ADVANCED COST & MANAGEMENT ACCOUNTING

Course Code: MBAF-521

Credit Hours: 2

Dr. Umashankar
Ph.D(Finance), NET, SET, FET, MBA, M.Com,.
 Course Description

This course describes cost and management accounting in the

broader sense. It provides information in the area of cost and
management accounting, which is helpful in the effective
utilization of resources with cost-controlling techniques.

It explores an activity-based costing, Application of

incremental/differential cost ,Target Costing, Life Cycle
Costing, pricing decisions, Service Company costing,
transfer pricing and other costing techniques and systems
in managerial decisions. In particular, the course emphasizes
modern and advanced costing theories of an organization.
 Course Objective

To apply various cost accounting techniques to

all types of organizations for Planning,
decision making and control purposes in
practical situations.
 syllabus
CHAPTER 1 – ADVANCED COST CONCEPTS
• Introduction
• Application of incremental/differential cost techniques
in managerial decisions
• Target Costing
• Life Cycle Costing
• Cost control and cost reduction
• Throughput accounting, Uniform costing, Target costing
and Kaizen costing
• Inter-firm comparison
 syllabus
CHAPTER 2 – Product Pricing
• Introduction
• Pricing of finished product
• Theory of price
• Pricing policy
• Principles of product pricing
• New product pricing
• Pricing strategies
 syllabus
CHAPTER 3 – ABC Costing
• Broad Averaging and Its Consequences
• Undercosting and Overcosting
• Product-Cost Cross-Subsidization
• Design, Manufacturing, and Distribution Processes
• Simple Costing System Using a Single Indirect-CostPool
• Refining a Costing System
• Reasons for Refining a Costing System
• Guidelines for Refining a Costing System
• Activity-Based Costing Systems
 syllabus
CHAPTER 4 – COSTING OF SERVICE SECTOR
• Introduction
• Main characteristics of service sector
• Collection of costing data in service sector
• Costing methods used in service sector
• Pricing by service sector
 syllabus
CHAPTER 5 – Responsibility Accounting and
Transfer Pricing
• Introduction
• Responsibility Accounting and Decentralization
• Objectives of transfer pricing system
• Methods of transfer pricing
• Conflict between a division and the company
• Multinational transfer pricing
 syllabus
CHAPTER 6 Measuring Organizational Performances
• Organizational roles of Performance measures
• Designing a system of performance measures
• Traditional Short-term Financial Performance
measures
• Non-Financial Performance Measures
• Balanced Score card, Quality Time and Theory of
Constraints
CHAPTER 1 – ADVANCED COST CONCEPTS
1. INTRODUCTION:
Accounting systems are designed to provide information to decision-makers.
Accounting language has two primary “variations”, Financial Accounting and
Management accounting. Cost accounting is a bridge between financial and
management accounting.

Financial Accounting, Cost Accounting and Management Accounting

Financial accounting reports the financial performance of the company mainly
to external users. It reports financial position and income according to GAAP.

Management accounting provides information for internal users (managers)

who direct and control its operations. The reports are not governed by GAAP.

Cost Accounting is a branch of accounting and has been developed due to

limitations of financial accounting. “cost accounting refers to classification,
accumulation, assignment and control of costs.
 Cost accounting
• Cost accounting is defined as “a technique or method for determining the
cost of a product, service, project, process, or things. It integrates with
financial accounting by providing product costing information for financial
statements and with management accounting by providing some of the
quantitative, cost-based information to managers to perform their tasks.
• Cost accounting has long been used to help managers understand the
costs of running a business. Modern cost accounting originated during
the industrial revolution, when the complexities of running a large scale
business led to the development of systems for recording and tracking
costs to help business owners and managers make decisions.
• Organizations that do not manufacture products may not required
elaborate cost accounting systems. However, even service companies
need to understand how much their services cost so that they can
determine whether it cost-effective to be engaged in particular business
activities.
 The Purposes of Cost Accounting Systems
Cost accounting systems provide information useful:
• For managing the activities that consume resources.
• For planning and control and for performance evaluation. Budgeting is
the most commonly used tool for planning and control and forces
managers to: Look ahead, translate strategy into plans, coordinate and
communicate within the organization and provide a benchmark for
evaluating performance.
• In addition, the cost information is reported on external financial
statements as, for example, inventories, cost of goods sold, and period
expenses. The costs of products and services produced and sold are
needed for tax purpose.
• Information about costs is also needed for a variety of management
decisions (both strategic and short-term decisions).
• For example : 1. product pricing
2. product discontinuance (shut-down)
3. make (produce) or buy
4. acceptance of a special order
 Cost Terms
Cost:The monetary measure of economic resources (Product or service)
given up/sacrificed to attain a specific objective/purpose such as acquiring
a good or service.(money sacrificed to attain a good or service)

Expense:A cost that has given a benefit and is now expired. Expenses are
incurred intentionally in the process of generating revenues.for
example:
1. Cost of goods sold.
2. Selling and Administrative expenses….
Unexpired costs that can give future benefit are classified as assets.

Loss:Losses are unintentionally incurred in the context of business

operation. For example: losses resulting from
1. Damage related to fire, floods.
2. Abnormal production waste.
3. Sale of productive asset below book value.
 Objectives of cost accounting
1. Cost Ascertainment: Cost estimation and determination.
2. Cost Reduction: Cost Reduction is a process, aims at
lowering the unit cost of a product manufactured or service
rendered without affecting its quality by using new and
improved methods and techniques
3. Cost Control : The process or activity on controlling costs
associated with an activity, process, or company
 Cost Classification
Costs vary with purpose and the same cost data cannot serve all purposes
equally well.
Now consider some ways of classifying costs:
1. Based on business function: (R&D, Production (Manufacturing),
Marketing, distribution, Customer service). For purposes of contracting
with government agencies design & R&D costs are treated as product
costs.
2. Based on financial statement presentation: (Capitalized, non-capitalized,
inventoriable, non-inventoriable: product vs. Period)
3. Based on assignment to cost object: (direct vs. Indirect)
4. Based on control: or significantly influence the cost ( controllable cost,
uncontrollable cost)
5. Based on behaviour in relation to cost driver: (variable vs. Fixed)
6. Based on aggregation: (total vs. unit)
7. Based on economic characteristics of costs: ( opportunity costs, sunk
cost, incremental cost /differential cost, marginal cost)
 2. Incremental Costing / Differential Costs
An incremental cost is the increase in total costs
resulting from an increase in production or other
activity.
• For instance, if a company's total costs increase on machine from $32000
to $36000 as the result of increasing its machine hours, output and
revenue increases from $32000 to $40,000, the incremental cost of the
$4000 on machine increases revenue $8000.
• The incremental cost is also referred to as the differential cost. The incremental
cost is the relevant cost for making a short run decision between two
alternatives.
• Differential costs are defined as the difference in total cost between any two
acceptable alternatives. Differential costs are also known as incremental costs.
• differential cost is a broader term encompassing both cost increase and cost
decreases between alternatives.
• But Incremental cost is different from Marginal Cost (economists view), which
is the cost of producing one more unit during a specified time period.
• Differential costs can be either fixed or variable.
 Differential Cost Techniques in Managerial Decisions

• It is a technique used for arriving at managerial decisions

in which only cost and income differences between
alternative courses of action are taken into
consideration.
• This technique is applicable to situations where fixed
costs alter.
• This technique emphasizes on comparing the incremental
costs with incremental revenues for taking a managerial
decision.
• So long as the incremental revenue is greater than
incremental costs, the decision should be in favour of the
proposal.
The areas in which the incremental costing analysis
can be used for making managerial decisions are
1. Whether to process a product further or not.
2. Dropping or adding a product line.
3. Making the best use of the investment made.
4. Acceptance of an additional order from a special customer
at lower than existing price.
5. Optimizing investment plan out of multiple alternatives.
6. Opening of new sales territory and branch.
7. Make or Buy decisions.
8. Submitting tenders
9. Lease or buy decisions
10. Equipment replacement decision.
Incremental Cost Analysis Decisions Sample Problems
Problem 1 - Coleman Company owns a machine that produces a component for the products
the company makes and sells. The company uses 1,800 units of this component in production
each year. The costs of making one unit of this component are
Direct material $7
Variable manufacturing overhead 6
Direct labor 4
Fixed manufacturing overhead 5
The fixed overhead costs are unavoidable, and the unit cost is based on the present annual
usage of 1,800 units of the component. An outside supplier has offered to sell Coleman this
component for $18 per unit and can supply all the units it needs.
Option - (A):
If Coleman buys the component from the outside supplier instead of making it, how much will
net income change? Should Coleman make or buy the component? Use the incremental
approach to justify your answer.
Ans:
Variable cost = $7 + $6 + $4 = $17
Incremental cost savings from not making component (1,800 x $17) $30,600
Incremental cost of buying component (1,800 x $18) (32,400)
Incremental decrease in net income due to buying component $(1,800)

Interpretation: Since net income decreases, Coleman should continue making the component.
 OPTION : (B)

Suppose Coleman could rent the machine to another company for $5,000 per
year. How would your response change to part A? Use the incremental approach
to justify your answer.

Ans:
Incremental cost savings from not making component (1,800 x $17)
$30,600
Incremental Annual rent from machine 5,000
Total 35,600
Incremental Cost of buying component (1,800 x $18) (32,400)
Incremental Increase in net income due to buying component $3,200

Interpretation: Since net income increases, the company should choose to buy
the components.
 3.Target Costing
1. The concept of target costing had its origin in Japan in 1960s as a result of
difficult market conditions.

2. Target costing can be defined as a cost management tool for reducing the
overall cost of the product over its products life cycle . Target costing is a
system under which a company plans in advance for the price points, product
costs, and margins that it wants to achieve for a new product. If it cannot
manufacture a product at these planned levels, then it cancels the design project
entirely.

3. Target costing is an approach in which companies set targets for its costs based
on the price prevalent in the market and the profit margin they want to earn.
Keeping its costs below the relevant targets helps the company generate profit.
Target cost = selling price – profit margin

Where the profit margin is based on cost, target cost can be found as follows:

Target cost = selling price

1 + profit percentage
 For Example

D&D is a denim manufacturer that operates in a very competitive environment. It sells

denim to different companies that manufacture and market jeans under their own brands.
D&D can only charge $2 per metre. If the company’s intended profit margin is 15% on cost,
calculate the target cost per unit. If 30% of the cost per metre of denim is related to direct
materials, what’s the target cost per unit for direct materials.

Solution
D&D wants to earn a margin of 15% on cost, so the following formula shall be used to set the total
target cost per unit.

Target cost per unit = selling price

(1 + profit percentage)

Target cost per unit = $2 per metre = $1.74

(1 + 15%)

 D&D has to keep its cost per unit below $1.74 in order to generate 15% profit margin on cost.
 If 30% of the unit cost is related to direct materials, target cost for direct materials shall be
$0.52 (0.3*$1.74).
 If D&D wants to earn 15% on selling price, the total target cost per unit shall be worked out as
follows:
 Target cost per unit = $2 * (1 – 15%) = $1.70
The primary steps in the target costing process
• The primary steps in the target costing process are:
1. Conduct research.
2. Calculate maximum cost.
3. Engineer the product.
4. Ongoing activities.

• The design team uses one of the following

approaches to more tightly focus its cost reduction
efforts:
1. Tied to components.
2. Tied to features.
 Application of target costing
1. Target costing was developed independently in both USA and Japan in different time periods.
2. Target costing was adopted earlier by American companies to reduce cost and improve
productivity, such as Ford Motor from 1900s, American Motors from 1950s-1960s. Although
the ideas of target costing were also applied by a number of other American companies
including Boeing, Caterpillar, Northern Telecom, few of them apply target costing as
comprehensively and intensively as top Japanese companies such as Nissan, Toyota,
Nippondenso. Target costing emerged from Japan from 1960s to early 1970s with the
particular effort of Japanese automobile industry, including Toyota and Nissan. It did not
receive global attention until late 1980s to 1990.
3. Traditional cost-plus pricing strategy has been impeding the productivity and profitability for
a long time. As a new strategy, target costing is replacing traditional cost-plus pricing
strategy by maximizing customer satisfaction by accepted level of quality and functionality
while minimizing costs.
4. Profit margin may be based on cost or selling price.
5. In most of the industries competition is high which means that prices are determined by the
interaction of market demand and supply which the market participants i.e. producers can’t
change. However, they can control their costs. In target costing, companies leverage their
ability to monitor and control their cost to generate a profit.
6. Target costing can be contrasted with cost-plus pricing, in which companies set price by
adding a profit margin to whatever cost they incur.
7. Target costing is a more effective approach because it emphasizes efficiency in order to keep
costs low. Target costing is particularly useful in industries that have low profit margins and
high Competition.
 Objectives of target costing
1. Downsizing the cost.
2. Making new products compatible to market needs.
3. Motivating the employees to attain target profit.
 Process of target costing

The process of target costing can be divided into three sections:

1. the first section involves in market-driven target costing, which focuses

on studying market condition to identifying product’s
allowable cost in order to meet company’s long-term profit at
expected selling price.

2. the second section involves in performing cost reduction strategies with

the product designer’s effort and creativity to identify the product-
level target cost.

3. the third section is component-level target cost which decomposes the

production cost to functional and component levels to transmit cost
responsibility to suppliers.
Process of target costing
Advantages of Target Costing
1. Induces for innovations
2. Reduces cost
3. Increase spirit of team work
4. Development of right products
5. Enhances the probability of market
success
6. Alings the cost of futures with
customer’s willingness to pay for them
 4. Life Cycle Costing

Introduction :
1. At the start of any project, it is important to understand the costs
involved. Traditional methods simply look at start up costs, cash flow
and profit or loss.
2. Life Cycle Costing topic is a strategic management accounting
techniques. It considers cost of an asset through out its life period.

Meaning:
• The process of identifying and documenting all the costs involved over
the life of an asset is known as Life Cycle Costing (LCC).
• Life-cycle cost analysis (LCCA) is a tool to determine the most cost-
effective option among different competing alternatives (Assets) to
purchase, own, operate, maintain and, finally, dispose of an asset or
process.
 Estimating Life Cycle Costs: Simple Formula
The life cycle cost of an asset can be expressed by the simple formula:

Life Cycle Cost = initial (projected) capital costs + projected life-time operating costs + projected
life-time maintenance costs + projected capital rehabilitation costs + projected disposal costs -
projected residual value.
Or

LCC = Capital + Lifetime Operating Costs + Lifetime Maintenance Costs + Disposal Costs –
Residual Value

LCC differs asset to asset and product to product.

For example: LCC differs asset to asset and product to product.
A company is planning a new product. Market research information suggests that the product should
sell 10,000 units at RM21 unit. The company seeks to make a mark- up of 40% product costs.
It is estimated that the lifetime costs of the product will be as follows :
1. Design and development costs 50,000 ETB.
2. Manufacturing costs ETB per unit 10 ETB.
3. Maintenance cost ETB 30,000.
4. End of life costs ETB 20,000.
Required : What is the original lifecycle costs per unit?
LCC = 50,000 + ( 10,000 units x 10 ) + 30,000 + 20,000.
= 200,000
10,000
 Life Cycle Cost Analysis
A life cycle cost analysis involves the analysis of the costs of a system or a component
over its entire life span. Typical costs for a system may include:
1. Acquisition costs: (or design and development costs).
2. Operating costs:
• Cost of failures
• Cost of repairs
• Cost for spares
• Downtime costs
• Loss of production
3. Maintenance costs:
• Cost of corrective maintenance
• Cost of preventive maintenance
• Cost for predictive maintenance
4. Disposal costs.
A complete life cycle cost projection (LCCP) analysis may also include other costs, as well
as other accounting/financial elements (such as, interest rates, depreciation, present
value of money/discount rates, etc.).
Life Cycle Cost Analysis
 Life Cycle Cost Analysis

1. The asset life cycle begins with strategic planning, creation of the asset,
operations, maintenance, rehabilitation, and on through
decommissioning and disposal at the end of the assets life.
2. The life of an asset will be influenced by its ability to continue to provide
a required level of service. Many assets reach the end of their effective
life before they become non-functional (regulations change, the asset
becomes non-economic, the expected level of service increases, capacity
requirements exceed design capability).
3. Technological developments and changes in user requirements are key
factors impacting the effective life of an asset.
 The objectives of life cycle costing

1. To Minimize the total cost of ownership of the Utility’s infrastructure to

its customers given a desired level of sustained performance;
2. To Support management considerations affecting decisions during any
life-cycle phase;
3. To Identify the attributes of the asset which significantly influence the
Life Cycle Cost drivers so that the assets can be effectively managed;
4. To Identify the cash flow requirements for projects.
 Estimating Future Costs
Knowing with certainty the exact costs for the entire life cycle of an asset is,
of course, not possible; future costs can only be estimated with varying
degrees of confidence. Future costs are usually subject to a level of
uncertainty that arises from a variety of factors, including:

• The prediction of the utilization pattern of the asset over time.

• The nature, scale, and trend of operating costs.
• The need for and cost of maintenance activities.
• The impact of inflation.
• The opportunity cost of alternative investments.
• The prediction of the length of the asset's useful life.
 LCCP Tool Structure

Users of the Tool should follow the flow chart through the various
sequential steps of creating a life cycle cost analysis profile. At each step the
user is able to access knowledge relevant to the particular step. The steps in
the Tool are:
• Step 1 – Define Project Basics
• Step 2 – Develop LCCP Data For Each Project Option
• Step 3 – Analyze Each Option
• Step 4 – Document Analysis
• Step 5 – Review and Finalize LCCP Projections
Useful of Life-cycle Costing Concept
Useful apply to low-technology issues, such as repair versus replace decisions
Eg-the New York State Throughway Authority uses life cycle concept to
determine the point at which it is more expensive to repair than to replace
bridges (Morse, Davis & Hartgraves third edition)
Cost Reduction in LCC
 Advantages and Disadvantages of LCC

Advantages of LCC Improve forecasting

1. The application of LCC technique allows the full cost associated with a
procurement to be estimated more accurately. Improved awareness
2. Provide management with an improved awareness of the factors that drive cost
and the resources required by the purchase. Performance trade-off against cost
3. LCC technique not only focus on cost but also consider other factors like quality of
the goods and level of service to be provided.

Disadvantages of LCC Time Consuming

4. Life cycle costing analysis is too long because of changes of new technology.
5. Costly
6. The longer the project life time, the more operating cost will be incurred.
7. Technology always change day to day.
 COST CONTROL AND COST REDUCTION
Cost Control

Definition of Cost Control

1. Cost Control is a process which focuses on controlling the total cost through
competitive analysis. It is a practice which works / product to maintain the
actual cost in accordance with the established norms. It ensures that the cost
incurred on an operation should not go beyond the pre-determined cost.
2. Cost Control involves a chain of functions, which starts from
• To preparation of the budget in relation to the operation.
• To evaluating the actual performance.
• To compute the variances between the actual cost & the budgeted cost.
• To find out the reasons for the variances.
• To implement the necessary actions for correcting discrepancies.

3. The major techniques used in cost control are standard costing and budgetary
control. It is a continuous process as it helps in analyzing the causes for
variances which control wastage of material.
 Cost Reduction
Definition of Cost Reduction:

Cost Reduction is a process, aims at lowering the unit cost of a product

manufactured or service rendered without affecting its quality by using new and
improved methods and techniques.

• It ascertains substitute ways to reduce the cost of a unit. It ensures savings in per
unit cost and maximization of profits of the organization.
• Cost Reduction aims at cutting off the unnecessary expenses which occur during
the production, storing, selling and distribution of the product.

To identify cost reduction, the following are the major elements:

– Savings in per unit cost.
– No compromise with the quality of the product.
– Savings are non-volatile in nature.
 Tools And Techniques Of Cost Reduction
The following are the widely used techniques of cost reduction:

1. Just-In-Time (JIT) System

2. Target Costing
3.Activity Based Management(ABM)
4.Life Cycle Costing
5. Kaizen Costing
6.Business Process-re-engineering
7.Total Quality Management(TQM)
8. Value chain
9. Bench Marketing
10. Management Audits
Key Differences Between Cost control and Cost Reduction

1. The activity of maintaining cost as per the established norms is known as

cost control. The activity of decreasing per unit cost by applying new
methods of production in such a way that it does not affect the quality of the
product is known as cost reduction.
2. Cost Control focuses on decreasing the total cost while cost reduction
focuses on decreasing per unit cost of a product.
3. Cost Control is temporary in nature. Unlike Cost Reduction which is
permanent.
4. The process of cost control is completed when the specified target is
achieved. Conversely, the process of cost reduction has no visible end as it is
a continuous process that targets for eliminating wasteful expenses.
5. Cost Control does not guarantee quality maintenance, however100%
quality maintenance is assured in case of cost reduction.
6. Cost Control is a preventive function as it ascertains the cost before its
occurrence. Cost Reduction is a corrective action.
 Throughput Accounting
INTRODUCTION:
Throughput Accounting (TA) is a principle-based and simplified management
accounting approach that provides managers with decision support
information for enterprise profitability improvement.

• TA was proposed by Eliyahu M. Goldratt as an alternative to traditional

cost accounting
• TA is relatively new concept in management accounting

It is an approach that identifies factors that limit an organization from

reaching its goal, and then focuses on simple measures that drive behavior
in key areas towards reaching organizational goals.
 Throughput accounting
Throughput accounting uses three measures of income and expense:
1. Throughput (T) is the rate at which the production system produces desired units. When
the desired units are money (in for-profit businesses), throughput is sales revenues less
the cost of the raw materials (T = S - RM) or throughput is net sales (S) less totally
variable cost (TVC), generally the cost of the raw materials (T = S – TVC). Note that T
only exists when there is a sale of the product or service. Producing materials that sit in a
warehouse does not count. ("Throughput" is sometimes referred to as "Throughput
Contribution" and has similarities to the concept of "Contribution" in Marginal Costing
which is sales revenues less "variable" costs).

2. Investment (I) is the money tied up in the production system. This is money associated
with inventory, machinery, buildings, and other assets and liabilities. In earlier TOC
documentation, the "I" was interchanged between "Inventory" and "Investment." The
preferred term is now only "investment." Note that TOC recommends inventory be
valued strictly on totally variable cost associated with creating the inventory, not with
additional cost allocations from overhead.

3. Operating expense (OE) is the money the system spends in generating desired units. For
physical products, OE is all expenses except the cost of the raw materials. OE includes
maintenance, utilities, rent, taxes, payroll, etc.
 Throughput accounting
Organizations that wish to increase their attainment of The Desired Goal should
therefore require managers to test proposed decisions against three questions. Will
the proposed change:

• Increase Throughput? How?

• Reduce Investment (Inventory) (money that cannot be used)? How?
• Reduce Operating expense? How?

The answers to these questions determine the effect of proposed changes on system
wide measurements:

• Net profit (NP) = Throughput - Operating Expense = T-OE

• Return on investment (ROI) = Net profit / Investment = NP/I
• Productivity (P) = Throughput / Operating expense = T/OE
• Investment turns (IT) = Throughput / Investment = T/I
 uniform costing system

• Uniform costing is not a particular method of costing. It is adoption of common

cost accounting principles and methods by member companies in the same
industry so that their cost figures may be comparable.

• Uniform costing can be defined as the ‘use by several undertakings of the same
costing principle and practices’.

• In other words, it is a technique or method of costing by which different firms in

industry apply similar costing system so as to produce cost data which have
maximum comparability. Standard costs may be developed and cost-control is
secured in firm through mutual comparison.

• Relative efficiency and inefficiencies in production may be identified and suitable

steps may be suggested to control and reduce the cost.

• The objectives of uniform costing are to standardize accounting methods and to

assist in determining suitable prices of products of firms which adopt this
 objects of a uniform costing system

1. It provides reliable data for making inter-unit comparisons

of cost performances.
2. It helps to arrive at the cost of production for the industry as
a whole on a common basis acceptable to all individual units
or firm of the industry.
3. It provides data to compare the cost of production and the
production efficiencies between one firm and others.
4. It ensures that the product prices are based on authentic
costing data.
 Application of Uniform Costing (Scope)
Application of Uniform Costing (Scope): Uniform costing may be applied in
two different situations.

(a) Common Control and Management:

Uniform costing may be applied when number of units or firm producing
similar goods and services are under a common control or controlled by the
same group of management.

(b) Trade Associations:

Uniform costing may be adopted by firms or units which are related to a
trade association. Different firm may form an association through which they
may adopt common costing method and practice.
 Requisites of Uniform Costing
Uniform costing can be adopted if certain pre-conditions exists. The success of a uniform
costing system depends primarily on the cooperation extended by different units or firm
towards the working of the system. Every unit should agree to supply required accounting and
costing information without reservation to a central body formed by them for implementation
of the uniform costing scheme.

Following are pre-requisites of uniform costing:

1. Firms or units adopting uniform costing must be ready to provide and share accounting
and costing information freely.
2. They should adopt a common system of costing regarding classification, distribution and
absorption of costs. They must agree on a common technique of costing e.g., absorption
costing, standard costing or marginal costing.
3. The firms must use a common terminology and procedure for cost ascertainment and
cost control.
4. There should not be any restriction from the Government in adopting uniform costing.
5. A central body or proper organisation must be set up for preparing comparative statistics
for the use of member units participating in the uniform costing.
6. Above all, the most important is that units or firms must have mutual trust, confidence
 Advantages and Disadvantages of Uniform Costing

Advantages:
1. It helps in installation of an ideal costing system.
2. Standard norms of operations are set for the industry as whole. Every member unit
can evaluate its performance against these standard norms and strive for betterment.
3. It helps in eliminating cut throat competition in the line of industry and ensures
stability
4. It leads economy and efficiency for medium and large scale firms.
5. It assists in making effective cost control.
6. It provides a suitable basis for making inter firm comparison.

Disadvantages:
7. This technique assumes that all the undertakings in the industry are identical, which is
not possible.
8. The installation of uniform costing is quite expensive and the medium and small sized
units are not in a position to adapt it.
9. uniform costing encourages monopolistic trend in the industry. monopolistic trends
have their own economic and social evil.
 Kaizen costing
Definition:
Kaizen costing is the process of continual cost reduction that occurs after a
product design has been completed and is now in production.
Cost reduction techniques can include
1. working with suppliers to reduce the costs in their processes, or
2. implementing less costly re-designs of the product, or
3. reducing waste costs.
These reductions are needed to give the seller the option to reduce prices in the
face of increased competition later in the life of a product.

• Kaizen costing is a cost-reduction system that is applied to a product in

production. It comes from the combination of the Japanese characters ‘kai’ and
‘zen’ which mean ‘change’ and ‘good,’ respectively. The word ‘Kaizen’
translates to ‘continuous improvement’ or ‘change for the better’ and aims to
improve productivity by making gradual changes to the entire manufacturing
process. Some of the cost-reduction strategies employed involve producing
cheaper re-designs, eliminating waste and reducing process costs. Ensuring
quality control, using more efficient equipment, utilizing new technological
advances and standardizing work are additional elements.
 Process of Kaizen costing
To understand Kaizen costing, one first needs to grasp standard costing
methodology.

1. Kaizen costing is based around improving the manufacturing process on

a continual basis, with changes being implemented throughout the year.

2. Cost-reduction targets are set on a monthly basis.

3. The goal here is to reduce the difference between profit estimates and
target profits.

4. The cost deviation analysis done in Kaizen costing examines the

difference between the target Kaizen costs and the actual cost reduction
achieved.

5. The basic idea here is to make tiny incremental cost reductions on a

continual basis in a product's life cycle.
 Process of Kaizen costing
• Since the goal is to reduce costs on a monthly basis, every department in the company
makes an effort to introduce operational changes on a daily basis.

• The Kaizen approach calls for analyzing every part of the process and generating ideas
on how they can be further improved.

• Kaizen costing takes into account aspects such as time-saving strategies, employee
efficiency and wastage reduction while incorporating better equipment and materials.

• The fundamental basis of the Kaizen approach centers around recognizing that
employees who work on a particular job are aware of how that particular task can be
greatly improved. They are then empowered to do so in the Kaizen costing system.

• Employees are treated as valuable sources of viable solutions, an approach that differs
greatly from the standard cost system that views employees as laborers with variable
performance levels.
Features and Advantages of Kaizen Costing

Features Of Kaizen Costing:

1. Widely applicable.
2. Highly effective and result oriented.
3. A learning experience.
4. Team based and cross-functional.

Advantages of Kaizen Costing:

5. Kaizen reduces waste - like inventory waste, time waste and
workers motion.
6. Kaizen improves space utilization and product quality.
7. Results in higher employee moral and job satisfaction.
8. Teaches workers how to solve everyday problems.
 Inter-firm comparison
Inter-firm comparison is a natural outcome of uniform costing system. Uniform costing is the
foundation stone over which the structure of IFC is developed and adopted in a large scale.

Meaning:
Inter-firm comparison can be defined as the technique of evaluating the relative
performance, efficiency, costs and profits of firms in a given industry’. The
meaning of IFC can be easily explained by considering the main object of the
system.

In other words IFC consists of following procedure:

a) Data are collected from participating organization or firm by their trade organization
or centre of inter-firm comparison.
b) The management of an organisation is provided with information which will allow
them to determine the efficiency being achieved, measured by comparing the
performances of other business.
c) An attempt is made to show why results vary from one business to another, i.e., any
weakness is highlighted.
d) Extensive use is made of financial and cost ratios.
Objectives of Inter Firm Comparison
1. The main purpose of IFC is improvement of efficiency by showing the management of
participating firm its present achievements and possible weaknesses.
2. These firms have to contribute their data to the central body which acts as a neutral
body.
3. This central body ensures confidence and it gives report regarding comparisons only to
participants.

• The main objective of IFC is the improvement of efficiency and identification of

weak points. IFC is a scheme consisting of exchange of information with regard to
cost, profit, productivity and efficiency between the participating firms through a
central organisation. IFC focuses the remedial measure of a number of problems
related to profit, sales and production.

• In inter-firm comparison coordinated and monitored through an apex body

or central organisation, attention is usually concentrated on the following
major important are:
• (i) Is profit adequate?
• (ii) How efficient is selling?
• (iii) How efficient is production?
 Procedure for IFC
The possible procedure may be as below:

1. Firms which are to participate in an inter-firm comparison have to submit their data
to the central body. These figures are compiled on the basis of uniform definitions of
terms, procedures, methods and accounting periods.

2. After all necessary steps have been taken to ensure that the participating firms can
benefit from the comparison, a number of ratios are compiled. These ratios are
shown in a summary form distinguishing.
– (a) Ratios for the group of firm participating in the inter-firm comparison.
– (b) Ratios for a single firm.
– (C) Each firm is given a report compiled along these lines.

3. The ratios for the group and the ratios for the single firm are compared one by one.

4. Once any significant deviation from the norm (average return on capital employed) is
established, the possible reasons for this deviation may be located by examining other
ratios.
ratios in inter-firm comparisons
These additional ratios are briefly explained below:

(A) Ratios of Performance Measurement

(B) Ratios to Judge Profitability
(C) Ratios related to Turnover
(D) Liquidity Ratios
 Advantages of Inter-Firm Comparison
1. Under IFC the weakness of participating firms are revealed and the management will be
guided to remedial actions.
2. The firm will come to know the trend of sales, profit and cost of an industry or trade as
shown by different ratios.
3. Management of participating firm are provided with most significant facts on the basis
of ratios
4. Whether firm is doing better or worse than other firms is made known through the
ratios. The firm can take positive steps to improve efficiency.
5. The experience of the central body is at the disposal of participating firms. This
knowledge can be very valuable in the analysis of performance and profitability of the
firm.
6. Participating firm provide information willingly knowing that this remains confidential.
7. IFC develops cost consciousness among participating firm.
8. IFC leads to avoidance of unfair competition.
9. Inter-firm comparisons and related data help in representing the problem of the industry
to regulating authorities and the Government in an effective and convincing matter.
10. Collective information provided under IFC can help the industry in its negotiations with
trade unions.
 Limitations of IFC
1. It is obvious that inter-firm comparison is useful in improving productivity,
efficiency and profitability. But benefits are obtained only when ratios are
properly calculated and impartially used. The limitations of ratio analysis
should be taken into consideration. It should be noted that a single ratio is of
a limited value and their trend is most important. Moreover the limitation of
uniform costing should also be taken into consideration because uniform
costing provides the very basis of inter-firm comparison

2. It should also not be ignored that certain extraneous factors such as

prolonged strike, power shortage may also adversely affect the performance
of the industry in a particular period. Limitations and short comings of annual
returns and data may also affect the reliability of conclusions.

3. It can also be pointed out that there are practical limitations in the
formation and maintenance of an independent central agency for inter-firm
comparisons.