Welcome to Presentation on

A Holistic Approach to Cost Control

and Reduction

Presentation By –
Kailash Sankhlecha
Kailash Sankhlecha & Associates, Cost Accountants
414, Saffron Complex, Fatehganj, Vadodara – 390 002.
 Basic Definitions
• Financial Accounting is creation of
accounting information for external parties
and government.

• Cost Accounting measures and reports

financial and other information related to
the organisation’s acquisition and
consumption of resources.
 Basic Definitions
• Management accounting measures and reports financial
as well as other type of information that assists
managers in fulfilling the goals of the orgnisation.

• Cost management is the set of action that managers

take to satisfy customer while continuously reducing and
controlling costs.
 Basic Definitions
• "Cost" is the monetary value of resources used or
sacrificed or liabilities incurred to achieve an objective,
such as to acquire or produce a good or to perform an
activity or service.
• Activities which affect costs are often called cost drivers.
• A major task in specifying cost behavior is to identify cost
drivers.
• There are two types of cost drivers:
– Volume related cost drivers
– Non-Volume related cost drivers.
 Basic Definitions
• To understand cost behaviour, we need to understand
distinguishing between variable cost from fixed cost.
• Variable cost is a cost that changes in direct proportion
to the change in the cost driver.
• Fixed cost is a cost that is not immediately get affected
by the change in cost drivers.
• Cost Accounting helps management to take various
decisions like,
– Product Pricing
– Addition or Deletion of Products.
– Make or Buy Decisions
– Which Territory or Customer to be catered
– Cost Control
 Traditional Cost Accounting
• Traditionally direct costs are identified with the cost
object and all indirect costs are absorbed in the product
on some volume based cost drivers like labour hours,
machine hours.
• With the technological development proportion of indirect
costs have increased in total cost.
• Each product consumes different amount of resources.
• Without understanding actual resources consumption by
a cost object, allocating cost on broad average leads to
wrong cost calculation.
• This leads to product cost cross subsidization.
 Traditional Costing
• Manytimes it happens that sales goes up but
corresponding increase in profit does not happen.
• Sometimes sales goes up but still company’s profitability
either decreases or company makes losses.
• This is all because of faulty costing.
• We understand this by a simple example –
• Four friends went to a Pizza Joint.
• They have ordered following foods:
Friends Starter Pizza Dessert Total
Ram 60 240 40 340
Rahim 100 180 0 280
Shyam 40 120 0 160
Sunder 60 120 40 220
Total 1000
Average 250

Now, this broad average will put Shyam at disadvantage.

 Activity Based Costing (ABC)
• ABC focuses on activity as a fundamental cost
object.
• ABC uses cost driver notion for collecting and
allocating costs.
• We take a small example to understand the
difference between traditional and ABC costing:
• We take a Electronic Board industry.
• Each board has Diodes, capacitors and integrated
circuits.
 Under Traditional Costing
• Costing under Traditional Costing
Particulars Board X Board Y

Direct Costs

Direct Materials 600 280

Direct Labour 32 56

Total 632 336

Factory Oveheads 40% of DM 240 112

Factory Adm OH 800% of DL 256 448

Total Manufacturing Cost 1128 896

Selling Price 1240 985

Profit or Loss 112 89

 Under ABC
• On analysis of activities, it observed that
• Activity Area Cost Driver Indirect Cost
per Number
Material Handling Parts Rs. 2 per part
Machine Insertion of M\C Inserted Rs. 0.50 per
parts Parts part
Manual Insertion of parts Mannually Rs. 4.00 per
Inserted Parts part
Wave Soldering Boards Rs. 50 per
Board
Quality Testing Test Time Rs. 50 per
Test
Particulars Board X Board Y
Direct Costs
Direct Materials 600 280
Direct Labour 32 56
Total 632 336
Indirect Cost
Material Handling (X, 81 and Y, 121 parts @Rs.2) 162 242
M\C Parts Insertion (X, 70, Y 90 parts @Rs. 0.50) 35 45
Manual Insertion (X, 10 and Y, 30 @ Rs. 4.0) 40 120
Wave Soldering 50 50
Quality Testing (X, 1.5Hr and Y, 6.5 Hrs @Rs. 50.0) 75 325
Total 362 782
Total Manufacturing Cost 994 1118
Selling Price 1240 985
Profit or Loss 246 - 133
 Bulk and Small Sales
Pharma
Panchmahal % JBC %
Sales 470.64 723.15

RM Consumption 354.2 75.26 219.6 30.37

PM Consumption 0.00 0 0.00
Employee Cost 13.4 2.85 93.4 12.92
Manufacturing Expenses 71.96 15.29 33.39 4.62
Administration and Selling Expenses12.06 2.56 188.54 26.07
Financial Charges 20.43 4.34 14.88 2.06
Depreciation 14.31 3.04 20.37 2.82
PBT -13.84 -2.94 91.78 12.69

NB 143.64 3.28 220.78 3.28

Inventory and Debtors

 Need of Cost Accounting
• Cost Accounting is basic for all managerial decision
making.
• We are in the era of competition and one of the worst
competition is price related.
• Correct cost work out is also necessary.
• Cost Accounting will provide direction for cost control
and reduction.
• Cost control and reduction should be seen from long
term perspective.
• Effect of cost should be seen on overall cost instead on
local cost.
 Cost Control Process
Control is the process through which conformity is
attempted between actual and planned performance.

• Identify your Major Cost Centres

• Identify the Major Type of Cost in each Cost Centre.
• Choose the Cost to focus on first.
• Systematic Cost Control
– Start with business objective\targets
– Establish standard cost for the objective.
– Establish realistic Budgeted Costs
– Record actual costs and compare with budget
– Periodical Review of the activities.
Cost Control Cycle
PRODUCTION DEPARTMENT
1A.) Area 1 : Ampoule

STD. Number
BATCH Production of Manhours Total
S.No PRODUCT SIZE Quantity Batches per Batch Manhours

1 Puregest 50 Inj 4761 18091.8 4 212 848

2 Puregest 100 Inj 1000 950 1 216 216

3 Susten 50 Inj. 1000 2850 3 212 636

4 Susten 100 Inj. 1000 4750 5 216 1080

5 Susten 200 Inj. 4ml 19230 493249.5 27 176 4752

6 Trapic Inj. 35555 776876.75 23 126 2898

TOTAL 1296768.1 63 1158 10430

 Example
 The marketing Department is asked to cut their budget by 10%.

 Their Budget was as follows:

Salaries Rs. 267,000
Benefits cost Rs. 59,000
Postage Rs. 17,000
Supplies Rs. 18,500
Telephone Rs. 12,000
Entertainmnet Rs. 6,500
Travel Rs. 3,000
Miscellaneous Rs. 4,000
_______________________________________
Total Budget Rs. 387,000

• A 10% budget reduction means Rs. 38,700

 Example cont.
• By looking at budget it seemed difficult.
• All work done may not be value added work.
• Strategy should be to either eliminate or
marginalise non-value added activities.
• A better way to approach the problem is to take
a look at the work done by the department and
see what opportunities exist to do the work
better.
 Example
On Close scrutiny of work done, following
informations are noticed:

– Receive orders @10 minutes per order.

– Resolve errors @ 30 min each
– Generate confirmations @ 5 minutes each
– Answer inquiries @ 20 min each
– Generate reports @ 1 hour management time
each.
 Example
• After a review, distribution of budget was as under:

• Receive orders (35,000/yr) Rs. 172,400

(Open mail, Review order, Input into order system)

• Resolve errors (6,300/yr) Rs. 97,300

(Missing information, Incorrect data Input corrected data)

• Generate Order confirmations (35,000/yr) Rs. 102,000

(Print Fold Insert Affix label Mail )
• Answer inquiries (500/yr) Rs. 14,060
• Generate reports (3/mo) Rs. 1,240
 Example
• we can find out and fix that problem, we will have our
budget savings identified.
• However, we also have an opportunity to look at other
areas.
• Is there a better way to receive orders and generate
confirmations?
• Can the inquires be categorized and FAQs issued?
 Example…
• Do the inquiries result from the high error
rates? Nevertheless, we can now focus on
cost reduction opportunities.
• The point here is that we need to actually
reduce work, not just people.
• Simply eliminating people is the lazy
manager’s way of cutting budgets. Of
course, the survivors have to work harder
because work was not eliminated!!
 Exmaple Cont
• The Accounting view is where costs must ultimately be
realized. The accounting view is primarily focused on
cash costs, not so much on non-cash costs.
• Process view is primarily focused on the cost of a
business process. This is where the costs are actually
incurred.
• Resources are allocated to a process.
• Begin by examining the 10 functions, then break out
business systems. Break it down to the smallest
measurable process.
• Look at inputs (resources) consumed during the process.
• Measure outputs from the process.
 Example
• In the process of examining all these
processes, you should also be on the
lookout for "folklore" processes: things that
are done simply because "that's the way
we've always done things.
• " Many of these may have made sense at
one time, but no longer do. Get rid of them
immediately.
 Cost Control - Conclusion
• cost control needs to be carefully managed.
• eliminating wasteful activities is clearly beneficial,
indiscriminate cost cutting can lead to falling quality and
poor morale
• Step for Cost Control
– Identifying where to focus your efforts.
– Managing cost control.
– Specific cost control opportunities.
 Control Through Labour Efficiency

• We have developed a module for

Formulation Company to control the cost
through just checking labour efficiency.
• We have got labour norms for all their major
production stages like –
– Granualation
– Compression
– Inspection and
– Packing
 Control Through Labour Efficiency ..

• Every month you can work out the labour

requirement of each stage by multiplying each
stage’s labour norms with actual batches
produced.
• This standard labour requirement can be
compared with actual labour hours consumed by
the department.
• The deviation can be analysed.
• The negative deviation can be on following
accounts:
 Control Through Labour Efficiency ..

• Material was not available in time (Purchase and

store department).
• Labour arrived late or less arrived (HR
Department)
• Idleness on account of Machine Break Down
(Engineering Department)
• Batch was released late or checked late (QC/QA
Department)
• Air Conditioning was available (Utiltity
Departement)
 Cost Reduction
Cost Reduction is a process of
efficient utilisation of the reources
at the disposal and removal of
wastages and non-value added
activities.
 Methods and Techniques
• Standard Costing
• Activity Based Management
• Target Costing
• Value Engineering
• Benchmarking
• Lean Manufacturing or Just in Time
 Traditional Cost Reduction
Practices
Several traditional methods of cost reduction are currently
being used. Most of them focus on
• reduction on purchases,
• Closing Canteens
• Stopping or Reducing Travelling Entitlements
• cutting down training expenses,
• laying-off people,
• stopping technological up-gradation of machines and
processes, etc.
Such cost cutting measures become counter productive
when demand revives and companies lose business when
opportunity arrives.
 Wastages in an organisation
• Over Production
• Waiting
• Unnecessary Transport
• Over Processing or Incorrect Processing
• Excess Inventory
• Unnecessary Movement
• Defects
• Unused Employee Creativity
 How Cost Gets built up - Michael
Hammer
• Suppose, you do 100 units in a month and each labour does
10 units in a day – you need 10 workers and one supervisor
• If you get order for 1000 units – your manpower requirement
will be how much – 10 times ie 110 persons – No.
• You will need 196 persons :
– 100 Workers and 10 Supervisors
– 1 Manager, 3 Assistant Managers
– 18 Persons for Payroll, Welfare, Training, etc.
– 19 Persons for Planning and Scheduling
– 22 In Accounts, Audit and Controls.
– 23 in Facilitation and Expediting
 Over Production
• Over Production is defined as
manufacturing of items for which there are
no orders.
• It can also be defined as making what is
unnecessary, when it is unnecessary and
in unnecessary amount.
 ill Effects of Over Production
• Anticipatory buying of parts and materials
• Blocked flow of goods
• Increased Inventory
• No Flexibility in planning
• Occurrence of defects
 Causes of Over Production
• Large lot production
• Anticipatory production
• Inability to achieve short changeover
times.
• Creating enough stock to replace defective
stock.
• Overstaffing, or too much equipments.
• Machines that turn out parts too quickly.
 How to eliminate Overproduction
• Line Balancing
• One piece flow
• Pull Production using Kanban
• Quick changeover operations
• Level Production – small lot, mixed
production.
 Inventory
• Over Production leads to inventory.
• Inventory means any goods that are
retained for any length of time inside or
outside factory.
• Inventory is symptoms of sick factory.
 Causes of Inventory
• Acceptance of inventory as a normal
• Poor equipment layout.
• Long changeover times.
• Large lot production
• Obstructed flow of goods
• Anticipatory Production
• Defective Parts
• Higher capacity of upstream processes
 How to Eliminate Inventory
• Layout of Equipments by process instead
of operation.
• Production leveling
• Regulating flow of production
• Pull production using Kanban
• Quick changeover operations
 Inventory and Debtors Turnover
Pharma Engg Engg
IndSwift % Bhansali % Machino %
Sales 580.51 225.11 84.32

RM Consumption 436.86 75.25 178.32 79.21 57.36 68.03

PM Consumption 0.00 1.66 0.74 0.00
Employee Cost 9.94 1.71 10.98 4.88 4.9 5.81
Manufacturing Expenses 7.35 1.27 13.6 6.04 6.97 8.27
Administration and Selling Expenses 42.82 7.38 1.79 0.80 8.2 9.72
Financial Charges 36.81 6.34 16.86 7.49 2.82 3.34
Depreciation 9.47 1.63 16.13 7.17 9.64 11.43
PBT 40.48 6.97 -19.45 -8.64 1.38 1.64

NB 147.15 3.95 182.66 1.23 75.65 1.11

Inventory and Debtors 443.9 1.31 174.55 1.29 15.51 5.44

 Conveyance
• More inventory leads to more conveyance
• Conveyance refers to any transport or
transference of materials, parts or finished
goods from one place to another for any
reason.
 Reasons for Conveyance
• Poor Layout
• Material Handling
• Moving things around for any reason
• Excessive conveyance distances or
heights
• Under utilisation of systems that create
flow.
 Ill Effects of Conveyance
• Use up valuable space in the factory.
• Increase in conveyance related worker
hours.
• Require more conveyance equipments
• Often leads to damaged products.
 How to Eliminate Conveyance
• U shaped manufacturing cells.
• Flow of production
• Multi-skilled workers
• Higher utilisation rate.
 Defects
• Defects include:
 Defects themselves
 Cost of Inspecting for defects
 Responding to customer complaints, and
 Making repairs.
 Causes of Defects
• Emphasis on down stream inspection.
• No standards for inspection work.
• Omission of standard operation.
• Material handling and conveyance.
 How to Eliminate Defects
• Standard Operations
• Mistake proofing devices
• Full-lot inspection
• Building quality in each process.
 Processing Waste
• This refers to operations and processes that
may not be necessary.
• This leads to increased work hours.
• Lack of Training and Standardization leads to
Processing waste.
• Design changes may not have been
communicated.
• Extra space between machine tools and work
piece adds to processing time.
 Causes for Processing Waste
• Inadequate study of processes
• Inadequate study of operations.
• Incomplete standardization.
• Materials are not studied.
 How to Eliminate Process Waste

• More appropriate process design.

• Review of Operations
• Through Standardisation.
• Promote Value Analysis and Value
Engineering.
 Idle Time
• It covers idle time of man and machine both.
• Idle time is caused because of –

– Obstruction of flow
– Poor Equipment layout
– Trouble at upstream process
– Capacity imbalances
– Large lot production
 How to Eliminate Idle Time

• Production Levelling
• Product specific layout.
• Mistake proofing
• Quick change over.
• Autonomous Maintenance
• Line Balancing
 Toyota Philosophy for Cost Reduction
• Continuous Improvement (Kaizen)
• Respect for people
• Partnership with suppliers.
• Long Term Philosophy.
• Process Oriented.
• Developing your people and partner.
• Solving Root Problem and Drive Organisational
Learning.
Value Addition and Non-Value Addition Activities
• Material Procured
• Retained in the Warehouse\Store
• Materials are conveyed to Processes
• Materials Retained at the Machines
• Materials are picked up for Processing
• Materials are processed
• Processed Goods are stored at Machine
• Goods are conveyed to an inspection point
• Goods are Retained until inspected
• Goods are picked up and inspected
• Goods are kept on other side after inspection
• Inspected Goods are conveyed to Finished Goods Store
• Finished Goods are Retained in Store
• Finished Goods are delivered to Customer
• Effective cost reduction involves four
major activities:
• detection of root cause,
• developing solutions,
• implementing solutions and
• sustaining the effect.
 Where to implement cost
reduction
Areas for cost reduction are
1. raw material procurement
2. logistics - inbound and outbound
3. production ( process ,time and work study,maintenance,
automation)
4. Energy
5. human resource ( out sourcing )
6. sales & marketing
7. finance
 Easy Savings
• Some costs can be reduced without impact on quality and
performance
– Suppliers bill may have over charging.
– Negotiate with suppliers or find alternate suppliers.
– There may be double payment to suppliers.
– Get rid of overcapacity (Excess phone line, etc.)
– Cut out balatant waste (Unnecessary lighting, AC on in night, etc)
– Scrap useless files and papers.
– Use E-mails
– Avoid over specifying
– Ban wasteful luxuries.
– Coputerise the process wherever possible
– Switch single monthly invoicing
– Outsource non-core area
 Goal II page 67
• Financial Performance has two important
factors:

i) Profitability
ii) Profit Cash Flow
Many company making profits still have
serious problem of cash flow.
 Capacity Balancing
• Plant in which everyone is working all the
time is very in-efficient.
• Bottleneck determines throughput.
• Local optimus is not an optimum system at
all. It is a very inefficient system.
 Cost Accounting
• We are living in complex manufacturing and multi
product era.
• When a company produces or provides services, it
consumes many type of resources.
• Ratio of these resources consumption to various
product or services is never equal.
• Consumption of resources is dependent on the
related cost drivers.
• Cost drivers depends on many aspects of the
product, service, cost object.
• Understanding the relation between costs and
their cost drivers allows managers in all types
of organisation:
 Evaluate new manufacturing methods or
service practices.
 Make proper short term decisions
 Plan of budget the effects of future activities.
 Design effective management control system.
• Make proper long term decisions
• Design accurate and useful product
costing systems.
• Provide input to advanced management
tools.
 The major parameters for any
manufacturing unit
• cost per unit ($/unit)
man-hours/unit
units produced/unit time
break down time (%)
change over time ( min/hrs )
waste (%)
defectives (%)
fuel consumption (k therms/unit)
electricity consumption (kwh/unit)
water consumption ( kltrs /unit )
inventory turnover ( %)
lead time (min/hrs / days)
 Efficiency and Effectiveness
• Measuring costs is an integral part of measuring
performance in terms of efficiency and cost-
effectiveness. Efficiency is measured by relating
outputs to inputs. It is often expressed by the
cost per unit of output.
• While effectiveness in itself is measured by the
outcome or the degree to which a
predetermined objective is met, it is commonly
combined with cost information to show "cost-
effectiveness."
 Cost Accounting Standard
Board
• The ICWAI has set up CASB.
• The ICWAI has given following objectives,
operating procedures, scope and
applicability:
• Preparation of uniform cost statement.
• Standard cost accounting practices in the
matter of compliance of statutory
obligations.
 Importance of Cost to various
Agencies
• Cost is not only important for the management
of an organisation, it is equally relevant for the
government.
• Government uses cost data at many places,
namely

• In valuation for determining base for levying

tax.
• Bringing price control in essential commodities.
• Determine predating prices.
• Determine case for levying anti-dumping
duty.
• For cost plus margin contracts’ value
determination.
• Help industry and Government in better
cost management.
 CAS in the USA
• In 1970, Congress established the original
Cost Accounting Standards Board.
• cost accounting standards designed to
achieve uniformity and consistency in the cost
accounting principles followed by defense
contractors and subcontractors under Federal
contracts in excess of $100,000.
• After adopting 19 standards, the original
CASB was dissolved on September 30, 1980
 Managerial Cost Accounting Concepts and
Standards for the Federal Government
USA

• The full costs of resources that directly or

indirectly contribute to the production of
outputs should be assigned to outputs
through costing methodologies or cost
finding techniques that are most
appropriate to the segment's operating
environment and should be followed
consistently.
• CASB was revived in 1988 within the
Office of Federal Procurement Policy (OFPP).
• The five standards set forth the fundamental elements of
managerial cost accounting:
(1) accumulating and reporting costs of activities on a regular basis
for management information purposes,
(2) Establishing responsibility segments to match costs with outputs,
(3) determining full costs of government goods and services, (4)
recognizing the costs of goods and services provided among
federalentities, and
(5) using appropriate costing methodologies to accumulate and
assign costs to output.
• Costing methodology
• 10. Costs of resources consumed by
• responsibility segments should be accumulated by type of resource. Outputs produced by
responsibility segments should be accumulated and, if practicable, measured in units. The
full costs of resources that directly or indirectly contribute to the production of outputs should
be assigned to outputs through costing methodologies or cost finding
techniques that are most appropriate to the
segment's operating environment and should be followed consistently.
11. The cost assignments should be performed using the following methods listed in the order
of preference: (a) directly tracing costs wherever feasible and economically practicable,
(b) assigning costs on a cause and-
effect basis, or
(c) allocating costs on a reasonable and consistent basis.
12. These accounting standards need not be
applied to items that are qualitatively and
quantitatively immaterial.
• The Chief Financial Officers Act of 1990
• includes among the functions of chief financial officers "the
development and reporting of cost information" and "the systematic
measurement of performance. "[Footnote 4] In July 1993, Congress
• passed the Government Performance and Results Act (GPRA)
which mandates performance measurement by federal agencies.
[Footnote 5] In September 1993, in his report to the President on
the National Performance Review (NPR), Vice President Al Gore
recommended an action which required the Federal Accounting
Standards Advisory Board to issue a set of cost accounting
standards for all federal activities.[Footnote 6] Those standards will
provide a method for identifying the unit cost of all government
activities.
 Costing and Financial Management

• Managerial cost accounting should be a

fundamental part of the financial
management system
• Managerial cost accounting should be an
essential element of proper financial
planning, control, and evaluation for any
organization or activity that uses resources
having monetary value.
 Costing and Financial
Management
• cost accounting supports and provides
data to the budgetary and financial
accounting functions.