Cost-Management (2019 - 11 - 16 08 - 26 - 32 UTC)

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Introduction to
Cost Management

Course Objectives
Introduction to cost management
Basic cost management concepts
Cost behaviour
Activity – based costing
Product and service costing – A process systems approach
Product and service costing – Job order system
Allocating costs of support department and joint

products
Budgeting for planning and control
Standard costing – A functional based control function
Decentralization – Responsibility accounting performance

evaluation and transfer pricing
Introduction
Tasty Bites is a newly started

organization engaged in
manufacturing of food
products
Let us see the cost

Recently they have two involved in the
On an average 10,000 varieties of potato wafersproduction of
these potato
packets are produced wafers
every month CLICK HERE!

Introduction
The selling price is $15

per packet which
means the company
earns a profit of $2 per
packet
Now move on
to next page
to see what
Cost incurred
per packet company is
thinking
Labor $3 The designing of CLICK HERE!
wrappers and
Raw Material $4 packing is currently
Designing and outsourced to third
$6
packing party who charge $6
Total cost for
$13
per packet
one packet
Introduction
The company is considering to

somehow reduce the cost and
earn more profit without
altering the selling price
They approach Samuels, a cost

accountant and discuss about
their ideas

Introduction
Currently, for designing and

packing, the company pays
$60,000 every month (10,000
packets x $6 per packet)
Samuel’s idea is, instead of

So, his workings are below: outsourcing, if the company itself
recruit 2 people to design the
• Salary for 2 designers to
wrappers and 3 more people to pack
design the wrapper = the item the company will be
$18,000 ($9,000 per incurring much less cost
designer)
• Salary for three packers =
$12,000 ($4,000 per
packer)
Introduction
So, by properly
managing the cost, the
company is able to
control the prices and So the designing and
also earn good profit packaging cost is $30,000
Let us learn how to for packing 10,000
“manage the cost” in packets which is only $3
detail per packet.
CLICK
Cost HERE!
incurred
per packet Now you can see that the
cost has come down to
Labor $3
$10 per packet and with
Raw Material $4 the same selling price of
$15 per packet, the
Designing and
packing
$3 company can now earn a
profit of $5 per packet
Total cost for
$10
one packet
Contents
Cost behaviour
Product and service costing – A process systems

approach

products

Cost management
Cost management is used both by
manufacturing and service sectors.
Efficient cost management helps those
organizations in increasing resource,
productivity and margins
Cost management system supports the

organization in achieving its goals and
objectives
A good cost management system provides

data to managers in achieving short-term
profitability and maintaining a competitive
position in the long-term

Goals of cost management
Develop reasonably accurate product/service cost
Assess product/service life cycle performance
Improve understanding of processes and activities
Control costs
Measure performance
Contemporary cost management tools
Companies always think of reducing their costs

and improving the quality of their
product/services. To be successful in the
contemporary business environment, certain new
cost management techniques were used.
Let us look at
various cost
management
tools on following
pages
CLICK HERE!

• Activity – Based costing (ABC)

• Activity – Based Management (ABM)
• Benchmarking
• Theory of constraints
• Just- In-Time costing
• Back flush costing
• Economic value added
• Target costing
• Life cycle costing Let us discuss
each one in detail
• Balanced scorecard CLICK HERE!

Activity – Based costing (ABC)
Activity based costing focuses mainly on the

activities that are performed when creating a
product – The costs are first traced to activities
and then to products

Activity – Based management (ABM)
Activity Based Management focuses on

reducing the costs and improving activity
performance. In this approach there is a five-
step process
• Identifying the process objectives
• Charting activities
• Classifying activities
• Continuously improving processes
• Eliminating activities whose costs go beyond
their value
Benchmarking
Benchmarking is a tool through which the

success factors of other firms are known. It
is also a technique of collecting information
on cost standards/performance and process
structures

Theory of constraints
Theory of constraints aims at finding out

the bottlenecks involved in the
production process and removes them.
Theory of constraints explains that the
activities that are performed other than
strengthening the weakest link of the
organization’s value chain will be a
waste of time and effort

Just-in-time costing
Under this system, the products are

produced only when order is received
from customers. In just-in-time systems
the inventory is reduced to lower levels
than those found in conventional
systems. It allows the organization to
focus more on quality

Back flush costing
Back flush costing redefines the point at

which accounting transactions are made
to alleviate raw material and work-in-
process inventories

Economic value added
Here, the emphasis is on forced cash

flow generated by products as the basis
for fund allocation and measuring
performance. Economic value added
costing focuses on value-based
management

Target costing
It is a tool which is used to find out

the cost at which a product with a
specified function and quality should
be produced. It aims at reducing the
cost of a product throughout the life
of the product

Life cycle costing
It is an extension of target costing.

Products are analyzed to find out
whether they provide profit over
their life time

Balanced scorecard
Balanced scorecard is one of the models

which emphasizes the linkage of various
types of important performance
measurement system into a strategic
bundle. It is the first systematic
performance measurement system that
renders an organization’s strategy into
clear goals, measures, targets, and
initiatives organized by key measures

Contents
Cost behaviour

approach

products

Cost object
A cost object includes products,

departments, projects, customers
etc. The costs are measured on
these and assigned. A cost object
can also be an activity.
For instance, in determining the cost
to manufacture a bicycle, the cost
object is the bicycle

Indirect and direct costs
co sts
Direct
I ndi r ec t
costs
Direct costs can be

Indirect costs are the traced easily and
costs that cannot be accurately to a cost
traced easily and object
accurately to a cost
object

Method of tracing
There are 2 methods –
in g
Direct trac
Driver tr
a c i ng

Method of tracing
e c t t ra c i n g
Di r
Direct tracing is the process of assigning cost to a cost

object that is physically associated
For example, the materials used in manufacturing a pair of
blue jeans are physically observable – Denim, Zipper,
buttons, and threads

Method of tracing
i ve r t ra c i ng
Dr
Driver tracing uses ‘drivers’ to assign costs to cost objects.

For instance, if you want to know the amount of
electricity used to run sewing machines, you need a meter
to measure the consumption. But this is not possible.
Thus, a ‘driver’ like ‘machine hours’ could be used to
assign the cost of electricity

Tangible products and services
Tangible products are created by using ‘Services’ are the activities performed by
labour, plant, land, and machinery. The a customer using a company’s products or
raw materials are converted to finished facilities
goods e.g., insurance coverage, medical care,
e.g., Vehicles, Television, clothes are few dental care are few examples
examples
Intangibility, perishability and inseparability
y
ty
ity
bilit
il i
il
ngib
hab
a
par
is
Inta
Inse
Per
Intangibility means the
‘Inseparability’ means
buyers of services ‘Perishability’ refers to
the provider and buyers
cannot see, feel, hear, or the services that cannot
of services should be in
taste a service before it be stored
direct contact
is bought

Production and non-production costs
Production costs are the costs Non-production costs are associated

involved in the manufacturing of with the research and development,
goods or provision of services selling and administration

Direct materials and direct labour
Direct materials are those which can be

directly traced to a product or services
produced. The cost associated with these
materials can be directly charged because
physical observation can be used
Direct labour can be directly traced to the

goods or services being produced. These
employees convert raw materials to finished
products or provide service to customers

Prime and conversion costs
When direct materials are added Conversion cost is obtained by

to direct labour we arrive at the adding cost of direct labour and
prime cost overhead cost

Non–production costs
Non–production costs can be split into
Research and Marketing Administrative

development costs costs
costs

Non–production costs
Research and The expenses which are

Marketing costs are
development costs are associated with the
incurred when a
expenses involved in general administration in
product or service is
creating new products and an organization are called
marketed or distributed
processes as ‘administrative costs’

Production and non-production costs
Production or manufacturing costs Non- Production or operating costs
Direct material
R&D expense
Prime cost
Direct labour
Marketing expense
Conversion
cost
Overhead Administrative
expense

Cost of goods manufactured
Cost of goods manufactured refers to the total expenditure incurred on manufacturing

of goods completed during a particular period. The only cost assigned to goods
manufactured are the cost of direct materials, direct labour, and overheads
Work-in-progress
Work-in-progress consists of goods that are semi-finished. They are still under
production at a given point of time. Beginning work-in-progress consists of partially
completed products at the beginning of a period and ending work-in-progress consists
of those semi-finished goods at the period’s end
Cost of goods sold
The cost of goods sold should be computed after the cost of goods
manufactured is known. The cost of goods sold may not be equal to the cost of
goods manufactured. The cost of goods sold should be treated as an
expenditure

MCQs
You are the manager of the company and you would like to know the
key success factors of other companies. How will you do that?
Option 1: By using benchmarking tool
Option 2: By using back flush tool

Click on any
one of the
options for Option 3: By using target costing tool
the correct
answer By using Activity-Based Costing (ABC) tool
Option 4:

Contents
Cost behaviour

approach

products

What is “cost behaviour”?
Cost behavior refers to the way how a cost changes when the activity
or output increases or decreases
Let us look
at an
example
The cost involved in manufacturing 10,000 umbrellas

is more than the cost incurred in making 20,000
umbrellas. In other words, the total cost should
increase when the output increases
Types of costs
Let us see how costs can be classified based on their behavioral pattern. The
classification is as follows:
1. Fixed cost
2. Variable cost
3. Semi-variable
Let us discuss
(semi-fixed) cost
each one with
examples in the
next few slides
4. Stepped-fixed
cost
Fixed costs
Look at the below conversation

between George and Richard
George is a cost accountant and is

helping Richard, his junior, in preparing
Cost Sheets and gives some examples
to make him understand various costs

Fixed costs
George: Hi Richard, can you tell me

how many shirts did we manufacture
this month and in the previous
months?
Richard: Sure George, we produced

5,000 shirts this month and during the
month of June we created only 4,000
shirts. In the month of May we
managed to produce only 2,000 shirts

Fixed costs
George: Did you notice that the rent paid

by us for the factory building is US$10,000
every month irrespective of the volume?
Whether we manufacture shirts or not, our
rent is fixed at US$10,000 every month. Is it
not a fixed cost Richard?
Richard: yes, now I got it

Fixed costs
Fixed costs are costs that are not affected in totality by the level of activity, and remain
the same regardless of how much or how little work is done in a period
Look at the diagram below. This

reflects the fixed costs in total
Cost $ Fixed costs in total
5000
0
Activity level
(no of widgets produced)
It is important to note that fixed costs need not remain the same over a period of time
Fixed costs per unit
If the cost is fixed for an item, the cost per unit has to come down or decrease when the
volume or activity level increases. Look at the diagram below
Cost $ Fixed costs per unit
0 Activity level
Fixed costs per unit – Example
Assume that the cost of manufacturing a shirt is $200. If 2 shirts are

manufactured, then the fixed cost per unit will be
$200
i.e. 100 per shirt
2
Similarly, if 100 shirts are manufactured, then the fixed cost per unit
will be
$200
i.e. 2 per shirt
100
Conclusion: As the level of activity increases, fixed costs remain the
same in total, but the per unit cost of the activity falls Let us look
at the
variable
costs in the
next slides

Variable costs
George: Richard, have you heard of

variable costs?
Richard: Yes George, but can you

please explain this to me clearly with
examples?

Variable costs
George: Sure. Variable costs are quite

opposite to fixed costs. Variable costs
are the costs that change in direct
proportion to the level of activity
Let us see an example in the

next slide

Variable costs – Example
Direct material is a classic example of variable costs. If additional quantities of
a product is produced, it needs the same quantity of raw materials which cost
the same
Look at the
diagram
below
Cost $ Variable costs in total
0 Activity level
Variable costs – Example
From the diagram in the previous slide, Look at thehave analyzed that the variable costs in
you must
total change at the same rate as the leveldiagram
of activity. However, within a reasonable range
of activity levels, it is found that variable cost per unit of output remains pretty much the
same
Cost $
Variable costs per
unit
below
$4
0 Activity level
Here we can come to a conclusion that, as the activity level increases, variable cost also
increases in direct proportion
Semi-variable costs
George: Do you understand the term

“semi-variable costs”
Richard: Yes . . . to some extent. I think it

has both fixed and variable elements in it.
Am I right?

Semi-variable costs
George: Absolutely! Semi-variable costs are

those that have fixed and variable elements
Richard: Can we consider telephone

charges as an example of “semi-variable
costs”?

Semi-variable costs
George: Exactly – Telephone charges

every month have two components.
The rent charged is a fixed cost and the
charges which we pay for the calls
made are variable costs
Let us look at a diagram in the

next slide

Semi-variable costs
A semi-variable cost, e.g. telephone charges
Cost $
0 Activity level
(no of phone calls)
Under semi-variable costs, the cost per unit falls as the level of
activity increases
Stepped-fixed costs
George: Richard, listen to the example and

then answer my question
Richard: sure George, go ahead

Stepped-fixed costs
George: For producing 200 shirts, you need

one supervisor. For manufacturing
additional 200 shirts, you need another
supervisor. Am I right?
Richard: Of course, after a certain range

your fixed cost increases

Stepped-fixed costs
George: Yes. The important feature about

these costs is that they remain fixed up to a
certain level of activity and they go up a
step when the activity level rises

Stepped-fixed costs
Stepped-fixed costs are also called as “step costs”. They remain constant for a
range of activity and then change and are in constant change for another
range. The below diagram will make it clear
Stepped-fixed costs, e.g. supervisors’ salaries

Cost $
0 Activity level
Using fixed and variable costs
The distinction between fixed and variable costs can be used:
To analyze To assess
profitability In product costing In decision To estimate
performance
making process future costs
– whether to
increase or
decrease the
activity level
Estimating future costs with cost behaviour
The cost behaviour analysis is used for variety of reasons. They are:-
• The future cost is estimated

based on the estimated volume
of activity The actual costs are
compared with the
expected costs for the
actual level of activity
achieved
Let us solve a problem in the

next slide

Example
Two products A and B are produced by a company. The cost estimation is as
follows:-
Product A Product B
• Direct materials costs (per unit) $14 $12
• Direct labor hours (per unit) 1.5 hours 2.5 hours
• Direct labor cost (per hour) $10 $10
• Variable overhead costs (per hour) $2 $2
Expected fixed cost is $220,000. 5,000 units of Product A and 2,000 units of
Product B will be produced
Calculate the total expected costs Click here to

know the
answer

Solution
Product A Product B Total

5,000 units 2,000 units
$ $ $
Variable costs
• Direct materials 70,000 24,000 94,000
• Direct labor 75,000 50,000 125,000
• Variable overhead costs 15,000 10,000 25,000
Total variable costs 160,000 84,000 244,000
Fixed costs 220,000
Total costs 464,000

Contents
Cost behaviour

approach

products

What is “Activity-Based Costing”?
• Activity based Costing is a tool for

measuring the performance. This
technique is used to assign costs,
identify and report on the operations
• ABC identifies the true cost of a

product and tries to improve the
effectiveness of business processes
and their efficiency
• The costs of individual activities are

calculated using the ABC system

Evolution of ABC
During the 1970s

and 1980s the The activities were
manufacturing sector analyzed and all
of the US developed associated costs to ABC mainly focuses on
the concept of ABC perform the activities activities. The first step in
were calculated designing ABC is identifying
the activities
Important terms in ABC
There are certain important terms involved in Activity-Based Costing. They are:-
1 Cost object (an item for which cost measurement is required)
2 Cost pool (indicates cost grouping in a particular activity)
3 Cost driver (the factor that causes a change in the cost of activity)

Stages of Activity-Based Costing
The different stages are:-
1
7
Let us discuss
8 each stages
in detail
CLICK HERE!









Activity-Based Costing methodology
The ABC methodology can be broadly classified as:-
Customer Profitability
Product Profitability
Process Efficiency
Let us discuss
each
methodology
CLICK HERE!

It is believed that: mers

p ro fita b le c u sto
tomers are
• High volume cus
m e rs a re a lso p rofitable ones
• Loyal custo
follo w if a c u sto m er is happy
• Profits will
Customer
Profitability

on th e activities that go into

ts b a sed
ABC costs the produc
it. This helps to:
iti on th e ir p ro d u c ts better
• Pos
ro d u c t m ix fo r th e market
P
• Facilitate better
p o w e r w it h th e c ustomer
Product aining
Profitability • Enhance the barg

th e e m p lo y e e s a cross
B C im p le m e nta ti on will make v o lved, which
A a rio u s c o sts in
n c tio n s to u n d e rs tand the v
fu
ill in tu rn e n a b le them to:
w
• Analyze the Cost. V a lue Added
eA d d e d an d N o n
• Identify the Valu
Process
Activities. a lize th e b enefit
efficiency provements a n d re
• Im p le m e n t th e im

1
Cos
t- red
ucti
o n
Dec
is
2
pro ion-m
duc a k in
reta i ng gr
inin a prod egardi
ga n
cus uct an g
tom d
er

Significance of Activity-Based Computing
Bud
g
per eting a
me forman nd
as u
rem ce
ent
Limitations of Activity-Based Computing
In some cases, the ABC does not conform

establishment of cause to generally accepted
and effect relationship accounting principles in
between cost drivers some areas
and costs is not a
simple affair
Cost of buying, implementing,
and maintaining activity-based
More time consuming to systems
collect data

MCQs
You have manufactured 10,000 television sets last month for a cost of
$1,00,000. This month, the cost involved in making 5,000 television sets
is $60,000. The changes in cost is known as
Option 1: Variable cost
Option 2: Future cost

Click on any
one of the
options for Option 3: Cost behavior
the correct
answer Product behavior
Option 4:

Contents
Cost behaviour

approach

products

Basic operational and cost concepts
Look at the products
below:
Car Computer Television Mobile
It is clear that in the production or manufacturing of the above products, there are
various processes involved. There are various homogeneous products passing
through various processes. Each process performs certain activity which makes a
product complete
Thus, process is a series of activities

Cost flows
If there is only one process

involved, the costs are shifted
to subsequent processes
1 3
2 Such costs that are
shifted/transferred
The process involved in from the prior
manufacturing will have a process to the
separate Work-In-Progress subsequent ones are
account to track called as
manufacturing costs “transferred-in costs”

Production report
The production report is a summary of the manufacturing

activity within a given period of time
The flow of units through the process is tracked and also

identifies the cost charged to the process

Unit costs
Unit costs are required to:-
1 Compute the cost of goods transferred out of the

process
2 Determine the value of the ending inventory

Process costing with no WIP
If no inventories are there then the average cost per unit
can be calculated by using process costing principles.
The formula is:
Unit cost = Cost of the period

Move on to the Output of the period
next slide to
know which
type of
industries have
no work in
progress

Process costing with no WIP
Process costing can be applied to industries with no WIP. The two types of no
WIP industries are
Service
industries
Just-In-Time
manufacturing
Let us look at firms
these two
industries in
the next slides

Service industries
The industries which provide service that are homogeneous can take advantage of
the process costing system
One good example is the airline companies. The sequence of services include
Reservation Ticketing Baggage Seat Flight Baggage

checking confirmation delivery

JIT manufacturing industries
JIT manufacturing firms that produce relatively homogeneous goods using stable
processes often use process costing. If the JIT manufacturing industries are
successfully implemented, it drastically reduces the work-in-progress inventory to a
minimum level
FIFO costing method
In the FIFO costing method only the current

period costs and current period outputs are
used. The costs that are found in the
beginning work-in-progress and equivalent
units found in the beginning inventory are
not included in the calculations

Operation costing
Operation costing is a kind of approach which is
used for a hybrid production method called
batch production process. Even though different
doses of materials are used in each batch, the
same demand is made on the conversion

Activity!
Let us do a small activity on whatever we have learnt in this section
1. A(n) _____________ is a series of activities or operations

that are linked to perform a specific objective
2. The costs transferred from a prior process to a subsequent

process are referred to as ________________
3. The _____________________________ is the document that

summarizes the manufacturing activity that takes place in a
process department for a given period of time
4. Under the _____________________________________, the

equivalent units and manufacturing costs in beginning work in
process are excluded from the current-period unit cost
calculation
5. _____________________________ is a blend of job and CLICK HERE TO

process costing procedures applied to batches of homogeneous CHECK OUT THE
products ANSWERS

Solution
Process is a series of activities or operations

1. A(n) _____________
that are linked to perform a specific objective
2. The costs transferred from a prior process to a subsequent

Transferred-in costs
process are referred to as ________________
Production report
3. The _____________________________ is the document that
summarizes the manufacturing activity that takes place in a
process department for a given period of time
FIFO costing method
4. Under the _____________________________________, the
equivalent units and manufacturing costs in beginning work in
process are excluded from the current-period unit cost
calculation
Operation costing
5. _____________________________ is a blend of job and
process costing procedures applied to batches of homogeneous
products

Contents
Cost behaviour

approach

products

Manufacturing firms vs. Service firms
Manufacturing Service
Manufacturing consists of combining A service is intangible in nature.

direct material, direct labor, and It can’t be separated from the
overhead to create a new product. customers. A pure service has
They are tangible in nature and can no raw materials and tangible
be moved from one place to another items for its customers
Setting up the cost accounting system
Cost accounting system is used to fulfill the needs of
Let us discuss
about these
three briefly in
the next slides
Cost accumulation Cost measurement Cost assignment

Cost accumulation
Cost accumulation means recording and

recognizing costs. The cost accountant keeps
track of all the costs as they occur. The
transactions are stored in the source document.
The data from these source documents are
recorded in a database

Cost measurement
Cost measurement means classifying the costs.

The value of direct labor, materials, and
overheads are determined. There are two ways
to measure – actual and normal costing
Actual costing uses the actual cost of resources

used in production. Normal costing makes all
firms to apply actual costs of direct material and
labor to units produced. Overhead is applied
based on predetermined estimates

Cost assignment
The cost should be assigned to the units of

product manufactured or units of service
delivered. Unit costs are considered important
for various reasons. A meaningful bid can be
submitted only after knowing the unit costs

Importance of unit costs to manufacturing firms
Valuing inventory, It is necessary to

determining income, and disclose the cost of
important decisions are inventories and income
made based on unit costs in financial reports at
the end of each year

Choosing the activity level
There are 2 activity levels:-
Expected activity level is the

Expected production level the firm expects to
activity level attain for the upcoming year
Normal
activity level Normal activity level is the
average activity usage that a firm
experiences in the long term
Let us look at an example to understand this concept clearly

Example
Please have a look at the data below

XYZ & Co’s manufacturing data
Year Units produced

1 22,000
2 17,000
3 21,000 Now, move
4 20,000 on to the
Expected for next year 18,000 next slide

Example
XYZ & Co. is planning to manufacture 18,000 units next year and
its estimated budgeted overhead is $216,000. If the expected
yearly capacity is used, the company will apply overhead using a
predetermined rate of $12
i.e., $216,000/18,000
But when normal capacity is used, then the denominator of the

equation for predetermined overhead is the average of the past 4
years of activity or 20,000 units,
i.e., (22,000 + 17,000 + 21,000 + 20,000)/4 Let us see in
the next slide
Then the predetermined overhead rate to be used for the which choice
upcoming year is is the better
$10.80 ($216,000/20,000) one

Example
• Of the two, normal activity has the

advantage of using pretty much the same
activity level year after year
• As a result, it produces less fluctuations
year on year in the assignment of per
unit overhead cost
• Of course, if the activity stays fairly
stable, then the normal capacity level is
roughly equal to the expected actual
capacity level

Job-order costing system
In job order production systems, the costs are accumulated with jobs. The
process of assignment of costs is called as “job order costing system”. A
few examples of job order process includes printing, construction,
furniture making, and automobile repairs

Contents
Cost behaviour

approach

products

What is cost allocation?
In cost allocation the costs are divided into pool

of costs and assigned to various sub units. The
total cost should not be affected because of
allocation. Cost allocation can affect behavior
of managers, profitability of individual
products, and bid prices
Types of departments
Before cost allocation is done it is important to find out
what the cost objects are. Normally they are departments.
Departments are of two categories. They are:
Producing
department
Let us discuss
each
Support
department
department in the next
couple of
slides

Producing
Producing
department
department
The producing department is directly

involved in creating products or
services. For example, in a public
Support accounting firm the producing
department departments will be auditing, tax, and
management advisory services. In the
manufacturing sector, these are
departments that are directly involved
in producing goods

Producing
department
These departments provide important and

Support
Support supportive services for producing
department
department departments. They are indirectly involved in
the production of goods and services.
Examples of support department are
engineering, maintenance, personnel, etc.

Types of allocation bases
The production department gives rise to various kinds of activities in

allied or support departments. The cost incurred in allied or support
departments is because of the activities of production department.

Direct method of allocation
When the costs of the support department are allocated only to producing
departments, it is called direct method of allocation. It is the easiest and
straightforward way to allocate support department costs
Let us look at an example for this in the next slide

Example - Direct method of allocation
Assume that there are four Now, using the direct After allocation, the
departments in an organization – method distribute all cost becomes zero for
Power, maintenance, grinding, and power and maintenance power and
assembly. Power and maintenance costs to grinding and maintenance, and all
are support departments and assembly overhead costs are
grinding and assembly are allocated to grinding
producing departments, each with and assembly
a bucket of directly traceable
overhead costs
Sequential method of allocation
Under this method, the interaction

among support departments is
recognized
Cost allocation is done following a
ranking procedure. Ranking can be
done in various ways – may be based
on the percentage of service they
provide to other support departments
Let us look at
an example
for this in the
next slide

Example - Sequential method of allocation
Let us take the same example of power, maintenance, grinding, and assembly
departments which we discussed for “Direct method”
Now let us look at the step-by-step procedure to be followed in sequential

method of allocation
Step 1
Rank support departments – No. 1-Power and No.2-Maintenance
Step 2
Distribute power to maintenance, grinding and assembly
Step 3
Then distribute maintenance to grinding and assembly
After allocation – Zero cost in power and maintenance; all overhead cost in
grinding and assembly
Reciprocal method of allocation
All interactions of support

departments are recognized
The usage of one support

department by another support
department is analyzed
It is done to find out the total

cost of each support
department, where the total cost
reflects interactions among the
support departments

What is a joint product?
When two or more products of

equal importance are produced
from a single raw material at the
same time, it is called a “Joint
Product”
One or two products might

undergo additional processing as
well. Products undergo the same
process till a split-off point
Features of joint product
Joint products are

produced from sample
raw materials
They are produced from

the common features of
the manufacturing
process
Joint products are of
equal importance and
value
They may require
further processing after
their split off or point of
separation
MCQs
The method used to determine current period costs and outputs is

known as
Option 1: Current Operation costing
Option 2: Production report

Click on any
one of the
options for Option 3: Cost for the period
the correct
answer FIFO costing
Option 4:

Contents
Cost behaviour

approach

products

Role of budgeting in planning and control
Budgets are the
quantitative expressions
of those plans which
identify the objectives of
an organization and the
necessary actions to
achieve them. Budgets
set the foundation for
operations
Control is termed
as the process by
which standards
are set, feedback
on real Budgets are useful
performance are in comparing
received, and actual and planned
corrective actions outcomes of an
are taken action
Advantages of budgeting
Budgeting forces the management to plan for future scenarios including

potential problems, and develop an overall direction for the firm in addition
to formulating policies for the future
Budgeting aids in conveying important information about the resource

capabilities of a firm, thus, helping make better decisions possible.
Example: Potential shortfalls are indicated by a cash budget
Budgeting helps in setting the standards for regulating the

use of a company’s resources as well as in controlling and
motivating its employees
Budgeting improves an organization’s communication

of its business plans to all the employees. They also
foster coordination as the various areas and activities
of an organization need to function together in order to
achieve its stated objectives
Types of budget
et
g) us
M
dg
lin u o
as
bu
te
ol n
r r onti
r
bu
C
dg
et
(o
Budget
Fin n g
bu an rati et Let us look
d g c ia p e g
et l O ud at each one
b
in detail
CLICK HERE

Types of budget
Master budget
M
et
g) us
dg
as
lin u o
te
bu
ol n
r
r r onti
The master budget is a
bu
dg
C
comprehensive financial
et
plan which consists of a
(o
Budget variety of individual,

departmental and activity
Fin ng
bu an ti budgets for the year
d g c ia e ra et
g
et l Op u d
b

Types of budget
M
et
g) us
dg
as
lin u o
te
bu
ol n
Operating budget
r
r r onti
bu
dg
C
Operating budgets define
et
the activities of income
(o
Budget
generation of a firm (for
Fin e.g., the inventories of
n g
bu an ati et sales, production, and
d g c ia r
e g finished goods). Operating
et l p
O ud
b budgets result in a pro
forma (budgeted) income
statement

Types of budget
M
et
g) us
Financial budget
dg
as
lin u o
te
bu
ol n
r
r r onti
bu
Financial budgets define
dg
C
the inflows and outflows of
et
(o
cash as well as the financial
position of the firm.
Budget
Financial budgets result in g
Fin n
a cash budget as well as a bu an rati et
pro forma (budgeted) d g c ia p e g
et l O ud
balance sheet b

Types of budget
Continuous budget
M
et
g) us
dg
as
lin u o
te
bu
A 12-month moving
ol n
r
r r onti
bu
budget is called a
dg
C
continuous (or rolling)
et
(o
budget. As a month in the Budget
budget gets over, an
additional month from the Fin g
n
future is added to the list bu an rati et
so that the company d g c ia p e g
et l O ud
always has a 12-month b
plan ready

Gathering information for budgeting
The data for preparing budgets is gathered by the following ways:
Historical
data
Sales Forecasting
forecasts other
variables

Preparing the financial budgets
The financial budgets are secondary to master budgets. The components of financial
budgets are cash budget, the budgeted balance sheet, the budgeted statement of cash
flows, and the capital expenditure budget
Cash budget
The cash budget is a detailed plan which displays all the expected sources as well as uses of
cash. Much of the information required to prepare these budgets are sourced from the
2
operating budgets. Its components are:
Cash d
Total cash available
isburs
e
ments
ce
lan
Cash Budget
ba
4
sh
Ca
Fin
3
5
an c
ing
cie ncy
or defi
excess
Ca s h
What is Zero-based budgeting?
Zero-based budgeting is a method in which all the expenditures for a new period
should be justified. It starts from a “zero base” and the needs and costs of each and
every function in a firm is analyzed. Budgets are then constructed around the
required resources for the upcoming period regardless of how it compares with the
previous budget in terms of its size
What is a Static budget?
Static budget is one which is based on the

projected output level before the start of a
period
In other words, a static budget is said to be the

“original” budget. Static budget variance is the
difference in value between the line item of an
original budget and its corresponding one from
the statement of actual results
Often, the most observed line item is the

“bottom line”, which is the total cost of
production for the factory and other cost
centers and the net income for profit centers

What is a flexible budget?
Flexible budget is a tool used to evaluate

performance. It cannot be prepared
before the conclusion of a period. A
flexible budget adjusts the static budget
for the actual output level

Preparing a flexible budget
The following steps are used to prepare a flexible budget:-
Determine the budgeted

level of fixed costs
Determine the budgeted
variable cost per unit of
output 1
2
4
3
Build the flexible budget Determine the actual

based on the budgeted volume of output
cost information and the achieved
actual volume of output
Activity-Based Budgeting (ABB)
ABB is defined as ‘a method of budgeting based on an activity framework and

utilizing the cost driver data in budget setting and variance feedback processes'

Contents
Cost behaviour

approach

products

Developing unit input standards
Price standards specify the amount

which needs to be paid for the input
quantity used
Quantity standards specify how much

input needs to be used per unit of
output
The unit standard cost for an input =

Standard price × Standard quantity

Responsibilities for establishing price standards
The quality of required inputs are determined by the

Operations Managers
Personnel and purchasing departments have the

responsibility to acquire input quality at the lowest
price which is determined by market forces and
trade unions
Accounting department is responsible for
noting down the price standards and
preparing reports

Types of standards
Ideal standards Kaizen Currently

standards attainable
standards
Ideal standards Kaizen standards Currently

can only be are continuous attainable
achieved if improvement standards can be
everything standards that achieved under
operates perfectly reflect a planned efficient operating
improvement conditions

Uses of standard costing system
Standard costing system is used for the following reasons:-
Managing costs
1
Improving
planning and
control
2
Facilitating
decision
making and
3 product
costing

Standard cost sheet
Standard cost sheet gives the standard costs and quantities of materials, labor, and
overheads which need to be applied to a specific product or service
Standard costing system
A standard costing system initially notes

down the cost of production at the standard.
Inventory units flow through the inventory
accounts (from work-in-progress to finished
goods to cost of goods sold) at their per-unit
standard cost
When actual costs become evident, adjusting

entries are created which restate every
account balance from standard to actual (or
approximates such a restatement)
The constituents of this adjusting entry

provide information regarding the
performance of the company for a period,
particularly with respect to production
efficiency and cost control

Contents
Cost behaviour

approach

products

Responsibility accounting
It is the system of dividing an organization

into similar units, with each of which is
assigned specific responsibilities. These units
may be divisions, segments, departments,
branches, product lines, and so on

Types of responsibility centers
Cost centers
Revenue
centers
Profit centers
Investment
centers

Decentralization
There is no single centralized entity

which makes decisions on behalf of
all the parties in a decentralized
system
Instead, each party or peer as they

are called makes autonomous local
decisions towards their individual
goals which may possibly conflict
with those of other parties
Peers directly communicate with

each other and provide services or
share information to fellow peers

Decentralization and decision making
In centralized decision
making In decentralized
• The top level in an decision making
organization makes
all the decisions • Lower level
• Managers at the Managers both make
lower level are and implement key
entrusted with the decisions on behalf
implementation of of the organization
decisions

Reasons for decentralization
Provide motivation
tion
g
n
rainin
valua
ti o
peti
me l
ge ra
nt
and t
tate e
na ent
om
ma of c
ly
c
e
Facili
e
in g
e ti
nc
us
a
o
h
m e
foc
s
En
w n
llo sp
o
r
A
tte re
i ti ve
n
Be
o i d cog
Av
s
i tation
lim
Have better access to local information

Units of decentralization
Decentralization is normally done by splitting the company into various

individual units. These units may be differentiated by:
1 2 3
Types of goods Types of
Geographic
or services customers
regions
provided served

Measuring the performance of investment centre
Return on Investment
• ROI measures the profits earned per dollar of investment made

• It is the most common measure of performance for an investment center
ROI is calculated using the below formula:-
Operating income
Average operating assets

Residual income
It is the difference between the operating income and the required

minimum dollar return on a firm’s operating assets. It is computed using
the below formula:
Residual income = Operating income – (minimum rate of return x operating assets)

Economic Value Added (EVA)
It is the post-tax operating profit earned minus the total cost of capital per annum.
EVA is expressed as a dollar value rather than the percentage rate of return. It
emphasizes post-tax operating profit as well as the actual cost of capital
The formula is:
EVA = Post-tax operating income - (weighted average cost of capital x

total capital employed)

Transfer pricing
The price charged for goods produced by

one division and transferred to the other
are called transfer price. It affects the
transferring division’s revenue and the
receiving division’s cost. It also impacts
the managerial performance of those
divisions

Setting transfer pricing
Cost based transfer price –
Full cost transfer prices are
the least preferred as they
3 can provide perverse

incentives as well as distorted
performance measures
Negotiated transfer price –
2 It is practical when there is

market imperfections for
the transferred goods
Market price – If a perfectly
1
competitive outside market for
the goods to be transferred
exists, then the market price
would become the correct
transfer price

MCQs
This budget cannot be planned or prepared before the end of a

particular period because it is used to analyze the performance. What is
the name given to this budget?
Option 1: Planned budget
Option 2: Flexible budget

Click on any
one of the
options for Option 3: Price budget
the correct
answer Cost budget
Option 4:

Summary
Cost Management – We have learnt that:
• Cost Management is a process of assessing the financial impact on

managerial decisions.
• Cost Management determines the budget and actual cost involved in
operations, processes, departments and analyzes the variances and
profitability.
• Cost Management is given importance for flexible budgeting for cost
control.
• Cost Management is perceived as important for meeting budgets.
• Cost Management serves as an useful tool to analyze product cost which
is used for pricing decisions.
• It encourages responsibility on accounting performance, evaluation and
other pricing models effectively.

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Basic cost management concepts

Activity – based costing

Product and service costing – A process systems approach

Product and service costing – Job order system

Allocating costs of support department and joint

Budgeting for planning and control

Standard costing – A functional based control function

Decentralization – Responsibility accounting performance

Tasty Bites is a newly started

Let us see the cost

© ManagementStudyGuide.com. All rights reserved.

The selling price is $15

The company is considering to

They approach Samuels, a cost

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Currently, for designing and

Samuel’s idea is, instead of

Basic cost management concepts

Activity – based costing

Product and service costing – A process systems

Product and service costing – Job order system

Allocating costs of support department and joint

Budgeting for planning and control

Standard costing – A functional based control function

Decentralization – Responsibility accounting performance

Cost management system supports the

A good cost management system provides

© ManagementStudyGuide.com. All rights reserved.

Develop reasonably accurate product/service cost

Assess product/service life cycle performance

Improve understanding of processes and activities

Companies always think of reducing their costs

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• Activity – Based costing (ABC)

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Activity – Based costing (ABC)

Activity based costing focuses mainly on the

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Activity – Based management (ABM)

Activity Based Management focuses on

Benchmarking is a tool through which the

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Theory of constraints aims at finding out

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Under this system, the products are

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Back flush costing

Back flush costing redefines the point at

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Economic value added

Here, the emphasis is on forced cash

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It is a tool which is used to find out

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