Costing sem 2.pdf

Prepared By: Bharat M. Prajapati 1

Master of Commerce

Subject: Cost Accounting

Unit-4 (Theoretical Aspect only)

1) Performance Measurement techniques

A scientific put on view used to assess how well an organization or business is

achieving its desired objectives.

Many business managers routinely review various performance measure types to assess

such things as results, production, demand and operating efficiency in order to get a more

objective sense of how their business is operating and whether improvement is required.

How well we are doing

If our processes are in statistical control

If we are meeting our goals

If and where improvements are necessary

If our customers are satisfied

Most performance measures

Effectiveness: A process characteristic indicating the degree to which the process output

(work product) conforms to requirements

Efficiency: A process characteristic indicating the degree to which the process produces

the required output at minimum resource cost.

Quality: The degree to which a product or service meets customer requirements and

expectations

Timeliness: Measures whether a unit of work was done correctly and on time. Criteria

must be established to define what constitutes timeliness for a given unit of work. The

criterion is usually based on customer requirements.

Productivity: The value added by the process divided by the value of the labor and

capital consumed.

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Safety: Measures the overall health of the organization and the working environment of

its employees.

Advantages of performance measurement of techniques

To identify whether we are meeting customer requirements: How do we know

that we are providing the services/products that our customers require?

To help us understand our processes: To confirm what we know or reveal what we

don't know: Do we know where the problems are?

To ensure decisions are based on fact, not on emotion: Are our decisions based

upon well-documented facts and figures or on intuition and gut feelings?

To show where improvement needs to be made: Where can we do better? How can

we improve?

To show if improvements actually happened: Do we have a clear picture?

To reveal problems that bias, emotion, and longevity cover up: If we have been

doing our job for a long time without measurements, we might assume incorrectly that

things are going well.

To identify whether suppliers are meeting our requirements: Do our suppliers know

if our requirements are being met?

Techniques of Goal Setting

Goal setting is a powerful process for thinking about your ideal future, and for motivating

yourself to turn your vision of this future into reality.

SMART Goals

• S – Specific (or Significant).

• M – Measurable (or Meaningful).

• A – Attainable (or Action-Oriented).

• R – Relevant (or Rewarding).

• T – Time-bound (or Tractable).

• Goal setting to play s impotent role in the success or failure of business. Just as captain of

a steamer is guided by route chart and drives the ship on that direction

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2). COST CONTROL

Meaning:

Executive Action by given members of an undertaking to maintain the cost with budget

and/or standards established.

According to CIMA “it is the regulation by an executive action of the costs of operating

an undertaking particularly where such action is guided by cost accounting.

The process of monitoring and regulating the expenditure of funds is known as cost

control.

In other words, it means to regulate/control the operating costs in a business firm.

Features of Cost control

Cost control process involves setting targets and standards, ascertaining the actual

performance, comparing the actual performance with standard, investigating the

variances and taking corrective action.

It aims at achieving the standard.

It is a preventive function.

In cost control, costs are optimized before they are incurred.

It is generally applicable to items which have standards.

It contains guidelines and directive management such as, how to do a thing.

Importance of cost control

Enables firm to achieving defined objective

Proper utilization of firm’s resources

Growth and survival of a firm

Make the organization efficient

Advantages cost control

• It helps the firm to improve its profitability and competitiveness.

• It helps the firm in reducing its costs and thus reduces its prices.

• It is indispensable for achieving greater productivity.

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• If the price of the product is stable and reasonable, it can maintain higher sales and thus

employment of work force.

Disadvantages of cost control

• Reduces the flexibility and process improvement in a company.

• Restriction on innovation.

• Requirement of skillful personnel to set standards.

3) Cost Reduction

Meaning

• The process of identifying and eliminating unnecessary costs to improve the profitability

of a business is known as cost reduction.

Importance of cost reduction

Improves the competitive capabilities and ensures survival, growth and prosperity

Optimum utilization of the resources

Provides reasonable prices to consumers

Preservation of the nations scarce resources

Keeps the price under control charges to consumer

Helps government in controlling inflation.

Features of Cost reduction

Cost reduction is not concerned with setting targets and standards. Cost reduction is the

final result in the cost control process.

Cost reduction aims at improving the standards.

It is continuous, dynamic and innovative in nature, looking always for measures and

alternative to reduce costs.

It is a corrective function.

This is applicable to every activity of the business.

It adds thinking and analysis to action at all levels of management.

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Difference between cost reduction and cost control

COST CONTROL COST REDUCTION

Prevention action(Tries to keep costs confined

to the limits set by norms)

Corrective Action(permanent reduction in the

unit cost of goods mfg

It is the means to an end, namely cost

reduction

It begins where cost control ends

Emphasis the present and past behavior of cost It emphasizes partly on present costs and

mainly on future costs

Lack of dynamism It is a dynamic concept

Establishing budget and/or standard and

initiating remedial action where there is a

deviation of actual results

Establishing by improving upon the standards

and the methods of production

Limited applicability Universal applicability

Tools of technique-budgetary control, standard

costing

Tools of technique-value engineering, work

study, operation research

Techniques of cost reduction

Organization and methods

Work study

Material handling

Automation

Value analysis

Variety reduction

Production control

Design

Materials control

Quality control

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3). Uniform Costing and Inter Firm Comparison

Meaning

Uniform Costing is not a distinct method of costing. In fact, when several undertakings

start using the same costing principles and/or practices they are said to be following uniform

costing. The basic idea behind uniform costing is that the different concerns in an industry

should adopt a common method of costing and apply uniformly the same principles and

techniques for better cost comparison and common good.

The principles and methods of compilation, analysis, apportionment and absorption of

overheads differ from one concern to the other in the same industry; but if a common or uniform

pattern is adopted by all, it helps mutually in cost control and cost reduction. Therefore, it is

necessary that a uniform method of costing should be adopted by the member unit of an industry.

Objectives of Uniform Costing:

Facilitates Comparison: To facilitate the comparison of costs and performances of

different units in the same industry; it provides objective basis.

Eliminates Unhealthy Competition: To eliminate unhealthy competition among the

different units of an industry.

Improves Efficiency: To improve production capacity level and labour efficiency by

comparing the production costs of different units with each other.

Provides Relevant Data: To provide relevant cost information/data to the Government

for fixing and regulating prices of the products.

Ensures Standardization: To bring standardization and uniformity in the operation of

participating units.

Reduces Cost: To reduce production, administration, selling and distribution costs, and

to exercise control on fixed costs.

Advantages of Uniform Costing:

The advantages accruing from the use of uniform costing system are as follows:-

The management of each firm will be saved from the exercise of developing and

introducing a costing system of its own.

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A costing system devised by mutual consultation and after considering the difficulties

and circumstances prevailing in different firms is readily adopted and successfully

implemented.

It facilitates comparison of cost figures of various firms to enable the firms to identify

their weak and strong points besides controlling costs.

Optimum achievement of efficiency is attempted by all the firms by utilising the

experience of other concerns in the industry.

Standing in the industry of each firm wil be known by making a comparison of its cost

data with others.

Services of cost consultants or experts may be available jointly to each firm in the

industry by sharing their experiences and expenses.

Research and development benefits of bigger firms may be made available to smaller

firms.

It helps in the reduction of labor turnover, as a uniform wage system is the pre-condition

of a uniform costing system.

It helps Trade Associations in negotiating with the Government for any assistance or

concession in the matters of taxation, exports, subsidies, duties and prices determination

etc.

Unhealthy competition is avoided among the firms in the same industry in framing

pricing policies and submitting tenders.

Prices fixed on the basis of uniform costing are representative of the whole industry and

thus are reliable.

Uniform costing provide a basis for the comparative assessment of the performance of

two firms in the same industry but in different sectors.

It helps the Government in regulating the prices of essential commodities such as bread,

sugar, cement, steel etc.

Limitations of Uniform Costing:

Sometimes it is not possible to adopt uniform standards, methods and procedures of

costing in different firms due to differing circumstances in which they operate. Hence,

the adoption of uniform costing becomes difficult in such firms.

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Disclosure of cost information and other data is an essential requirement of a uniform

costing system. Many firms do not wish to share such information with their competitors

in the same industry.

Small firms in an industry believe that uniform costing system is only meant for big and

medium size firms, because they cannot afford it.

It induces monopolistic trend in the business, due to which prices may be increased

artificially and supplies withheld.

Inter-Firm Comparison

Meaning

It is technique of evaluating the performance, efficiency, costs and profits of firms in an

industry. It consists of voluntary exchange of information/data concerning costs, prices, profits,

productivity and overall efficiency among firms engaged in similar type of operations for the

purpose of bringing improvement in efficiency and indicating the weaknesses. Such a

comparison will be possible where uniform costing is in operation. 1 Requisites of inter-firm

comparison system : The following requisites should be considered while installing a system of

inter-firm comparison :–

Centre for Inter-Comparison: For collection and analysing data received from member

units, for doing a comparative study and for dissemination of the results of study a

Central body is necessary. The functions of such a body may be :–

i) Collection of data and information from its members;

ii) Dissemination of results to its members;

iii) Undertaking research and development for common and individual benefit of its

members;

iv) Organizing training programmers and publishing magazines.

Membership: Another requirement for the success of inter-firm comparison is that the

firms of different sizes should become members of the Centre entrusted with the task of

carrying out inter-firm comparison.

Nature of information to be collected: Although there is no limit to information, yet

the following information useful to the management is in general collected by the Centre

for inter-firm comparison.

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Information regarding costs and cost structures.

Raw material consumption.

Stock of raw material, wastage of materials, etc.

Labour efficiency and labor utilization.

Machine utilization and machine efficiency.

Capital employed and Return on capital.

Liquidity of the organization.

Reserve and appropriation of profit.

Method of Collection and presentation of information: The Centre col ects

information at fixed intervals in a prescribed form from its members. Sometimes a

questionnaire is sent to each member ; the replies of the questionnaire received by the

Centre constitute the information/data. The information supplied by firms is generally in

the form of ratios and not in absolute figures. The information collected as above is

stored and presented to its members in the form of a report. Such reports are not made

available to non-members.

Advantages of Inter-firm comparison :

The main advantages of inter-firm comparison are :–

Such a comparison gives an overall view of the industry as a whole to its members– the

present position of the industry, progress made during the past and the future of the

industry.

It helps a concern in knowing its strengths or weaknesses in relation to others so that

remedial measures may be taken.

It ensures an unbiased specialized reporting on particular problems of the concern.

It develops cost consciousness among members of the industry.

It helps Government in effecting price regulation.

It helps to improve the quality of products manufactured and to reduce the cost of

production. It is thus advantageous to the industry as well as to the society.

Limitations of inter-firm comparison

Top management feels that secrecy will be lost.

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4). Cost Audit

Meaning:

According to the Institute of Cost and Management Accountants of England, cost audit

represents the verification of cost accounts and a check on the adherence to cost

accounting plan. Cost audit, therefore, comprises:

verification of the cost accounting records such as the accuracy of the cost accounts, cost

reports, cost statements, cost data and costing techniques, and examination of these

records to ensure that they adhere to the cost accounting principles, plans, procedures and

objectives

Types of Cost Audit

Cost audit on behalf of the management

Establishing the accuracy of the costing data, as for example, cost of material used,

allocation of wages into direct and indirect and on different products, functions and cost

centers.

Ensuring that the objectives of cost accounting are being achieved through appropriate

collection, segregation, analysis and compilation of data.

Ascertaining abnormal losses and gains along with the relevant causes, expressed in

financial terms in a manner that the person responsible for such loss or gain is identified.

Determination of the unit cost of production in a precise but practicable manner.

Fixation of contract price and the determination of the additional or supplementary

charge that can be raised against customers for alterations, etc.

Improving the quality of cost accounting system by obtaining the audit observations and

suggestions of cost auditor.

Audit on behalf of a customer:

In case of cost plus contracts, often the buyer or the contracted insists on a cost audit to

satisfy himself about the correct ascertainment of cost.

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More often than not, the provision, for a cost audit in such a circumstance is put in the

relevant contract with the stipulation that the supplier or the contractor wil extend all co-

operations to the cost auditor.

Cost audit on behalf of Government:

Sometimes, government is approached with requests for subsidies, protection, etc. Before

taking a decision the government may prefer to have the cost of production of the product

determined on the basis of cost audit to satisfy itself whether the need is genuine or the

industry seeking assistance is generally efficiently run.

Cost audit by trade association:

Where activities of a trade association include maintenance of a price of the products

manufactured by the member units or where there is pooling or contribution

arrangements, the trade association may require the accuracy of costing information

submitted by the member-units checked.

Statutory cost audit:

This is covered by the provisions of Section 233B of the Companies Act.

Advantages of Cost Audit

Management will get reliable data for its day-to-day operations like price fixing, control,

decision-making, etc.

A close and continuous check on all wastages will be kept through a proper system of

reporting to management.

Inefficiencies in the working of the company will be brought to light to facilitate

corrective action.

Management by exception becomes possible through allocation of responsibilities to

individual managers.

The system of budgetary control and standard costing will be greatly facilitated.

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A reliable check on the valuation of closing stock and work-in-progress can be

established.

It helps in the detection of errors and fraud.

Useful of cost Audit

To Society –

Cost audit is often introduced for the purpose of fixation of prices. The prices so fixed are

based on the correct costing data and so the consumers are saved from exploitation.

Since price increase by some industries is not allowed without proper justification as to

increase in cost of production, inflation through price hikes can be controlled and

consumers can maintain their standard of living.

To Shareholder:

Cost audit ensures that proper records are kept as to purchases and utilization of materials

and expenses incurred on wages, etc.

It also makes sure that the valuation of closing stocks and work- in-progress is on a fair

basis. Thus the shareholders are assured of a fair return on their investment.

To Government -

Where the Government enters into a cost-plus contract, cost audit helps government to

fix the price of the contract at a reasonable level.

Cost audit helps in the fixation of ceiling prices of essential commodities and thus undue

profiteering is checked.

Cost audit enables the government to focus its attention on inefficient units.

Cost audit enables the government to decide in favor of giving protection to certain

industries

Prepared By: Bharat M. Prajapati 13

Linear Programming

Introduction:

An economist faces the problem of making an optimum allocation of resources among

competing projects. A business-planning manager has to decide how many units of each

product be produced to maximize profit subject to constraints on production capacity and

demand for these products. We need a model that can help us to find the best solution in

the context of constraints that are operating on the problem. Linear programming

provides solutions to such problems. The word programming implies planning.

What is Linear Programming?

Linear Programming (LP)

Linear Programming is concerned with the best way of allocating scarce resources among

competing ends. The word optimization is used in the context of either maximizing or

minimizing an objective function. Organizations do have problems such as minimizing

cost of production, or maximizing the profit. The resources that are available in limited

quantities are called constraints and the optimization will have to take place subject to the

constraints the organization has.

Learning Objectives: After reading this module, you will be able to:

Know what is Linear Programming (LP)

Formulate Linear Programming Problems

Use Graphical Method to Solve LP

Appreciate Shadow Prices and Interpret

Appreciate Computer Solutions for Large LP problems

Contents:

1. What is Linear Programming?

2. Steps in formulating LP Problems

3. Solution-Graphical Method

4. Computer Solution

5. A Comprehensive Case on LP

6. Module Summary 7. Review Question

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Steps in formulating LP Problems

Identify the decision variables.

Decision variables are those for which you are trying to find the solution. Identifying the

decision variables is important in solving an LP problem

Formulate the objective function in terms of the decision variables

If the organization’s goal is to maximize profit, the objective function will be a maximization

case. Likewise, in a blending problem, if the aim is to minimize cost, then the objective function

will be a minimization case. At any rate, you must be able to express the objective function in

terms of the decision variables.

Formulate the constraints in terms of the decision variables.

Constraints represent limitations on resources. They will also have to be written in terms of the

decision variables

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STRATEGIC MANAGEMENT ACCOUNTING

What is strategic management accounting (SMA)

Strategic management accounting is defined as ‘a form of management accounting in which

emphasis is placed on information which relates to factors external to the entity, as well as non-

financial information and internally generated information.’

There are various strategic analytical tools that could be used for the SMA, including

benchmarking, balanced scorecards, value chain analysis, and Porter’s value chain model. This

research project reviewed the usage of some of these analytical tools in agriculture.

Strategic management accounting is a type of accounting that focuses not only on internal factors

of a company, but factors that are external. This includes industry-wide financials, averages and

upcoming trends.

The set of managerial decisions and actions that determines the long-run performance of a

corporation. It includes:

Environmental scanning (internal & external)

Strategy formulation

Strategy implementation

Evaluation and control

It focuses on integrating management, marketing, finance/accounting,

production/operations, research and development, and computer information systems to achieve

organizational success.

Benefits of Strategic Management

Clearer sense of strategic vision

Sharper focus on what is strategically important

Improved understanding of rapidly changing environment

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Where is the organization now?

If no changes are made, where will the organization be in one, two, five or ten years? Are

the answers acceptable?

If the answers are not acceptable, what specific actions should management undertake?

What are the risks and payoffs involved?

Strategies management account

A strategy is a comprehensive master plan stating HOW the corporation will achieve its

mission and objectives. There are three types:

Corporate - a corporation’s overall direction and the management of its businesses.

Business - emphasizes improving the competitive position of a corporation’s products or

services in a specific industry or market segment.

Functional - concerned with developing a distinctive competence to provide a company

or business unit with a competitive advantage.