production.
• Mar. Costing : WIP and F. Goods -- Only VCs are
considered.
3. Profit Vs. Opening and Closing Stock
 UTILITY OF MARGINAL COSTING
• Helps in determining the volume of
production.
• Helps in selecting production lines.
• Helps in deciding whether to shutdown or
continue.
 MARGINAL COSTING Vs. ABSORPTION COSTING

The following information relates to ABC Company for the

year 2004-05:
Sales 10,000 units at Rs. 5 each;
Production 15,000 units at the following costs:
Rs.
Direct materials 15,000
Direct labour 30,000
Variable expenses 6,000
Fixed expenses 12,000
Determine net profit.
Income Statement for the year 2004-05

Sales 50,000 50,000

Marginal Absorption
costing Rs. Costing Rs.

Cost of Production:
Direct materials 15,000 15,000
Direct labour 30,000 30,000
Variable overhead 6,000 6,000
Fixed overhead _ 12,000

51,000 63,000
Less Closing Stock 17,000 21,000
Cost of goods sold 34,000
42,000
Contribution
(50,000- 34,000) 16,000
4,000

Net profit 8,000

Valuation of closing stock:

Less Fixed Overhead 12,000
Marginal costing = (5000/15,000) x 51,000
= Rs. 17,000
Absorption costing = (5000/15,000) x 63,000
= Rs. 21,000
Note: Difference in profit is due to the difference in
stock valuation.
CASE
From the following cost, production and sales data of AB Motors Ltd., prepare
comparative income statement for three years under
(i) Absorption costing method, and (ii) Marginal costing method.
Indicate the unit cost for each year under each method. Also evaluate closing
stocks. The company produces a single article for sale.

PARTICULARS YEARS
2003 2004 2005
Rs Rs. Rs.
Selling price per unit 20 20 20
Variable Mfg. Cost per unit 10 10 10
Total fixed manufacturing cost 5000 5000 5000
Opening stock - 500
Units produced 1000 1500 2000
Units sold 1000 1000 1500
Closing stock - 500 1000
 BREAK-EVEN ANALYSIS
Narrow Sense :
Determination of that level of activity where
total cost equals selling price.

Broad Sense :
The system of analysis which determines the
probable profit at any level of activity.
Refers to Cost-Volume-Profit Analysis

BEP - Represents a minimum acceptable

level of operation
- Level of activity : Income equals Expenditure
- No profit no loss point
 C=S-V=F+P

At BEP, P = 0; Thus, C = F

Or, Units at BEP x Contribution per unit = F

Or, BEP(units) = F / Contribution per unit

BEP (sales) = (F / Cont. per unit) x S.P. per unit

= (F/C) x S = F/c/s
= F / p/v ratio
Contribution Margin Ratio =
P/V ratio =
Contribution / Sales = C / S
= Change in Profit / Change in
Sales

MOS = Total Sales – BEP

 BREAKEVEN ANALYSIS FOR
MULTIPLE PRODUCTS
A multi products Company has a sales ratio of 2: 3: 5
for models X, Y and Z respectively.
Total fixed cost for the year are Rs. 2,00,000.
The other information are as follows:

Model X Model Y Model Z

Sales Price Rs. 50 Rs. 25 Rs. 10
Variable Costs Rs. 30 Rs. 15 Rs. 8
Contribution Margin Rs. 20 Rs. 10 Rs. 2

WHAT IS IT’S BEP ?

 BREAKEVEN ANALYSIS FOR MULTIPLE PRODUCTS
A market basket approach is used to compute the
breakeven point in units.
The average market basket is based on the sales ratio and
consists of 10 units with a total contribution of
Rs. 80 = { (2 x Rs. 20) + (3 x Rs.10) + (5 x Rs.2) }
BEP in market baskets = FC / Contribution of one baskets
= Rs.200,000 / Rs.80 = 2,500 baskets.

To fill 2,500 baskets : The following units for each model.

• Model X : 5000 units ( 2,500 x 2)
• Model Y : 7500 units (2,500 x 3)
• Model Z : 12500 units (2,500 x 5)
 COST –VOLUME – PROFIT ANALYSIS
• Examines the behaviour of total revenues, total
costs and operating income :
As changes occur in the
output level, the selling price, the variable cost per
unit, and / or the fixed costs of a product.
– One of the decision models
– One aspect of CVP Analysis : BEP Analysis
– A useful technique for planning profits
(budgeting), pricing decisions, sales-mix
decisions and production capacity decisions.
CVP Analysis evaluates the effects of:
 Price changes on Net Profit (NP)
 Volume changes on NP
 Price and volume changes on NP
 Changes in VC on NP
 Changes in FC on NP
 All four factors, viz., price, volume,
VC and FC on NP.
Sensitivity Analysis & Uncertainty
• A “what-if” technique
• Analyze the sensitivity of their decisions to
changes in underlying assumptions.
• Managers use this technique to examine -
How a result will change : If the original
predicted data are not achieved or
if an underlying assumption changes.
 C-V-P ANALYSIS
INCOME TAX
I.T. : No effect on BEP
S – VC – FC = Op. Income
=Target Net Income / (1-T)
Desired Sales in Units = ?
Desired Sales in Rupees = ?
 DO-ALL SOFTWARE
• SP = Rs.2,000 per unit
• VC = Rs.1,200 per unit
• FC = Rs.20,000
The organisation anticipates selling 40 units.

1. Decision to Advertise
Proposed Advertisement = Rs.5,000
Effect : Increase in Sales by 10%
DECISION ?
2. Decision to reduce S.P.

Proposal : Reduce SP to Rs.1,750

Effect : Increase in Sales by 10 units
Purchase from Whole-seller
at Rs.1,150 per unit.
DECISION ?
RELEVANT COSTS & REVENUES
• Expected future costs
• Expected future revenues
• Differ among the alternative courses of action

 Insourcing or Outsourcing products or services.

 Accepting or Rejecting special order.
 Shutdown or Continue.
Qualitative & Quantitative Relevant Information
 COST ALLOCATION / APPORTIONMENT
An inescapable problem in every organization.
• How should the costs of service
departments be allocated among production
departments ?
• How should the manufacturing overhead be
allocated to individual products in a multi-
product company ?
The answers are seldom clearly right
or clearly wrong.
 PURPOSES OF COST ALLOCATION
 To provide information for economic decision :
Pricing decisions; Make or buy decisions.
 To motivate managers and employees :
To push high margin products or services
 To justify costs or compute reimbursement :
Reimbursement for a consulting firm that is paid a
percentage of the cost savings
 To measure incomes and assets for external
reporting : - valuation of inventory
SURVEY OF COMPANY PRACTICE
Why allocate corporate and other support costs
U. S. A. to divisions and departments ?
• To remind profit-center managers that indirect costs exist and
that profit-center earnings must be adequate to cover those costs
• To encourage use of central services.
• To stimulate profit-center managers to control service costs
U. K.
• To acknowledge that divisions would incur such costs if they
were not provided centrally.
• To make division managers aware that central costs exist.
• To stimulate divisional managers to put pressure on central
support managers to control costs.
• To stimulate divisional managers to economize in usage of
central services.
CRITERIA FOR COST ALLOCATION DECISION
• CAUSE AND EFFECT:
Rent- Floor area occupied
• BENEFITS RECEIVED:
• FAIRNESS OR EQUITY:
Government contracting
• ABILITY TO BEAR:
Corporate executives salaries on the
basis of divisional operating income.
COST POOL POSSIBLE ALLOCATION BASE
• Corporate executive Sales; Assets employed;
salaries : Operating income
• Legal Department : Estimated time or usage;
Sales; Assets
• Marketing Department : Sales; No. of sales
personnel
• Payroll Department : No. of employees;
Payroll Rupees
• Personnel Department : No. of employees;
Payroll Rupees
ACCOUNTING AND CONTROL OF OH COSTS

 Classification
 Codification
 Collection
 Allocation and apportionment
to cost centers
 Absorption in costs of products,
services etc.
 WHY TO CLASSIFY?
• Effective cost control : Flexible Budgets

Absorption of cost

• Decision Making : CVP Analysis

 CODIFICATION

• Numeral method : Numbers

• Mnemonic Method :
Symbols / Letters
• Mixed
 COLLECTION OF MANUFACTURING OHs
• Material Issue Analysis Sheet / Material
Abstract
• Wages Analysis Sheet
• Cash Book
• Subsidiary Records
Plant Register : Depreciation
Asset Register : Depreciation
Journal : Outstanding expenses
•
 DISTRIBUTION OF OVERHEAD COSTS
• Primary Distribution:
Departmentalization of overhead to
Production and service departments.
• Secondary Distribution:
Re-distribution of service departments costs among
production departments.
Re-apportionment
• Final Distribution: Absorption
Overhead costs of production departments are
distributed among the units produced.
“CHALLENGE YOUR CURRENT
PRACTICES AND ENHANCE
YOUR HORIZON”
IIMB
 ACTIVITY BASED COSTING
REFINING A COSTING SYSTEM :
WHY?
• Intense competition
• Advances in IT
 ABC system
Calculates the costs of individual
activities:
 Assign costs to cost objects
such as products and services
 On the basis of the activities
needed to produce each product
or service.
 A SIMPLE COSTING SYSTEM:
• A single indirect cost rate to
allocate cost to products
• Weak cause-and-effect relationship
• Cost Smoothing : Under-costing &
Over-costing
• Product cost cross-subsidization
 ABC : BENEFITS
• Obtaining true product cost
• Cost Management
• Better decision making
 PROCESS : ABC
• Direct cost tracing
• Indirect-cost pools
• Cost-allocation bases
IMPLEMENTING ABC: Steps
• Identify the Products : Cost Objects
• Identify Direct Cost of the products
• Select the Cost Allocation Bases : For allocating
indirect costs to the products
• Identify the Indirect Costs : Associated with each
cost-allocation base.
• Compute the Rate per unit of each cost- allocation
base : Used to allocate indirect costs to the products
• Compute the Total Indirect Costs allocated to the
products
• Compute the Total Costs of the products : Adding
all direct and indirect costs assigned to the product
 PLASTIM CORPORATION
• Manufactures lenses for the rear lamps
(tail lights) of automobiles
• Contract with G Motors : To supply
– CL5, a complex lens ($137 per lens)
– S3, a simple lens ($63 per lens)
• Operating at full capacity & incurs very low
marketing costs.
• Minimal customer-service costs.
• Business Environment : Very competitive with
respect to S3.
 Process : Plastim Corporation
• Design products and processes
• Manufacturing operations
• Shipping and distribution

G. Motor’s purchasing manager :

A new competitor offering to supply the S3 lens
at a price of $53.
Plastim’s management is worried.
 Options for Plastim:
 Lower its selling price.
 Give up G. Motor’s business.
 Reduce cost.
 Existing Costing System
60,000 15,000
S3 CL5

Total($) Per Unit($) Total($)

Per
Unit($)
Direct Material 1125,000 18.75 675,000 45.00
Direct labour 600,000 10.00 195,000 13.00
Total Direct
Cost 1725,000 28.75 870,000 58.00
Indirect cost
Allocated 1800,000 30.00 585,000 39.00
Total Cost 3525,000 58.75 1455,000 97.00
Actual indirect Actual total cost in indirect cost pool
cost rate =
Actual total quantity of cost allocation base
= 2385,000 / 39750(Labour Hours)
= $60 per Labour hour
S3 : Uses 30,000 labour hours = $1800,000
CL5 : Uses 9,750 labour hours = $585,000
 Possible Reasons :
• Plastims technology and process
are inefficient in manufacturing
and distributing S3 lens.
• Ineffective cost management.
• Is costing system over-costing the
S3 lens ?
SEVEN ACTIVITIES OF PLASTIM
 Design products and processes : $ 450,000
 Set up of molding machines : $ 300,000
 Manufacturing operations : $ 637,500
 Cleaning and Maintenance : $ 270,000
 Shipment set up : $ 81,000
 Distribution : $ 391,500
 Administration : $ 255,000
 Guidelines for refining the costing system :
• Direct Cost Tracing
To identify some costs or cost pools that can be reclassified
as direct costs instead of indirect costs (improves cost
accuracy) Example: Cleaning and maintenance activity

• Indirect Cost Pools

To create smaller cost pools linked to the different activities:
Plastim : Subdivides- One direct activity cost pool & Six
indirect activity cost pool

• Cost Allocation Bases

A measure of activity performed serves as the cost
allocation base for each activity-cost pool
 Activity – Cost Rates for Indirect–Cost pools
Activity Total Cost-allocation OH allocation
Cost Base Rate
Design $ 450,000 100 parts- $ 500 per part-
square feet square foot
Setups of $ 300,000 2000 $ 150 per setup-
Molding Setup-hours hour
Machines
Manufacturing $ 637,500 12,750
operations Molding $ 50 per molding
machine hours machine-hour
Shipment $ 81,000 200 $ 405 per
shipment
Setup

Distribution $ 391,500 67,500 $ 5.80 per cubic

Cubic feet foot shipped
Administration $ 255,000 39,750 $ 6.4151 per
Direct manuf.
Direct manuf.
Labour hours labour –hour
 Product Cost using ABC
S3(60000)
CL5(15,000)
Total($) Per unit($) Total($) Per unit
Direct Costs :
Direct Materials1125,000 18.75 675,000 45.00
Direct Labour 600,000 10.00 195,000 13.00
Direct Mold Cleaning120,000 2.00 150,000 10.00
Total Direct Costs1,845,000 30.75 1,020,000 68.00
Indirect Costs :
Design activity costs:
S3, 30 parts-sq.ft.*$4,500 135,000 2.25
CL5, 70 parts-sq.ft.*$4,500 315,000 21.0
Setup activity costs:
S3, 500 setup-hours*$150 75,000 1.25
CL5, 1,500 setuphours*$150 225,000 15.00
Manufacturing operations
Activity costs:
S3,9,000 moulding
Machine hours*$50 450,000 7.50
CL5,3,750 moulding
Machine hours* $50 187,500 12.50
Shipping setup activity:
S3, 100 shipments*$405 40,500 0.67
CL5, 100 shipments*$405 40,500 2.70
Distribution activity:
S3,45,000 cubic feet
Shipped*$5.80 261,000 4.35
CL5, 22,500 cubic
feet shipped*$5.80 130,500 8.70
Administration activity:
S3,30,000 dir. Manuf.
Labour-hours*$6.4151 192,453 3.21
CL5,9,750 Dir. Manu.
Labor-hours*$6.4151 62,547 4.17
Total indirect costs: 1,153,953 19.23 961,04 64.07

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

 WHO SAID THESE WORDS ?
• A manager’s job is to pursue the
interests of society.
• Customer is the only valid reason for
the existence of a business.
• Entrepreneurship and innovation are
not inborn characteristics.
• Management is neither an art nor a
science, but a practice.
 PETER F. DRUCKER
• Father of Modern Management.
• The most enduring Management Thinker of our
Time : Business Week
• Born in Austria:1909; Died in Los Angeles:2005
• Studied Law in Germany at Hamburg University
• Received Ph.D. from Frankfurt University in
International Law.
• Moved to London & Taught Economics.
• Married Doris & Moved to America as a
Correspondent for several British Newspapers.
• Professor of Management at New York University.
 “Without proper cost and
management accounting,
decision would be like
taking a jump in the dark.”
 COST ACCOUNTING SYSTEM
• Determines per unit cost.
• Helps management in planning and
controlling costs.
• Provides information for decision making
• Used to develop timely information about:
- Cost of producing specific products.
- Cost of performing specific functions / services.
 CAS
 Most widely used in manufacturing companies
 Also used in services sector:
– Banks
– Accounting firms
– IT sector
– Govt. agencies

US congress has passed legislation requiring

hospitals to measure and report the average
unit cost of their “product”.
 Why to find unit cost?
• Basis for inventory valuation.
• Measurement of cost of goods sold.
• Useful in fixing selling prices.
• Deciding : Products to manufacture.
• Evaluating the efficiency of operations
• Controlling costs.
 DESIGNING COSTING SYSTEM
• Cost-benefit Approach
• Tailored to fit the operations/functions
• Facilitate decision making

Costing System : Only one source of

information for Managers – combine non-
cost information & non-financial
performance measures
 BUILDING-BLOCK CONCEPTS
• Cost Object
• Direct Costs of a Cost Object
• Indirect Costs of a Cost Object
 Cost Tracing
 Cost Allocation
Cost Pool & Cost Allocation Base
 CAS
• DELL COMPUTER
• WIPRO

Will they have same CAS ?

 Two basic types of CA system:
Two extremes of product costing :
• JOB ORDER COST SYSTEM
• PROCESS COST SYSTEM
 JOB ORDER COST SYSTEM
Used by companies:
• Producing “one-of-a-kind”
products
• Tailor products to the specifications
of individual customers
 APPLICATIONS
 Ship / Aircraft Building, Printing,
 Defense Contractors, Hospitals,
 Motion Picture Studios, Furniture Makers,
 Accounting Firms, Advertising Industries,
 Consultancy Firms, Construction Firms.
 JOB
• Represents the goods manufactured at
one time to fill a particular order
• Unique Feature : Cost are accumulated
separately for each job.

JOB COST SHEET : JOB-COST RECORD

Heart of JOCS
 JOB COSTING
• A method of ascertaining cost.
• Also known as “Specific Order Costing” .
• Production : Always against customers orders
and not for stock.
• Each Job : Different characteristics and needs special
treatment.
• Each job undertaken : A cost unit or cost object.
• A separate job cost sheet : To ascertain
profit or loss for each job .
• No uniformity in the flow of production from one
department to another in respect of jobs.
 GENERAL APPROACH TO J.C.
• Identify the Job : Cost Object
• Identify the Direct Costs of the Job
• Select Cost-Allocation Bases
• Identify the Indirect Costs
• Compute the Rate per Unit of Base
• Compute the Indirect Costs allocated
• Compute Total Cost of the Job
 ACTUAL COSTING Vs. NORMAL COSTING
Direct Cost : Actual Rates Actual Rates
Indirect Cost : Actual Rates Budgeted Rates

Both Methods Use :

 Actual Quantities of Inputs for
Tracing Direct costs
 Actual Quantities of Allocation Bases
for Allocating Indirect Costs
Some organizations use budgeted rates to assign
both direct costs & indirect costs, to jobs.
 JOB COST SHEET
Job Number ---------- Product --------------
Date Started ------------- Date Completed --------------
Number of units ------------
DIRECT MATERIAL
Date Requisition Number Quantity Unit Price Cost

DIRECT LABOUR
Date Time Card Number Hours Rate Cost

MANUFACTURING OVERHEAD
Date Activity Base Application Rate Cost
 COST SUMMARY
Cost Item Total Cost Unit Cost
Total Direct Material used
Total Direct Labour
Manufacturing Overhead applied
Cost of Finished Goods manufactured

“Job costing is a compromise between

actual costing and standard costing.”
 ACCOUNTING
ACCOUNTING FOR DIRECT MATERIALS
: Job Costing
End of each week or month : Summary entry
WIP Inventory Rs. 50,000
Materials Inventory Rs. 50,000
ACCOUNTING FOR DIRECT LABOUR
End of each month or week
WIP Inventory Rs.20,000
Direct labour Rs. 20,000
ACCOUNTING FOR ‘OH’ COSTS
End of each week or month:
WIP Inventory Rs. 10,000
Manufacturing overhead Rs. 10,000
ACCOUNTING FOR COMPLETED JOB
Finished goods Inventory Rs. 80,000
WIP Inventory Rs. 80,000
ABC Furniture (S. Drs.) Rs. 100,000
Sales Rs 1,00,000
Cost of goods sold Rs 80,000
Finished goods Inventory Rs. 80,000
 CONTRACT COSTING
 One type of specific order costing
 Used in civil engineering works
 Each contract : Separate accounts for each
contract

AS – 7 : Construction Contracts
Fixed Price Contracts
Cost Plus Contracts
 COSTS
– Materials
– Labour
– Direct Expenses
– Indirect Expenses
– Plant and machinery :
Depreciation
 WIP : Presented in the Balance Sheet
Balance Sheet as at…..
Assets Amount
Work in progress :
• Value of work certified
• Cost of work uncertified
Less Reserve for unrealized profit
Less Amount Received from contractee
Profit on Incomplete Contracts:
• Work Completed : Less than 1/4th : No profit

• Work Certified : More than 1/4th but less than half :

Profit = 1/3 x Notional Profit x (Cash Received / Work
Certified)

• Work Certified : Half or more than half :

Profit = 2/3 x Notional Profit x (Cash Received / Work
Certified)

• Contract is almost complete :

Profit = Estimated Profit x (Work Certified / Contract Price)
or, Estimated Profit x (Cash Received / Contract Price)
 PHARMACEUTICAL INDUSTRY
• Multi-Products
• Production in batches
• Identical products in a batch

Use Process Costing

 PROCESS COSTING
• A method of costing
• Costing of process : Converting raw
materials into finished products.
• Find Out : Cost of operating each
process.
 APPLICATIONS
• Manufacturing Industries : Iron and
Steel, Cement, Textiles, Soap
Making, Biscuits, Food Products
• Mining Industries : Oil, Coal
• Chemical Industries : Drugs & Medicines
• Public Utility Services : Electricity, Water
Supply
CHARACTERISTICS : Process Costing
• Production : Continuous
• Products : Processed in one or more processes.
• Products: Homogeneous, Identical and Standardized.
• The Finished Product of one process : Raw Material of
the next process.
• Costs : Collected process-wise.
• Unavoidable wastage : Generally arises at different
stages.
• Different products with or without by-products :
Simultaneously produced.
 JOB COSTING VS. PROCESS COSTING
 Job costing: Production is by specific orders.
Process costing: Products are homogeneous.
 Costs are determined by jobs or batches.
Costs are complied on time basis.
 Each job is separate and independent.
Products lose their identity : continuous flow.
 There may or may not be any WIP.
There is WIP as production is continuous.
 There is normally no transfers from one job to another.
Products move from one process to another.
 Control is difficult. More managerial attention is required.
Proper control is comparatively easier.
 Unit cost of a job is calculated.
Unit cost of a process is calculated.
 AUSTRALIA : COSTING SYSTEM
Textiles Chemicals Refining Printing
% % % %
Process 91 75 100 20

Job 18 25 25 73

Other 12 13
Normal Loss
• Inherent in the processing operation; Unavoidable.
• Cost of Normal Loss : Absorbed by good units
produced.
Abnormal Loss
Caused by unexpected or abnormal conditions viz.,
carelessness, accident, bad plant design
• Value of Abnormal Loss
=( Normal cost of Normal output / Normal output) x
Units of Abnormal Loss
Abnormal Gain
Actual Loss < Expected
• Calculation : Similar to Abnormal Loss.
Joint Products or Co-products
• Represent two or more products,
• Separated in the course of the same processing
operation,
• Usually requiring further processing.
Example : Oil Industry: Gasoline, Fuel Oil,
Lubricants, Kerosene.
By- product
• Recovered from materials discarded in a main process
or from the production of some major products.
 WHY ALLOCATE JOINT COSTS?
• Computation of cost of goods sold,
• Cost reimbursement under contracts,
• Insurance-settlement computations.
 APPROACHES FOR
ALLOCATING JOINT COSTS

• Using market based data : Revenue

• Using physical measures : Weight
 INTER PROCESS PROFIT
Out put of one process is transferred to a
subsequent process at a price.
WHY ?
• To show cost of production in relation to
the market price.
• To make each process stand on its own
efficiency and economies.
• To induce competition amongst different
processes : Leads to cost control.
 BALANCE SHEET: ADJUSTMENTS

• Adjust : The closing balance of inventories

as it includes unearned profit.

• Create : A provision to reduce the stock to

actual cost price.
 EQUIVALENT FULL UNITS OR
EQUIVALENT PRODUCTION
• EP : Production of a process in terms of
completed units
• WIP : Creates problem to find out cost per unit.
• To overcome this problem : Express the
partially completed units in equivalent
full units of completed product.
• Material Cost per unit = Total cost of direct
materials used / Equivalent full units produced
Work done by a Manufacturing Department :

• Completing opening WIP units.

• Working on units started and
completed.
• Working on closing WIP units.
STATEMENT OF EQUIVALENT PRODUCTION
Units Portion Equivalent
completed full
in July units
Opening WIP :
(60% completed in June) 5,000 40% 2,000
Unit s started &
Completed : 37,000 100% 37,000
Total units completed : 42,000

Closing WIP :
(25% completed) 4,000 ` 25% 1,000

Total Equivalent Units : 40,000

 STATEMENT OF EQUIVALENT PRODUCTION
• Estimate : The percentage of completion of opening WIP
• State : Opening WIP in equivalent completed units
( Apply the % work required to complete)
• Units completed during the period :
Units representing opening WIP
Units introduced and completed
• Closing WIP : State in equivalent completed units
(apply the % work done)
• Normal Loss : Not taken for calculation of EP
• Abnormal Loss & Abnormal Gain : Treated like “units
finished and transferred to next process”.
 HMT
Five Divisions :
 Machine Tools;
 Tractors;
 Industrial Machinery;
 Engineering and Components;
 Consumer Products .
 SEGMENT PERFORMANCE ANALYSIS
AS- 17 : SEGMENT
 Business Segment
 Geographical Segment

Segment :
A distinguishable component of an organization:
• Engaged in providing products and services
• Subject to risks and returns that different from
other segments.
 SEGMENT / DIVISION
• A sub-unit
• Headed by a man fully responsible
for its operation.
• A Responsibility Center
• A Decision Unit
 WHY DIVISIONALIZATION?
• Decentralization
• Measurement & evaluation of
performance
• Training ground for top mgt. personnel
• Planning and allocation of resources.
• Controlling operations
RESPONSIBILITY ACCOUNTING
A Control Device
“R. A. collects and reports
planned and actual
accounting information about
the input and output of
responsibility centers.”
 Process of R.A.
• Identify : Responsibility Centers (Decision Units)
• Define : Extent of Responsibility for each R.C.
• Specify : Controllable and Uncontrollable
Activities at Various Levels of Responsibility.
• Accounting system: To Accumulate Information
of R. C.
• Prepare : Performance Reports.
 Why responsibility Centers?
 Defines the corporate objectives and goals of R.C.
 Determines the contribution of a R. C.
 Provides a basis for evaluation.
 Motivates the managers.
 Provides a system of closer control.
 Helps “Management by exception”.
 Facilitates decentralization.
 Sets realistic plans and budgets for R.C..
 Creates a sense of cost consciousness.
 Requirements of effective R. A.
• A sound organization structure.
• Dividing the organization into RCs.
• Accurate and acceptable budgets.
• Top management support.
• Healthy organizational environment
COST CENTRE
• Manager : Accountable only for costs incurred.
• Output of cost center : Not measured in monetary
terms.
• Evaluation : Actual cost vs. Budgeted cost
• Employed in : Legal Dept, Accounting Dept, Public
Relation Dept, HR Dept.

REVENUE CENTRE
• Manager : Accountable for revenues only.
• Evaluation : Actual Revenue Vs. Budgeted Revenue
• Employed in : Sales Dept., Product Centre.
PROFIT CENTRE
• Manager : Held responsible for both costs (inputs)
and revenues (outputs), i.e., profits
• Inputs & outputs :Capable of financial measurement.
• Measures effectiveness and efficiency and motivates
managers.
• Employed in: Production Dept., production centers.
INVESTMENT CENTRE
• Manager : Responsible for costs, revenues &
investment in assets used.
• Evaluation : By profit and ROI
• A measure of overall performance, and facilitates
comparison.
 RESPONSIBILITY & CONTROLLABILITY
• Controllability : Degree of influence that a
specific manager has over costs, revenues, &
related items for which he or she is responsible.
• Manager should avoid over-emphasizing
controllability & fixing blames.
• R.A. is more far-reaching : Emphasis on
human aspects
• R.A. focuses on information, knowledge &
behaviour, not on control.
 ASSIGNING REVENUE & COSTS
TO SEGMENTS
REVENUE :
• Assigning revenue : Electronic Cash Register

COSTS : Two Approaches

• Classify costs : Fixed & Variable
Contribution Margin Approach
• Charge each segment :
Traceable V.C. & Traceable F.C.
Absorption Costing Approach
MEASUREMENT OF PERFORMANCE
ROI Approach : Popular Approach
Accounting Rate of Return
• Pioneer : Du Pont Co.
• Return on Sales x Investment
Turnover
 RI Approach :
• Pioneer : General Electric Co.
• RI = Income – Minimum Return
on Investment
EVA : A specific type of RI
= After-tax operating income –
Weighted average cost of capital
(Total Assets – Current Liability)
 Return on Sales
• Income to Revenue (or Sales) Ratio
• A component of ROI

COMPARING PERFORMANCE MEASURES :

 ROI
 RI
 EVA
 ROS
 DESIGNING ACCOUNTING-BASED
PERFORMANCE MEASURE(PM)
• Choose PM that align with Top Mgt.’s
Financial Goals.
• Choose the Time Horizon of each PM
• Choose Definition of components in each PM
• Choose a Measurement Alternative for each
PM
• Choose a Target Level Performance
• Choose the Timing of Feedback.
 FINANCIAL PERFORMANCE
MEASURES – A Survey
COMPANY COUNTRY PM
Ford Motors US Income, ROS, ROI
Guinness UK Income, RI, EVA
Krones Germany Revenues, Income
Mayne Nickless Australia ROI, ROS
Mitsui Japan Revenues, Income
Pirelli Italy Income, Cash-flow
Swedish Match Sweden ROI
 SIX SIGMA
• Pioneer: Motorola
• A Management Philosophy
• Setting extremely high objectives
• Collecting data
• Analysing results
• Reduce defects in products & services
STANDARD COSTING AND
VARIANCE ANALYSIS
Objective : Cost Control
Accounting system :
Historical Costing
Standard Costing
 Standard
 A measure of desired
performance.
 A predetermined
criterion for evaluating
the actual performance
 WHY STANDARDS ?
• Cost Control
• Pricing Decision
• Performance Appraisal
• Cost Awareness
• Management by Objective
TYPES OF STANDARDS
 Ideal standards
 Expected standards
 Current standards
 Basic standards
 PROCESS OF DEVELOPING
STANDARDS
Varies from company to company :
• The standard committee
• Technical input
• Past experience
• Other inputs
• Coordination
 Standard Costing
• A control device
• Not a separate method of product costing
• Used with any method of product costing :
Job or Process Costing
• Generally used in manufacturing concerns
 Standard Costing involves :
• Ascertainment of standard cost
• Measurement of actual cost
• Comparison
• Analysis of variance and taking
appropriate action where desired
 VARIANCES
Favourable Variance &
Unfavourable Variance

 Controllable Variance &

Uncontrollable Variance
 Variances:
 Sales Variances
 Cost Variances

Cost Variances:
• Direct material cost variances
• Direct labour cost variances
• Overhead cost variances
 DIRECT MATERIAL COST VARIANCES
1. Material Cost variance = Standard cost for actual output -
Actual cost of material used
= Qs. Ps – Qa. Pa
2. Mat. Price var. = Qa (Ps – Pa)
3. Mat. Quantity var. = Ps (Qs – Qa) = Usage Variance
= Efficiency Variance
4. Mat. Mix var. = Ps (Smqa – Qa) = Standard Price (Revised
standard mix – Actual mix)
5. Mat. Yield var. = Ps (Qs – Smqa) = Sub-usage variance
= (Actual yield – Standard yield) x Standard
cost per unit of output
1 = 2 + 3, 3 = 4 + 5
Note : Qs = Standard Quantity; Qa = Actual Quantity;
Ps = Standard Price; Pa = Actual Price;
Smqa = Standard Mix in Actual Quantity.
 DIRECT LABOUR COST VARIANCE
1. Labour Cost var. = Standard cost of labour for actual
output – Actual cost of labour
= Hs.Rs – Ha.Ra
2. Labour Rate of Pay var. = Ha (Rs – Ra)
3. Labour Efficiency var.= Rs (Hs – Ha)
4. L. Mix or Gang Composition var.= Rs (Smha –Ha)
5. L. Net Efficiency var. = Rs (Hs – Smha)
6. Idle Time var.= No. of Hours Lost (Abnormal) x Rs
1 = 2 + 3, 3=4+5+6
Note : Ha = Actual hours worked
VARIABLE OVERHEAD VARIANCES
Variable Overhead Cost Variance
= St. V. OH – Ac. V. OH
= AO . SRO – AO . ARO
= SH . SVRH – AH . AVRH
Variable Overhead Spending Variance
= AH(SVRH – AVRH)
Variable OH Efficiency Variance
= SVRH(SH – AH)
FIXED OVERHEAD VARIANCES
• Fixed Overhead Cost Variance
= Standard Cost – Actual Cost
= AO . SRO – AO . ARO
= SH . SFRH – AH . AFRH
• Fixed Overhead Expenditure Var.
= Budgeted Cost – Actual Cost
= BO . SRO – AO . ARO
= BH.SFRH - AH.AFRH
• Fixed Overhead Volume Variance
= Standard Cost – Budgeted Cost
= AO . SRO – BO . SRO = SRO (AO – BO)
=SFRH (SH – BH)
 SALES VARIANCES
• Sales Value Var. = Actual Value of Sales
– Budgeted Value of Sales
• Sales Price Var. = Act. Quantity sold
(AP – SP)
• Sales Volume Var. = SP(AQ – BQ)
• Sales Mix Var. = SP(AQ- Smqa)
 POSSIBLE CAUSES OF COST VARIANCES
• Mat. Price Var. : Changes in actual price, Failure to
purchase anticipated quantity, Not taking
cash discounts, Changes in freight cost
• Mat. Quantity Var. : Poor material handling, Inefficient
machine operator, Pilferage, Waste,
Labour Turnover.
• Lab. Efficiency Var. : Defective machine and equipment,
Poor supervision, Inexperienced employee,
Insufficient training, Poor working condition
• OH Volume Var. : Failure to use normal capacity, Lack of
sales order, Machine break down, Defective
materials, Labour troubles, Power failure
• OH Expenditure/Efficiency Var. = Same cause as Labour
Efficiency Variance.
 RESPONSIBILITY FOR COST VARIANCES
Variance Persons Responsible
• Mat. Price Variance : Purchase Agent or
Purchase Manager
• Mat. Quantity Variance : Plant Supt. , Dept. Supervisors,
Machine Operators, Quality
Control Dept.
• Labour Rate of Pay Variance : Personnel Manager, Dept.
Supervisors, Plant Superintendent
• Labour Efficiency Variance : Plant Superintendent
• OH Expenditure Variance : Variable portion : Foremen or
Supervisor; Fixed portion: Top Mgt.
• OH Volume Variance : Top Mgt.
Few businesses plan to fail,
but many of those that flop,
failed to plan.
 BUDGETARY CONTROL
BUDGETS AND PERFORMANCE REPORTS

MANAGER Feedback
Managers plan &
act using budgets

PERFORMANCE
OPERATING PROCESS
Managers evaluate using
a report that compares
actual results with budgets
 STRATEGY AND PLANS

LONG-RUN PLANNING
LONG-RUN BUDGETS
• STRATEGY
SHORT-RUN PLANNING
SHORT-RUN BUDGETS
 Budget
“A financial and / or quantitative statement
prepared and approved prior to a
defined period of time , of the
policy to be pursued during that period for the
purpose of attaining a given objective.”
• Planning for the future activities
• Survey of past events, present
happenings and the future things.
 BUDGET Vs. STANDARD
• Standard : A carefully determined price,
cost or quantity
• Budget : A broader term
• Budgeted Costs : Need not be based on
standard
• Standard = Budget : When standards are
used to obtain budgeted inputs or outputs
 Features of a budget:
• Comprehensive and coordinated
plan of action based on the
objectives of the organization.
• Plan for the operations and
resources
• For a specified future period
Budgetary Control System:WHY?
• A tool for strategic planning & control
• Ensures economy in workings
• Promotes co-ordination &
communication among subunits
• Management by exception
• Optimum utilization of resources
• Continuous review of performance
• Motivates managers & employees
 BUDGETING PROCEDURE
Varies widely from company to company.
Common steps:
• Obtaining estimates from each sub-unit
or division or department.
• Co-coordinating estimates.
• Communicating the budget to
responsible managers.
• Implementing the budget plan.
• Reporting interim progress: Performance
Report
 Pre-requisite for Introduction of
Budgetary Control
• BUDGET CENTRE
• ORGANISATION CHART
• BUDGET COMMITTEE
• BUDGET MANUAL
• BUDGET PERIOD
• PRINCIPAL BUDGET FACTOR
 FIXED BUDGET vs. FLEXIBLE BUDGETS

FIXED BUDGET
• Remain unchanged irrespective of level of activity obtained.
• Prepared for a particular level of activity
• Acts as a target for the forthcoming period
• Not adjusted with actual activity

FLEXIBLE BUDGETS
• Designed to change in relation to the level of activity attained
• Prepared for a range of activities
• Recognizes the behavior of costs: fixed ~ semi-fixed ~ variable
• Facilitates performance measurement and control
 BEHAVIOURAL DIMENTIONS OF BUDGETING

• Implications of Participative Budgeting

• Excessive Pressure Created by Budget
• Budgetary Slack (Cushion)
• Top Management Support
• Inter-Departmental Conflict
 OPERATING AND FUNCTIONAL BUDGETS
• Sales Budget
• Production Budget
• Production Cost Budget
– Direct Materials Budget
– Direct Labour Budget
– Factory Overhead Budget
• Cost of Goods Sold Budget
• Selling Expense Budget
• Administrative Expense Budget
• Budgeted Income Statement
 FINANCIAL BUDGETS
• Capital Expenditure Budget
• R & D Budget
• Cash Budget
• Budgeted Balance Sheet

NON-FINANCIAL BUDGETS
- Space, Equipments, Workers
 MASTER BUDGET
• A comprehensive budget:
• A Tool for coordinating all budgets.
• Summarizes : Planned activities of all
subunits of an organization.
• Incorporates:
Summary of all functional budgets.
 MASTER BUDGET
Normally comprises :
 Budgeted P.& L. A/C ;
 Budgeted Balance Sheet;
 Budgeted Cash Flow Statement.

• Reveals: Top management goals of

incomes, expenditure, cash
flows and financial position.
 ELEMENTS OF MASTER BUDGET
 Sales Forecast
 Production Schedule
 Manufacturing Cost Budget
 Operating Expense Budget
 Capital Expenditure Budget
 Budgeted Income Statement
 Budgeted Balance Sheet
 Cash Budget
BUDGET PRACTICES: Master Budget
• U.S. : 91%
• U.K. : 100%
• Japan : 93%
• Holland : 100%
• Australia : 100%
BUDGET GOALS :
U.S. : ROI
Japan : Sales
 What reduces effectiveness of Budgeting?
SURVEY OF CFOs IN THE U.S. :
 Lack of well-defined strategy
 Linkage of strategy to operational goals
 Lack of individual accountability for
results.
 Lack of meaningful performance
measures

SAIL Vs. TATA STEEL

 ROLLING BUDGET
• A Continuous Budget
• A Plan : Always available for a
specified future period
• Adding a period in the future as the
period just ended is dropped
• ELECTROLUX :
A four-quarter rolling budget
 KAIZEN BUDGETING
• Kaizen : Continuous Improvement
• Continuous Improvement Goals
• Incorporates continuous
improvement during the budget
period into the budget numbers
• JAPANESE COMPANIES
• Citizen Watch Co.
 ACTIVITY-BASED BUDGETING
• Incorporating Activity-based
Cost Drivers into Budgets
• Focuses on the Budgeted
Cost of Activities
• Budget for each Activity
 ZERO BASE BUDGETING

A method of budgeting
 All Activities : Evaluated
 Every item of expenditure :
Fully Justified
 Involves starting from scratch or zero

ZBB & GOVT.

 STEPS OF ZBB
• Identify each separate activity :
A decision package
• Evaluate : Each decision package
• Consider : Alternatives for each decision
package.
• Rank : Decision packages - priority for
resource allocation.
• Allocate :Resources to the packages.
 “Budgeting is the common
accounting tool companies use for
planning and controlling what
they must do to satisfy their
customers and succeed in the
market place.”