overview of management control systems

8/2/2019 Overview of Management Control Systems

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Chapter-1

Overview of Management Control Systems

Synopsis

1.1 Conceptual foundation

1.1.1 Management

1.1.2 Control

1.1.3 Systems

1.1.4 Management Control System

1.2 Boundaries of Management Control

1.3 Characteristics of Management Control System

1.4 Structural Foundations of Management Control

The objectives of this chapter are:

Explain the need for Management Control Clarify the concept of Management Control Systems Discuss the boundaries of Management Control Focus on the characteristics of management control systems Review the structural foundations of Management ControlPrelude

India stands third, having the largest technically trained

manpower in the world. But theoretical technical knowledge is only

half the story, the other half being its practical applications. With the

liberalization of the Indian economy and globalization, there is now acut throat competition from various corners of the world. As a result,

there is now a race to secure a place for survival. In such a scenario,

Management Controlskills is the cry of the day.

There is some confusion in the use of three words, namely,

Management Control, Operational Control and Financial Control. In

order to understand the full and correct meaning of these words, we

have to first understand each of these words separately and then

discuss their interrelationship, need, cause and effect later.

Management, essentially, is the art and science of optimum

utilization of resources with maximum benefit to the society. When wetalk of resources, the general impression is of the natural resources

{minerals etc.) which are used by industry for making useful things.

However, resources also include men, money, materials, machinery,

and time. Naturally, to be effective, a manager has to control, and

control effectively. And in order to control effectively, he must know

the various alternative methods (or systems).

1.1 Conceptual Foundation

To study the subject, we must first understand the meaning of

three words, namely Management, Control and Systems.


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1.1.1 Management Management refers to the team of people

at the helm of affairs of an organization which is responsible for

running and guiding the destiny of the enterprise. Used as a verb, it

means getting things done through people. Incidentally, for the

purpose of our discussion, we intend to use it as a noun.

An organization is an inanimate creature. It, therefore, needs

people to run it and shape its destiny. These people are its leaders and

are known collectively as the Management. It is headed by a Chief

Executive Officer, who is known by various names namely Managing

Director, Executive Chairman, etc. Below him are a hierarchy of

managers.

The team has the responsibility for planning, organizing,

activating and formulation of the organizations strategies which are

expected to attain its objectives. Apart from this, they are also

responsible for coordination, directing, staffing, and managementcontrol by the use of people and resources (George R. Terry

Principles of Management).

1.1.2 ControlControl means making events conform to plans.

Thus, it presupposes the existence of plans. So, management has to

consciously plan the activities of a firm, namely decide what the entity

should do.

Reports containing information about actual outcomes are then

prepared. These are then compared against plans or norms.

Deviations from plan or norm are then isolated, analysed, and

classified by responsibility centres. Action is thereafter taken based on

the significance of variances, so as to prevent them from reoccurring.

Thus, essentially, control means identification of variances,

their causes, and corrective action.

1.1.3 Systems An organization is a system by itself. It

consists of a number of subsystems. A system may be defined as a

prescribed manner of carrying out repetitive activities. It involves

coordination.

Modem organizations and the environment in which they

operate are becoming more and more complex day by day moreproducts, more players, and rapidly changing technology and

markets. As a result of this complexity, no single individual or group

can evolve a solution which is considered optimal. Consequently,

there arises the need for various systems.

1.1.4 Management Control SystemManagement Control is a

type of planning and control activity that is done in an organization. It

is the process by which management influences other members of the

organization to implement the organizations strategies effectively and

efficiently.

A number of activities are involved in management controlnamely planning, coordination, communication, evaluation, decision


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making, and influencing others behaviour. Management control does

not necessarily mean that actions should conform to a plan. In case

the circumstances are now believed to be different from those

assumed during the preparation of plan, the planned actions may

cease to be appropriate. Thus, management control should anticipate

future situations.

The Chief Executive Officer and his team has the responsibility

for formulating the companys strategies that are expected to attain

the organizations objectives e.g. what business it should remain in or

new business it intends to enter into, or whether it would compete on

cost or quality etc. It is possible that the strategies may look

wonderful on paper. But, unless they are implemented, the

organization has nothing to gain.

Therefore, to stun up, management control system is a

systematic method used by management to exercise control over theimplementation of strategies.

1.2 Boundaries of Management Control

After having discussed in brief the meaning of Management

Control Systems, we next come to the boundaries (i.e. limits) that

distinguishes it from other planning and control systems namely

strategy formulation, operational control and financial control.

Strictly speaking, management control lies between strategy

formulation and operational control. Out of the three, strategy

formulation has been found to be the least systematic, operational

control the most systematic, and management control falling in

between the three. While strategy formulation focuses on the long run,

operational control on short-term operating activities, and

management control lies in between. Strategy formulation is based on

rough approximations of the future, operational control makes use of

current accurate data, and management control is in between.

Although each activity involves planning and control, the degree

varies. Planning is much more important in strategy formulation, both

planning and control processes are of equal importance inmanagement control, while the control process is much more

important in operational control. Financial control is systematic, uses

accurate data, and gives equal importance to planning and control.

The question is how do we distinguish the three terms from

management control? In order to do so, we must first know the

meaning of each of these terms.

Strategy formulation Strategy formulation is essentially a

planning process used by firms for deciding on the goals of the

organization and strategies to be used for achieving the goals.

Goals are the broad overall aims of any organization.Generally, the same are not changed. They may differ from


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organization to organization. Some firms have the goal of achieving a

large market share, in others it may be to earn a satisfactory return,

and still in others (non-profit organizations i.e. schools, colleges, etc.)

it may be to provide maximum service to the society with the available

funds.

There are a number of ways of achieving these goals. Strategies

basically are the plans for attaining the organizations goals. They are

important and comprehensive. Such plans state in general terms the

direction which top management would like the organization to follow.

A firm may choose a number of ways of achieving these goals. In case

the goal is to achieve a large market share, the firm may select such

industries, in suitable geographical areas, and profitable product

lines.

It may bench mark itself against its major competitors. Based

on this, its cost and price structure could be brought in line withthem. It may decide to manufacture and market the products or

market the products of other manufacturers. It decides the emphasis

to be placed on sales promotion, advertising, research and

development etc.

Once a firm has formulated its strategies, it operates in

accordance with it. During the annual strategic planning exercise,

some of these strategies may be reexamined, some may be changed, or

new strategies may be adopted. The need for changing strategies may

arise owing to a threat that is being perceived by the organization or to

benefit from a perceived opportunity.

Ideas to deal with threats or to take advantage of opportunities

may come from any part of the organization and at any time.

Distinction between Strategy Formulation and Management Control

Strategy formulation is concerned with the process of deciding

the organizations strategies while management control involves the

process of implementing strategies. Strategy formulation is an

unsystematic activity because it takes place as and when threats and

opportunities arise and suffice it to say, the same can arise any

moment. On the other hand, there is generally a fixed time table and aseries of steps in accordance with which management control takes

place.

During the process of strategy analysis, few people are generally

involved while in the case of management control, the involvement of

the whole organization takes place.

Operational ControlThe process used for ensuring that tasks

which are specified are carried out efficiently and effectively is known

as operational control. It involves the control of individual tasks.

Incidentally, the rules to be followed for accomplishing the tasks are

prescribed as part of the management control process.Operational control can be achieved through the medium of


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human beings or machines. Computers used in process control,

robots etc. are examples of machines used in operational control.

It must be noted that many operational control activities are

scientific in nature. This means, the relationship between cause and

effect, the action needed to bring an out of control situation back to

the desired state, or the optimum decision, are known within

acceptable limits. The economic order quantity, waiting time and other

techniques of operational research are used in task control.

There are different systems for different types of tasks. We have

the procurement system, sales system, cash management system,

quality control system etc.

Examples of operational control are scheduling of production,

maintenance of personnel records etc.

Distinction between Operational Control and Management Control

Operational Control focuses its attention on specific tasks whichare performed by organizational units while in the case of

management control the attention is on organization units.

Many task control systems are scientific in nature while this is

not so in the case of management control. Management control

involves the behaviour of managers as managers interact with other

managers and this cannot be shown in the form of equations.

Financial Control Financial Control is the process by which

management ensures that an organization carries out its financial

plan effectively and efficiently.

During each year, financial plans are prepared and submitted to

top management for the purpose of review and approval. Once they

are approved, the same is used as yardsticks or norms. Actual

outcomes are then compared to the plan or budget for different levels

of management and deviations ascertained. Variances which are

significant in nature are analysed by causes and responsibility centres

and reported to appropriate levels for information and corrective

action.

Financial control includes control of direct materials, direct

wages, direct expenses, manufacturing overheads, discretionaryexpenses, and revenue control.

Distinction between Financial Control and Management Control

Management control represents the whole while financial

control is a subset of management control.

As a matter of fact, management control involves the

implementation of an organizations strategies; financial control on the

other hand leads to the implementation of financial plans of an

organization.

The focus of management control is neither on the short run nor

on the long run. Financial control is concerned with the short run.


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1.3 Characteristics of Management Control Systems

We have seen from our earlier discussion that the management

control process begins after the formulation of the organizations goals

and strategies. It is a broad concept involving all interrelationships

between managers and their subordinates.

As pointed out earlier, planningand controlare common to all

systems. But planning is basically decision making an intellectual

process of finding out different courses of action, and selection of the

best, to meet the objective. This automatically leads the planner to self

appraisal long term objective plan of action.

An effective management control system must possess the

following characteristics:

1. Strategic Plan and its Communication: There should be a strategicplan and strategies should be communicated to the subordinates

who are responsible for their execution.2. Profit Plan and Budget: A profit plan or budget should exist. This

provides proper direction to the organization, sets forth standards

of measurement, and shows the desired profit-cost relationships. It

should be prepared on the basis of responsibility centres and

communicated to the people down the hierarchy who are

responsible for executing it.

3. Motivation of Subordinates: The subordinates must be motivated toact efficiently and effectively.

4. Effective Management Information System: It is necessary to havean effective management information system so that the

performance of the subordinates are measured and objectively

evaluated.

1.4 Structural Foundations of Management Control

The key pre-requisite to effective design of the management

control system is to recognize the main features of the various sub-

units in an organization. An organization converts inputs namely

money, raw materials, and human efforts into desired outputnamely

profit. The manager exercises control or authority over the inputs, andprocess is responsible for generating the desired output.

A firm is divided into simpler, more homogenous sub-units or

functions or departments. Each of these can be viewed as a process of

convening inputs into desired outputs. For instance, the marketing

department converts these finished goods into rupees or revenue, the

personnel department converts job applicants into supervisors,

salesmen, etc.

Each department is quite different from the other and these

differences are extremely important from the point of view of planning

and control. In describing each subunit of organizations from the viewpoint of designing appropriate planning and control mechanisms, the


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most important attribute of each subunit or department is whether its

outputs can be quantified and measured. The second major

distinguishing feature of various types of departments is whether the

process they use are well defined and understood.

Using these two major considerations, we can identify four types

of departments, as indicated in the under noted process output

matrix.

Known Type I Known Type II

MeasurableOutputs

Most Manufacturingdepartments (Focus onInput-output relation-ship. Efficiency)

Some Staff departments

such as legal, some

marketing departments

(Focus on Output)

Not-Measurable Type III

Some staff departmentssuch as personnel(Focus on Process,Procedures, andPractices)

Type IV

Some R&D departments(Focus on Inputs-Resource Allocation)

Fig. 1.1. Process Output Matrix

In the case of Type I departments, the process is Known and the

output is measurable. They are easiest to manage. Type II

departments where the process is unknown but outputs can be

measured, require control mechanism that focus on the extent towhich desired outputs are achieved. Type III departments are

extremely difficult to manage well. Although one can focus on whether

accepted practices and procedures are being followed carefully and in

a timely manner, it is often impossible to ascertain whether the

desired results are being obtained. Under Type IV departments fall

R&D units which are engaged in basic research. As both the process

and outputs are unclear, the quantity and the quality of inputs or

resources provided to these departments is to be managed.

QUESTIONS1. Why is management control important? (Ref. Prelude).2. What is meant by the term management control? (Ref. 1.1.4)3. (a) Discuss the boundaries of management control. (Ref. 1.2)

(b) Is there any difference between strategy formulation,

management control, operational control, and financial control?

(Ref. 1.2)

4. All Management Control Systems are effective. Discuss. (Ref. 1.3).5. What are the factors that should be considered while designing

management control systems? (Ref. 1.4).


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FORMULA AND BASIC STEPS

While solving the problems relating different chapters the

following Formula / steps / basic knowledge which must kept in

mind.

ELEMENT OF COST AND OUTPUT COSTING

1) When the closing stock of finished goods is not given Finding outclosing finished goods

Opening stock of finished goods x

Add purchase of manufactured goods xx

Add Goods produced during the period xx

xxxxx

Less : sale of goods xxxClosing finished goods xx

2) When the sales are not given Finding out salesOpening stock of finished goods xx

Add purchase of finished goods xx

Add goods produced during the period x

xxxxx

Less Closing stock of finished goods xx

Goods Sold xxx

3) When the goods produced is not givenFinding out goods producedClosing stock of finished goods xx

Add sales (Goods sold) xx

xxxx

Less opening stock of finished goods x

Less purchase of finished goods x

Goods produced / manufactured xx

4) When the opening stock of finished goods is not givenFinding out opening stock of finished goods

Closing stock of finished goods xx

Add sales (Goods sold) xx

xxxx

Less Goods produced xx

Opening stock of finished goods xx

5) Cost per unit =producedunitsofNo

productionofCost

6) Valuation of Closing stock of finished goodsIt is valued at cost per unit


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Value of closing finished goods = Cost per unit closing finished

goods

OR

Closing finished goods =

unitperCost

stockclosingofValue

7) Valuation of Opening stock of finished goodsThere are two methods for valuation.

1) If the purchase price of finished goods are givenIn such case opening stock of finished goods should be

valued at price of finished goods.

Value of opening stock = Opening finished goods

Purchase price of finished goods

2) If the purchase price is not given. In such case opening stockis valued at cost per unit.

Value of opening stock of finished goods = Cost per unit

opening finished goods

8) Selling expenses should be calculated based on the number ofunits sold.

Selling expenses = Number of units sold x selling expenses per unit

sold.

9) Adjustment of opening and closing stock of work in progress beforeworks cost.

10) Adjustment of opening and closing stock of finished goodsbefore cost of goods sold.

MATERIAL CONTROL

1) Re-order level = Maximum consumption Maximum Deliveryperiod RL = MaC MDP

Reorder level = Minimum stock + Average Consumptions (Safety of

stock) during normal delivery

Time (i.e Lead time consumption) i.e. Re-order level = Safety of

Stock + (Average consumption) (Lead Time)

OR

Re-order level = Normal Consumption (Minimum Stock Period +

Average Delivery) NC (MnSP ADP)

2) Minimum Stock Level = Reorder level - (Average Consumption Average Delivery Period) MiSL = RL (AC ADP)

Note :

a) Average Stock =2

Con.MaximumnConsumptioMinimum

(Normal)

b) Average Deliver period


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2

PeriodDeliveryMaximumPeriodDeliverMinimum

Safety Stock =days365

DemandAnnual

(Maximum Delivery period - Normal Delivery period)3) Maximum Stock level = Reorder level + ordering quantity -

minimum (Consumption Minimum Delivery Period)

MaSL = RL + EOQ - (MiC MiDP)

OR

Maximum Stock Level = Safety Stock + EOQ

(Minimum Stock Level + Ordering Quantity)

4) Average Stock level =2

LevelStockMaximumLevelstockMinimum

OR

Average Stock level = Minimum Stock Level +2

1Reorder quantity

5) Danger level = Minimum Consumption Emergency Deliveryperiod

6) EOQ (Economic Ordering Quantity)C

OA2EQOR

C

AO2EOQ

Where A = Annual Consumption

O = Ordering Cost or Buying Cost per order

C = Carrying Cost is storage Or Holding of inventory costs

Note : 1) Carrying Cost includes

Cost of Storage space

Cost of bins

Cost of Insurance

Cost of Spoilage

Cost of Obsolescence

Cost of..........i.e. Evaporation

Interest on Capitals invested

Cost of maintaining the materials to avoid deteriorationand cost storage.

2) Cost of Carrying is Calculated on material cost.

Cost of carrying cost = Material cost x carrying cost


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INVENTORY TURNOVER RATIO

Inventory Turnover Ratio =StockAverage

ConsumedMaterials

Inventory Turnover Ratio in days =

RatioTurnoverInventory

365

Total Inventory Cost = Ordering Cost + Carrying Cost + Purchase Cost

LABOUR COST

1) Labour Turnover Ratea) Separation method =

100periodtheduringworkersofnumberAverage

periodtheduringsSeparationofNumber

b) Replacement method =

100periodaduringworkersAverage

periodainreplacedworkersofNumber

c) Flux method =

100workersAverage

tsreplacemenofNoseparationofNo

2)Time wagesEarning = Time taken Time rate

3) Straight piece rateEarning = Output Piece rate per unit

Note : If the output not given

Earnings = Standard Time allowed Rate per hour

1) Differential piece rate(A) F.W. Taylors Plan

Earnings = output differential piece rate

Differential piece rate

Law piece rate = 80% of piece rate below standard.

High piece rate - 120% of piece rate at or above standard.

(A) Merrick differential piece rate system

Earnings = output differential piece rate

Three piece rates :1) The lowest rate is for the beginners

2) The middle rate is developing workers

3) Highest rate is for highly efficient workers

Rate of remuneration are :

Level of efficiency Rate

Below 83% Piece rate

upto 83% to 100% efficiency 110% piece rate

Above 100% efficiency 120% piece rate

Formula for Calculation efficiency


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Efficiency = 100outputstandard

outputActual

2) Combination of Time and piece rate1) Gantt Task and Bonus system.

Earnings = Time taken Time rate Bonus on Time wages(Time wages)

Wages computed is as follows :

Output Payment / Rate of Bonus

Output below standard Time wages (No bonus)

Output at standard Time wages + Bonus 20% of

Time wages

Output above standard High piece rate

Note: If high piece rate is not given in such case Time wages +

130% of Time wages.

2) Emerson efficiency plan :Earnings is calculated as follows :

Efficiency Payment

Below 3266 % Time wages (No Bonus)

66.66% to 100% Time wages + Bonus 20% of

Time wages

Above 100% Time Wages + 20% Bonus

Time wages + 20% Additional

Bonus for every 1%

Increase in efficiencyEarnings = Time wages + Bonus on Time wages

Time wages = Time taken Time rate

3) Bedaux Point SystemEarnings = Hours worked Rate per hour + Bonus

Bonus = hourperRate100

75

60

SavedPoints

PREMIUM BONUS PLANS :

1. Halsey Plan :Earnings = Time wages + Bonus

Time wages = Time taken Time rate

Bonus = 50% of Time Saved

So earnings = Time taken Time rate + of Time Saved Time rate

2. Halsey - Weir Premium PlanEarnings = Time wages + Bonus

Bonus = hourperRatesavedTime100

33 31

Earnings = rateTimesavedTime100

33rateTimetakenTime 3

1


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3. Rowan Plan :Earnings = Time Wages + Bonus

Bonus = rateTimetakenTimeTimeStandard

SavedTime

Earnings =rateTimetakenTime

timeStandard

savedTimerateTimetakenTime

OVERHEAD

Overhead Absorption Rate =absorptionforBasis

Overhead

(Overhead recovery rate)

Machine hour rate =hoursMachine

Overhead

Machine hour rate =hoursMachine

ExpensesMachine

Labour hour rate =hoursLabour

Overhead

Percentage of material cost = 100MaterialDirect

Overhead

Percentage of Labour Cost = 100hoursLabourDirect

Overhead

Labour hours = Daily working hours No of working days No of

workers in each Department

CONTRACT COSTING

Profit on incompleted Contract :

1) For the Contracts which have just started i.e. If the works certifiedis less than of contract price. No profit is transferred to profit &

Loss A/c. So entire profit retain as Reserve.

2) When the work certified is or more but less than of thecontract price. In such case the following formula is used to

determine the amount credited to Profit & Loss A/c.Profit & Loss A/c =

CertifiedWork

receivedCashProfitNational

3

1

OR

Profit & Loss A/c = receiveCashofPercentageProfitNational3

1

3) When the work certified is or more but less than of thecontract price. In such case 32 of notional profit is transferred to

P&L A/c.

Profit & Loss A/c = CertifiedWork

receivedCash

3

2ProfitNational


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Profit & Loss A/c = receiveCashofPercentageProfitNational3

1

4) If the work completed is 3/4 or rearing completion of the contracti.e. contract is almost complete. In such case profit transferred to

profit & Loss A/c. based on estimated profit.Profit & Loss A/c =

PriceContract

receivedCashProfitEstimated

Work Certified =receivedcashofPercentage

100receivedCash

OPERATING COSTING / SERVICE COSTING

1) Calculation of Number of Cost UnitsIn case of Bus/Passenger Transport.

Total Passenger Kilometer = No of buses Trips Distance

Seating Capacity of each bus No of

days percentage of seat occupied.

OR

Total passenger Kilometer = Total passenger carried during the

period total kilometers run during

the period.

In cased Goods Transport

Total Tonne Kilometer = No of Trucks Trips Distance

Loading Capacity Days percentage

of load Available.Total Tonne Kilometer = Total Tonnes carried Total Km. of

Trips Tonnes carried.

2) Calculation Kilometer runKilometer run = No of buses/Trucks Distance Trips

Days

3) Calculation of Total Passenger carried during the period.Total passenger = No of buses Trips Seating Capacity Days

4) Calculation of Total Tonnes carriedTonnes Carried = Total Tonnes carried during the period Total Kilometer run during the period.

In Case of Hotel

Room/Guest days = No of Rooms No of Weeks or month Days

in a week or month % of Room occupied.

OR

Guest days = No of Rooms No of days in a year No of

beds percentage of room occupied.

In case of Cinema Costing

Men shows = No of seats Daily shows No of days in a

year Capacity weightage.


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In case of Hospital Costing

Patient days = Number of days number of patients.

PROCESS COSTING

1.Normal loss = Input

percentage of loss on onput

2. Scrap = Input percentage of Scrap on input3. Normal output = Input Normal loss Scrap By Product4. Abnormal loss = Normal output Actual output5. Abnormal gain = Actual output Normal output6. Cost per unit =

outputNormal

productsbyofSalevalueScrapcostTotal

MARGINAL COSTING

Contribution = Sales Variable Cost

OR

Contribution = Fixed Cost + Profit

Sales Variable Costs = Fixed Costs + profit

OR

S V = F + P

From the above Equation if out of four three factors are in

the Equation. The fourth factor can be easily find out.

1. If Profit is not givenProfit = Sales Variable Cost Fixed Costor

Profit = Contribution Fixed cost

or

Contribution = Sales V

Pratio

Percentage of Profit = Percentage of margin of safety percentage of

V

Pratio

2. If Fixed Cost is not givenFixed cost = Contribution Profit

or

Fixed cost Contribution + Loss

or

Fixed cost = Total cost Variable Cost

Total Cost = Fixed Cost + Variable Cost

Fixed Cost = BEP Sales V

Pratio

At BEP sales contribution and Fixed Cost are equal. So at BEP

sales Contribution is the fixed cost


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Contribution = Sales V

Pratio

3. If Variable Cost is not givenVariable Cost = Total Cost Fixed Cost

orVariable Cost = Sales Contribution

or

Variable Cost = Sales Fixed cost profit

or

Variable cost in Percentage =SalesinChange

costtotalinChange

or

Variable Cost = Sales percentage of V.C. on Sales.

4. If Sales is not givenSales = Contribution + Variable cost

Sales Price unit =unitsofNumber

BEPatSales

Profit Volume Ratio (V

Pratio or PVR)

1)V

Pratio =

Sales

onContributi

2)V

Pratio =

Sales

CostVariableSales

3)V

Pratio =

Sales

ProfitCostFixed

4)V

Pratio =

SalesinChange

onContributiinChange

5)V

Pratio =

SalesinChange

Loss/ProfitinChange

6) Required Sales =

ratioV

P

ProfitDesiredCostFixed

Break Even Point (BEP)

1) BEP (Sales Value) =

ratioV

P

CostFixed

2) BEP (in units) =unitperonContributi

CostFixed

3) BEP (Sales Value) =unitperonContributi

unitperPriceSellingCostFixed

4) BEP (Sales Value) =(Total)onContributi

(Total)ValueSalesCostFixed


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5) BEP in Sales = Actual Sales Margin of Safety

Margin of Safety

Margin of Safety =

ratioV

P

Profit

Margin of Safety = Actual sales BEP Sales


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Nature and Significance of Cost Accounting

Need for Cost Accounting

Modern era is called the Industrial era. Everywhere there is a

vast development in the field of industry. On account of the

development of the industries, the modern industries require

minimum cost of production and as such maximization of profits. For

this purpose, they depend on the financial statements such as trading

profit and loss account and the balance sheet. But these financial

statements give information as whole. It means the entire industry is

treated as one unit, it is a difficult task to locate the errors. y But

modern management needs much more detailed information than /the

one supplied by these financial statements. Thus the Cost Accounting

has been primarily developed to meet that or the required need of the

management.Cost Accounting is a recent development. It is the branch of

financial accounting. It maintains the records unit wise, processwise,

jobwise, departmentwise. At the end, we can easily control or help in

reduction of costs by preparation of the statements unitwise or

jobwise. So, cost Accounting is developed basically to remove the

limitations of financial accounting.

Limitations Financial Accounting : Financial Accounting

suffers from the various draw backs. They are as follows :

1. Collective Information : Financial Accounting supplies the

information regarding profit and loss to the management collectively.

Where in the whole industry is treated as one unit. But it is a difficult

task for controlling or reducing the cost. Because if the factory is

under loss in any year or profit is decreased, then the management is

to locate the reasons, and also the person responsible. But in financial

accounts no one is. responsible because every person escapes from

his responsibility stating that his department is not responsible.

But in cost accounting the records are maintained units wise,

processwise or job wise and the responsibility can be fixed. It helps for

controlling and reducing the cost.2. Historical in nature : Financial accounts are prepared at the

end of the year. It means, for the whole year expenditure is incurred,

then after closing the accounts or at the end of the accounting year

calculation of how much expenditure is incurred and what will be the

costs per unit is made. There is no proper system of control and

calculation of the day to day cost.

Financial accounting is like a thermometer which can tell us the

temperature of the body only but cannot diagnose the disease.

3. Materials and supplies are not properly controlled.

(No proper methods for the control of materials and supplies)


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There is no proper method for controlling of materials and

supplies, which leads to loss wastages, deterioration, excessive scraps

and misappropriation of the materials.

4. Expenses are not classified : Expenses are not classified,

such as Controllable and Uncontrollable, Direct and Indirect and

Fixed and Variable.

These classifications help in controlling and reducing the cost.

For example: If the profits of the company are decreased as compared

to the previous year, the management has to find out the reasons as

to why the profits are decreased, whether it was due to direct

expenditure or indirect expenditure. But when the expenses are not

classified, it is difficult task to control or reduce the cost.

5. Fails to help in cost reduction : It is not possible to

maximize the profits, since cost reduction is not possible under the

financial accounting system. In the modern era, profits can bemaximized only by increasing the volume of sales and sales can be

increased if the prices charged are competitive and comparatively low.

6. Fails to provide cost information in price fixation : It is

very difficult to fix the prices of production on services, or tenders

because the financial accounts do not provide detailed cost

information.

7. Labour cost is not recorded Jobwise : In financial

accounting, labour costs are not recorded processwise or job wise. It is

very difficult to find out the cost per unit or process or job. There is no

system of incentives which may be easily used to compensate the

workers for their above standard performance.

8. Fails to provide information for appraisal and comparison :

Financial accounting does not provide information to the management

for appraisal and comparision of the profits under alternative

methods. Not only this, even it fails to provide useful information to

management for taking vital decisions such as replacement of labour,

introduction of new techniques or make or buy the products etc.

COST ACCOUNTINGIntroduction :

There is a quick deriving worlds of economic activity in this

modem world, when the competition is the deciding fate of commercial

and industrial units. Price of commodity or a service is the instrument

to measure its success or failure. If price is a policy, cost is the

determent of this price. It is the cost which makes a unit to flourish or

to kiss the dust. That is why every management should keep abreast

of its cost structure. So that it can create, substain and extend the

demand for them. Therefore cost acts as the spring board to take a

jump in the deep water of the business. Cost is the very foundation on


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which the super structure of business can be built. Cost, Costing,

Cost Accounting and Cost Accountancy

These three terms are often used interchangeably. However,

there is a definite distinction between these terms which should be

kept in mind while using these terms.

Cost :

For a common man cost of a meal is its price, and price implies

value expressed in terms of money. In fact, it should mean cost of

preparing and making the product (meals) ready for consumption.,

Therefore cost means a sacrifice. It is the amount of expenditure

incurred, on a given thing or in rendering service. It is nothing but on

outlay. In other words, it is the amount spent on given item.

Definitions :

1. W.M. Harpur A cost is the value of economic resources used as aresult of producing or doing the thing costed.

2. I.C.M.A. London Cost is the amount of expenditure incurred on orattributable to a given thing.

3. According to Oxford Dictionary, Cost is the price paid forsomething.

4.The committee on cost concepts and standards of AmericanAccounting Associations defined cost as follows :

Cost is a foregoing, measured in monetary terms incurred or

potentially to be incurred to achieve a specific objective.

5. Gordon Shilling Law defined Cost presents the resources that havebeen or must be scarified to attain a particular objective.

The resources may have tangible (e.g. Materials, Machinery)

or they may take the form of services (e.g. wages, rent power or

time spent).

Thus cost is the amount of resources given up in exchange

for same goods or services. The resources given up are generally in

terms of money or if not in terms of money, they are always

expressed in monetary units.

The term cost is a generic term purposely defined and used

in a variety of ways so as to encompass all the various types ofcosts. So the word cost is used in such a wide variety of ways that

it is advisable to use it with an adjective or phrase which will

convey the meaning intended.

Cost, Expenses, Loss

These are three different terms.

COST

It is the amount of expenditure incurred on or attributable to

cost, objective. It is a measure of resources that is or must be

sacrificed for a cost of objective, E.g. Factory overhead (manufactory

overhead is treated as cost) i.e. Asset included in the cost of finishedgoods inventory which is an asset unless sale is made as it is.


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DEFERRED COSTS

Deferred costs are the expenses, incurred but the economic

benefit is not received during the accounting period. Generally, it is

shown on the asset side of the Balance Sheet.

Examples :

Acquisition of plant & Machinery, Building Equipment cost of

inventory.

Prepaid rent and Insurance.

EXPENSES OR EXPIRED COSTS

When the amount is spent and the economic benefit is received

immediately is called expenses. It is charged to profit and loss a/c it is

also called as expired costs. Expired costs (expenses) are properly

deducted form the revenue to calculate the net income.

Expense is incurred that is used up in generating revenues. It is

paid or a promise to pay made for the benefits obtained.Examples of Expenses

Selling expenses

Distribution expenses

Administrative expenses.

Expenses may be described as the gone asset i.e. as the benefits

or resources used for of securing revenue.

LOSS

When the actual expenses exceed the incomes is called loss. In

other words no benefit is received from the cost incurred.

Thus when there is no matching concept (matching of revenues

and expenses) of economic benefit for expired cost is called loss.

Which is charged to Profit & Loss A/c.

Chart showing cost expenses and loss

Expenditure

Cost

Deferred Cost Expired Costor

Unexpired Cost

Balance Sheet Expenses Loss

Profit & Loss A/c


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Types of Costs

or

Different Cost Concepts

1) Historical Costs :

These costs are ascertained or collected after they are incurred.

These costs are past events or past mortem costs.

2) Future costs :

The costs which are expected to be incurred at a later point of

time.

3) Replacement cost :

It is the cost of replacement in the currentmarket.

In otherwords

Current cost of replacing an asset is based on the assumptions

that if the asset is replaced now the current market value will be

incurred for its replacement.4) Standard cost :

It is a predetermined cost based for each element of cost viz

material labour and overheads based on scientific study.

5) Estimated Cost :

It is an approximate assessment of what the cost will be. It is

based on past experience adjusted to anticipated future changes.

6) Product Cost :

The Cost which can be directly charged allocated and

apportioned to a product is called product cost.

7) Production Cost :

Prime cost plus absorbed production overhead is called

production cost.

8) Direct Cost :

The costs which can be identified with a specific product,

process and departments are called Direct Costs.

9) Prime Cost :

The aggregation of direct material cost, direct labour cost and

direct expenses is called Direct cost or Prime cost.

Note : According to the terminology of ICMA Landon The term directexpenses has been excluded from Prime Cost recently.

10) Indirect Cost :

The costs which cannot be identified to particular department

are called indirect cost.

11) Fixed Cost or Period Cost :

Fixed cost is a cost which does not change in total for a given

period of time despite the wide fluctuation in output. It is called

overhead / Expired cost.

These costs (Total amount) will remain the same irrespective of

output. Such costs are incurred for a period and that is why they arecalled period cost.


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12) Variable cost :

The cost which changes with the level of activity or output is

called variable cost.

In other words variable costs are the costs that vary directly and

proportionately with the output. E.g. Direct Material cost, Direct

Labour Cost.

13) Opportunity Cost :

The Maximum possible alternative income that is earned if the

resources are applied to some alternative use.

In other words, Opportunity cost is the cost of selecting one

course of action in terms of the opportunities which are given up to

carry out that course of action.

Definition :

Edward Hermanson and Salmonson define an opportunity cost

as the benefits lost by rejecting the best competing alternative to theone chosen. The benefit lost is usually the Net earnings or profits that

might have been earned from the rejected alternative.

From the above definition it is clear that the opportunity cost of

any asset is the amount that can be received if the asset is utilized in

its next best alternative. Opportunity costs are often market values.

In short, Opportunity cost is the value of a benefit, sacrificed in

favour of an alternative course of action.

14) Controllable cost :

It is the cost which can be controlled by managing properly at a

given organizational level E.g. Indirect labour, Power Costs.

15) Non-Controllable Cost :

The costs which are not controlled at any level of managerial

supervision.

16) Imputed cost or Notional Cost :

The costs which are not actually incurred but considered in cost

accounts are called Notional Cost.

According to ICMA London Notional cost as the value of a

benefit where no actual cost is incurred.

Examples of Notional Costa) Notional Depreciation :

It is fully written off in respect of asset but still having some

useful life.

b) Notional rent is charged on own premisesc) Provision for Interest on Own capital but actually no interest

is paid.

17) Joint Costs or Common Costs :

Joint costs arise where the processing of a single raw material

or production resources results in two or more different products

simultaneously.


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In other words when the raw materials are processed two or

more products are obtained, such products are known as Joint

products. Expenses on raw material is called Joint Cost.

Thus Joint Cost is the cost of two or more products that are

produced simultaneously by a single process and are not identifiable

as individual types of products until a certain stage of production

known as the split-off point is reached. Joint costs are distributed to

different products on suitable bases.

In short Joint Costs are total costs incurred upto the Point of

Separation.

Examples of Joint Cost

Kerosene

Fuel Oil

Gasoline

CoalFlour mill

18) Sunk cost and Sunk Loss :

These costs are the past costs, which are not taken into account

in decision making. In other words a cost which incurred or had been

already sunk in the past and is not relevant in a particular decision

making at the present time.

This is an irrecoverable cost as a result of discarding of an

asset. Thus, the Written Down Value (WDV) of a machine less

realizable value of scrap is the sunk cost and will not be taken into

consideration in the machine replacement decision. The loss will be

treated as the Sunk loss.

19) Programmed Cost :

These are costs relating to the top management decision for

example company incurred the expenditure under the government

programmes. E.g.

1) 20 Point programme initiated by the government.

2) Some of Employees will send to foreign trip for business. 20)

20) Differential Cost :

Change in total Cost from one level to another level of activity iscalled Differential Cost. It is also called incremental Cost. In short

It is the difference in total cost between alternatives calculated

to assist the decision making.

21) Discretionary / Managed Cost / Policy Cost

Expenditure incurred for Research and Development policy is

called policy cost.

These cost are of fixed nature and incurred in accordance with

the certain policy decisions of top management. These costs may not

have any particular relation to current level of activity i.e. Input and

output. Even expenditure may be incurred in excess of currentrequirements.


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Examples :

Research and Development

Employee Training programme

Advertising

Sales campaign

Donations etc.

There costs are also called managed cost.

In USA it is called programmed cost.

22) Conversion Cost :

The Cost or expense which is incurred for converting the raw

material into finished product is called Conversion Cost.

Examples :

Direct Labour

Direct Expenses

Factory OverheadIn other words Total amount of direct wages and Production

overhead in connection with converting raw materials into work-in-

progress and finished goods.

Note : Direct material cost is not included.

23) Relevant Cost :

The Costs which is appropriate to a specific management

decision is called Relevant Cost.

24) Set down cost :

The Cost incurred will be continued even if the plant is

temporarily shut down.

Examples :

Rent & Rates

Taxes

Maintenance

Depreciation

25) Postponable Cost :

The Cost which can be shifted to the future is called

postponable cost.

26) Out Pocket Cost :While imputed costs do not involve cash outlays, out of packet

costs signify the cash cost associated with an activity. Non-Cash

costs, such as depreciation are not included in out of packet costs.

In other words the cost which involves the cash outflow due to a

particular management decision.

Example : Depreciation on asset is an item of cost which will not

form part of outpocket cost, because it does not involve cash outflow.

27) Marginal Cost :

It is the cost of one unit of product of service. In other words, it

is the total of direct material, direct wages, direct expenses and


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variable overheads in relation to product or service, or process or

departments.

28) Traceable Cost :

A cost which can be directly identified with cost unit or cost

centre is called Traceable cost.

29) Capacity Cost :

It is an alternative term used for fixed cost. It represents costs of

providing facilities of a system for a particular period.

30) Committed Cost :

It is a fixed cost which advises on account of decisions of prior

period. The amount of committed cost is fixed by decisions which are

made in the past and are not subject to managerial control in the

present.

Example : Insurance Premium

RentDepreciation

31) Avoidable Cost :

It is the specific cost of an activity of business which can be

avoided if the activity did not exist.

32) Decision Driven costs :

The Costs incurred as per the policy decisions which will

continue to be incurred until the decisions are changed. Such costs

are not changed with the changes in the output.

33) Target Cost :

A Product cost is estimate on the basis of competitive market

prize. Such costs are called target cost.

34) Quality Related Costs :

The expenses incurred for ensuring and assuring quality are

called Quality costs.

35) Social Responsibility Cost :

In order to produce or provide social responsibility some

expenses are incurred. Such costs are social responsibility costs.

E.g. Pollution by industrial effluent.

ACCOUNTANTS AND ECONOMISTS CONCEPT OF COST

The term cost is wider in economics than in accounting. Both

discipline take into account all costs the organization actually incurs.

Accountants concept of Cost

Generally cost means expenses incurred for production of goods

and services. In other words Accountants cost is the cost incurred by

a firm on the factors/inputs hired by it from outside.

According to accountants cost includes cost of material, labour,

depreciation, interests and other expenses.

Thus the term cost in managerial sense includes that arerelated with production and selling of the organizations goods and


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services. / In short, companys revenues less the cost that are

incurred by producing and selling the goods and services sold equal

profit or loss.

The owners of the company decide how to use this profit. Profit

can be distributed to the owners, or they can be left in the

organization to finance further investment. The partly or total

distribution of profit to the owners provides them an interest return

for the financial means they invested in to the company. Hence, cost

in a managerial sense do no include interest for the owner s

investment into the company. These interests have to paid from profit.

In business management returns to owners have to paid from

profits.

Economist Concept of Cost

Cost means price, price means value expressed in terms of

money.Economic cost includes accounting cost and the cost the firm

would have incurred on those factors or inputs which are contributed

by entrepreneur.

According to economist cost is an opportunity cost. In

economics cost includes an adequate interest return on the capital

invested by the owners. Opportunity costs are the costs or

compensation for not exploited alternative opportunities. Thus

economics take into considerations that the owners could invest their

money differently than into his particular organization e.g. Bonds,

Shares Funds, property etc. As compensation for the (Secure) interest

returns the owners would get from these alternative investments, the

economist allocates an adequate interest return on the capital

invested into a company to the owners. Hence costs in an economical

sense includes all those costs that are necessary to keep the company

in business including a compensation for owners.

A famous economist J.M. Clerk in his book stated that Studies

in the economics of overhead costs is indicative of the fact that the

term cost has a wide variety of meanings and as such the same

should be defined and understood in its proper context. For example,To Customers,

Cost is the price he pays for a commodity

To the Economist

Cost includes explicit or accounting costs and also the imputed

costs.

Engineers

The engineer is concerned with the comparisions of total cost for

different kinds of plant.

Psychologist

The psychologist is concerned with psyctic costs of the nature ofmental dissatisfactions.


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Sociologist

Sociologist is concerned with the social costs. Such as the some

nuisance of a factory.

Distinguish between Accountants cost and Economist Cost

It is important to differentiate between accountants cost and

economic cost.

Points Accountants cost Economists Cost

1 Importance 1 The accountants view of cost

stresses out of pocket

expenses historical costs,

depreciation and other book

keeping entries

1 Economists focus on more

opportunity cost.

2 Labour costs 2 Expenditures on labour are

current expenses and hence

cost of production.

2 Labour is an explicit cost.

Labour services are contracted

at some hourly wage and it isassumed that this is also what

the labour could earn in

alternative employment.

3 Capital costs 3 Accountants are the historical

price of capital and apply

some depreciation rate to

determine current costs.

3 Economists refer to the

capitals original price as a

Sunk cost and instead regard

the implicit cost of the capital to

be what someone else would

be willing to pay for its use.

4 Cost ofEntrepreneurial

services

4 Accountants believe that theowner of a firm is entitled to

all profits. Revenues or losses

left over after paying all inputs

costs.

4 Economists consider theopportunity cost of time and

funds that owners devote to the

operation of their firms. Part of

accounting profits would be

considered as entrepreneurial

costs by economists.

5 Distinction of

costs

5 Costs are not distinguished. 5 Costs are distinguishes such as

fixed cost and variable costs.

6 Type of cost 6 It is a partial cost 6 It is a full cost

COSTING

As per the words of I.C.M.A. of London costing is the

Techniques and processes of ascertaining costs. These techniques

are the rules and regulations to govern or regulate the process of

ascertaining the costs or services. Therefore these rules and

regulations are carried from unit to unit immediately to the industry

and to the formation of policy. Thus costing is a routine work of cost

ascertainment.


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COST ACCOUNTING

Cost accounting means recording of expenditure and income in

a systematic way would be useful in arriving at the cost of production

process, etc.

Definitions :

Van Sickle defined Cost Accounting is the science of recording

and presenting business transactions pertaining to the production of

goods and services whereby these records become a method of

measurement of a means of control.

Gordon shilling law Cost Accounting is defined as the body of

concepts methods and procedures used to measure, analyse, or

estimate the cost profitability and performance of individual products

departments and other segments of a companys operations for either

internal or external use of both and to report on these questions to the

interested parties.According to H.J. Wheldon : Cost Accounting is the classifying,

recording and appropriate allocation of expenditure for the

determination of the costs of products or services, the relation of these

costs to sales values and the ascertainment of profitability.

Stallmen and Russel define to cost accounting as that portion of

the accounting discipline concerned the development of cost

information related to the activities of an economic entity. This

information may be estimated future costs developed for planning

purposes or accumulated actual costs directed toward the evaluation

of performance. It may emerge some what routinely out of a carefully

designed system which has been developed to provide information

regarding recurring activities or be the result of a special cost study

directed to an objectives not considered in the design of a regular

system.

According to Morse : Cost Accounting is the processing and

Evaluation of monetary and non-monetary data to provide information

for external reporting, internal planning and control of business

operations and special analysis and decisions.

According G. Gillespie : Cost Account is a set of procedures fordetermining the cost of product and various activities involved in its

manufacture and sales and for planning and measuring performance.

According to Charles T. Hongren : Cost Accounting is a

Quantitative method that accumulates, classifies summarizes and

interprets information for three major purposes :

a) Product Costingb) Operational Planning and Control andc) Special Decisions.

Gerald E. Nicholas defines Cost Accounting as a system of cost

accumulation and classification of product costing and managerialplanning control and decision making purposes.


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ICMA London defines cost accounting as Process of accounting

for cost from the point at which expenditure is incurred or committed

to the establishment of its ultimate relationship with cost centres and

cost units. In its widest usage, it embraces the preparation of

statistical data, the application of cost control methods and

ascertainment of profitability of activities carried out or planned.

From the above definitions, it is clear that cost accounting is the

process of accounting for costs which begins with the recording of

income and expenditure and ends with the preparation of statistical

data.

The cost accounting provides data on the costs incurred in the

distribution of product, and in the administration of the organization.

Cost accounting consists of the methods and procedures

applied to ascertain actual costs for the activities performed in a

business enterprise. Cost accounting provides a means of evaluating aproposed activity by analysing its different cost generating

components and determining cost estimates those components and

for the overall activity.

Thus cost accounting is used to accumulate costs and report

business activities to the needs of management and should be

adaptable to the changing and specific requirement and management

style.

Cost Accounting is the science, art and practice of cost control

of a cost Accountant.

SCIENCE

It is a science because it has its own set of principles which are

applied to solve the problems of commerce and industry.

In other words, Science, includes the systematic knowledge

which a cost accountant should process for proper discharge of his

responsibilities.

ART

It is also an art because it demands a commanding ability,

talent, skill, rich fund of knowledge to solve the problems. These

problems include the ascertainment of costs, control of costs,ascertainment of profitability, replacement of plants by new and

improved ones, etc.

PRACTICE

It is a practice as it warrants ceaseless efforts of presenting the

information to suit the needs of management in making vital decision.

Thus Cost Accounting is a specialized branch of accounting that

pertains to the activities of classification, accumulation, assignment

and control of cost. Broadly, cost accounting includes three things:-

(1)Cost ascertainment(2)Cost presentation(3)Cost control


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COST ASCERTAINMENT

The main object of cost accounting is to ascertain the cost of

production of goods, services and jobs. First of all the expenses

incurred are collected and classified for calculating the cost of

production. Then these expenses are presented in the form of cost

sheet for ascertaining cost of production.

COST PRESENTATION

It provides the cost data to the management. Cost data helps

the management to take vital decisions. It involves the presentation of

right cost data to the right personnel, at the right time in the proper

form. It presents data in the form of statement called the Cost Sheet.

COST CONTROL

Cost control is the guidance and regulations by executive action

of the costs of operating of the undertaking. Cash Control is achieved

by setting the targets of performance, collecting actual cost forachieved responsibility. Comparing actuals with targets and reporting

to the management about variation from targets so that necessary

action is taken on responsible employees in respect of controllable

items. For controlling the cost, the following steps are taken :

(1)To fix the production and expenses target(2)To compare the actual production or expenses with standard and

to find out the differences.

(3)To find out the reasons for the variances.(4)To take the action to eliminate the variances.

Cost Control and Cost Reduction One should not get confused

with cost control and cost reduction are not one and the same.

Meaning of Cost reduction :

The achievement of real and permanent reduction in the unit

cost of goods manufactured or services rendered without reducing the

quality of the product.

Therefore cost reduction is not cost control.

Differences between Cost Control and Cost reduction

Cost Control Cost Reduction

1 It is the effort towards achieving the costreduction.

1 It is the final result

2 It is a preventive function 2 It is a corrective function

3 It is not dynamic approach 3 It is a dynamic and continuous approach

4 The process of cost control is to set up a

target like any other control measure

4 It is the final achievement in the process

of cost control

5 Cost control assumes existence of

standards

5 It assumes existence of concealed

potential savings in the standards which

are challenged and costs are reduced


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SCOPE OF COST ACCOUNTING

(coverage of the study of cost accounting )

Scope of cost accounting means what exactly we study in cost

accounting. So the scope of cost accounting is wide. It covers the

following aspects.

1) Cost ascertainment2) Cost presentation3) Cost control.

The above points have already been explained

Difference Between Costing and Cost Accounting :

One should not get confused with the words Costing and Cost

Accounting. These words are used interchangeably in common usage.

There is a vast difference between these two terms. Costing is

arithmetic process employed to find out the cost of a product or

service.Cost Accounting denotes frame work for ascertaining cost and is

employed to forecast and control costs. It is a very comprehensive

term.

Therefore, we can say that Cost Accounting is costing but only

costing is not Cost Accounting. In other words costing is the childhood

state of cost accounting.

COST ACCOUNTANCY

It is the widest of all terms and it embraces not only Costing

and Cost Accounting but also Cost Control, Cost Audit and Budgetary

Control.

Definition

ICMA London defined Cost Accountancy as the application of

costing and cost accounting principles methods and techniques to the

science, art and practice of cost control and ascertainment of

profitability as well as presentation of information for the purpose of

managerial decision making.

According to the above definitions the term Cost Accountancy

includes costing, cost accounting, Budgetary Control and Cost Audit.

Cost Accountancy is used to describe the principles,conventions techniques and systems which are employed in a

business to plan and control the utilization of its resources.

Cost Control

Cost control is the guidance and regulation by executive action

of the costs of operating and undertaking.

Budgetary Control

It means the fixation of budgets or estimated cost and

comparison of actual cost with the budget fixed.

Cost Audit

Cost audit is the verification of the correctness of cost accountsand check on the adherence to the cost accounting plan.


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NATURE OF COST ACCOUNTANCY

Cost accountancy is a science an art and a practice

SCOPE OF COST ACCOUNTANCY

It has a vast scope. It includes many aspects. They are

Costing

Cost Accounting

Cost Control

Budgetary Control

Cost Audit

The above points are already explained.

Distinction between Cost Accounting and Cost Accountancy

Points Cost Accounting Cost Accountancy

1 Objectives 1 The main objective of cost

accounting is to ascertain the

cost of production andprofitability of the industry

1 The main objectives of cost

accounting are to ascertain the

cost of production profitabilityof the industry and to help in

controlling the cost.

2 Term used 2 This term is used in the

narrow sense as it records

expenditure, incomes and

allotment of costs to the cost

centres for ascertaining only

cost of production

2 It is a widely used term which

includes costing, cost

accounting and cost

accountancy.

Aims or Objectives of Cost AccountingMost specifically cost accounting is charged with four tasks.

However, the authors like T. Long, Wildson, Big, and even some

Indian authors have given as many as 20 objectives. Keeping aside the

tug, we can see that reflective of all the projective objectives of cost

accounting in the letters of the word AIMS.

In other words there are four main objectives of cost accounting.

A = Ascertaining and analysing cost and income.

I = Insists on cost control or Inventory control.

M = Matching costS = Securing control over cost and operating efficiency.

A = Ascertaining and analysing cost and income :

The first aim is to ascertain and analyse cost and income of a

given enterprise with the intention of having comparison of divisions

at a given level of activity. So that it is possible to assess, the

operating efficiency of each division, department, product etc. Cost

accounting has developed a definite procedure, for analysising,

productwise, customerwise etc.

I = Inventory valuation or Insist on cost control :

Second aim is to accumulate and utilize the cost data for thepurpose of controlling cost. The object of control is to maintain the


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cost at minimum point, cost control consists of examination of each

element of cost, in the light of benefit obtained. So that each rupee

spent brings back optimum return. Such control is achieved through

budgeting, budgetary control and standard costing.

M = Matching Cost :

The third aim is to have matching cost and revenues. It is

important that cost and income data should present the various of

elements cost with reference to the sales for a given period of time.

S = Securing control over costs and operating efficiency :

Costs are classified and records are maintained jobwise,

processwise. Standard time is fixed for completion of work. If the work

is not completed within the stipulated time, necessary action should

be taken against such workers.

Secondly the workers who complete the work within the time

stipulated, for them incentives should be provided. In this way costand efficiency are controlled.

FUNCTIONS OF COST ACCOUNTING

In order to realize the objectives cost accounting has to perform

the following functions.

1) Recording : Cost Book Keeping2) Cost Analysis3) Cost Control4) Cost Comparison5) Quotation6) Cost Planning7) Cost budgeting8) Reporting9) Providing cost information for decision making

1) Recording :

Recording of relevant transaction is the primary function of cost

accounting. Various accounts are maintained according to the

principles of cost accounting. This helps for ascertainment of cost.

2) Cost Analysis :

It means costs are classified into different groups, viz. directcost and indirect cost; normal cost or abnormal cost, etc.

3) Cost Control :

Cost accounting establishes ideal standard costs. Afterwards

comparison of standard cost with actual cost and analysis of

variances to their causes and remedial measures.

4) Cost Comparision :

This is the function of comparing of cost for ascertainment of

profitabilities, projects, proposals, plans and actions. This comparison

helps to take the right decisions at crucial points of time.


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5) Quotation :

It estimates the cost of job or work order more scientifically to

quote the price.

6) Cost Planning :

Each element of cost should be properly planned and expenses

incurred accordingly. The overall cost planning helps the management

in order to activate the objectives.

7) Cost Budgeting :

This function helps to formulate the cost budgets. The budget

means fixing the overall limit of expenses and the cost information

guides to be within the set framework.

8) Reporting :

Revealing and reporting inefficiencies of various elements of cost

units, cost centres, products etc to management.

9) Providing cost information for decision making

ORIGIN AND GROWTH OF COST ACCOUNTING

The evolution of cost accounting is a major progress of human

civilization.

There is evidence that costing was practiced by the Sumerians

in Mesopotamia in 5000 B.C. and it was well-developed in Florence in

the middle-ages. It is reasonable to assume that people at different

periods employed some measures of cost accounting at least to

ascertain the prices to be charged to customers.

The earliest reference to cost accounting is traceable in Robert

Loders accounts 1610-20.

Until 1800 cost accounting was in the domain of the engineer,

because the first book devoted to cost accounting with the title

Factory Accounts was published by Emile Garcke and J.M. Fells in

1883. The work includes as an appendix, a summary of the factory

and workshop Acts of 1878 and 1883. However, electrical and

mechanical engineers were concerned initially with cost records and

with cost accounts. As such memoranda by engineers for engineers

were too important to be left to accounts.Continuous efforts were put to improvise system of cost

accounting both in theory and practice.

A comprehensive book on Cost Accounting Theory and practice

was published by J.L Nicholson from New York in 1913.

The most rapid developments in cost accounting took place after

1914 with the growth of heavy industry and mass production

methods, when costs (i.e. overheads) other than materials and labour

constituted a significant portion of total cost of production. The

scientific management movement led by Taylor gave impetus to the

development of cost accounting because it contributed to the use of


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standard costs in planning manufacturing operations and in

evaluating performance.

The institute of cost and works accountant was established in

U.K. in 1919 to give a proper shape to the cost accounting profession.

In India Institute of cost and works accounting come into

existence through on act passed in the parliaments in 1959. Its head

office is in Kolkotta.

Most importance was given to cost accounting when the

Government of India introduced cost audit under section 233-B of the

Indian companies Act, 1956 and framed cost accounting record rules

in 1968 for this purpose.

At present 44 products come under the fold of cost audit and

the companies producing these products have to maintain cost

accounting records and subject the same to cost audit every year.

Advantages of cost accountingCost accounting is a tool of management. It provides

management with records of the costs of products, operations or

functions. It compares actual costs and expenses with predetermined

budgets and standards. A good system of cost accounting will provide

the following benefits to the management. Advantages to the

management :

1. It discloses profitability of activities.2. It helps in cost control.3. It helps in inventory control.4. It aids in formulating policies.5. It helps in decision making.6. It guides in fixing selling prices.7. It discloses idle capacity.(1) It discloses profitability of activities : Cost accounting discloses

the departmentwise profit or loss. Hence it helps the management for

taking vital decision i.e. if any department or job or process discloses

any loss, the management will findout the reasons for such losses and

take the necessary steps so as to make it profitable.

(2) It helps in cost control : The main object of cost accounting is tocontrol cost. For this purpose budgets will be fixed and the actual

expenses and budgeted expenses will be compared. In case the actual

expenses exceed the budgeted expenses, the management will find out

the reasons for such increased expenses and take the necessary steps

to reduce the cost.

(3) It helps in inventory control : Cost accounting helps the

management for inventory control. For control of inventory, various

techniques are adopted, such as fixing the stock levels, economic

ordering Quantity (i.e. EOQ), Materials turnover ratio, ABC analysis or

pricing of materials.


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(4) It aids in formulating policies : Cost accounting supplies the cost

data which will help the management for formulating the policies for

production, pricing and for preparing tenders and quotations.

(5) It helps in decision making : Cost accounting provides the cost

data and other information which will help the management for

decision making as to whether goods should be produced in own

factory or buy them in open market.

(6) It guides in fixing selling prices : Cost data helps the

management for fixing selling prices particularly during depression

period.

(7) It discloses idle capacity : Some organizations may not be

working with full capacity due to some reasons, such as shortage of

raw materials, lack of demand for goods etc. Cost accounting helps for

finding out idle capacity of machineries. The management will take the

necessary steps to utilize the machinery with full capacity.Advantages to the workers :

1. It rewards the efficient workers.2. It helps for fixing the standard of efficiency of workers.3. It provides job security.(1) It rewards the efficient workers : In cost accounting, wages are

paid generally on piece rate system on the basis of output. Ultimately,

each worker produces more goods in order to earn more wages. Hence

the efficient workers will be benefited by way of wages and bonus, if

any.

(2) It helps for fixing the standard of efficiency : It evaluates the

standard of efficiency of the workers through time and motion study

which helps them for merit rating and job promotions.

(3) It helps for job security : Generally, the efficient workers are not

terminated from their services.

Advantages to Government :

1. It helps in preparing National plans for economic development.2. It facilitates the assessment of excise duty and income tax and

formulation of policies regarding industry, export, import and

taxation.3. Cost accounting provides the cost data which will help the

government for fixing wages, price control, granting of subsidy etc.

4. Cost accounting provides the government for evaluation ofefficiency of public sector undertakings and to take steps for

improving the performance of such undertakings.

Advantages to the Society :

1. People will get better quality goods at a reasonable price.2. Curbing inflationary trend in the economy.3. Public feel that the prices charged by the concerns are fair and

reasonable.


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Advantages to the Creditors :

1. It helps the creditors and investors to judge the financial positionand creditworthiness of the business. In other words, the creditors

and the investors will findout the solvency of the concern on the

basis of the cost data before sanctioning the loans.

2.The cost reports are useful to the creditors for ascertaining thefuture prospectus and profitability of the enterprise.

Disadvantages of cost accounting :

1. Absence of a ready made system2. Cost differences.3. Cost data have no usefulness in themselves.4. It is not true or exact cost.(1) Absence of ready made system : In cost accounting, there are no

fixed rules for ascertaining the cost because the different techniques

are adopted for ascertaining the cost of production by costaccountants.

(2) Cost differences : Since the uniform procedure is not followed by

the cost accountants in ascertaining the cost of production, there will

be difference in the cost arrived by one cost accountant to the other

one.

The following are the reasons for the differences :

(a)Inclusion or exclusion of certain items.(b)Use of different methods for pricing of materials.(c)Use of different methods of classification of expenses.(d)Use of different methods of payment of wages.(e)Use of different methods of absorption of overheads.

(3) Cost data have no usefulness in themselves : The cost data

becomes useful if the management takes actions at right time,

otherwise such data will not be of any use. So the success or failure of

cost accountant depends upon the management ability and

willingness to take the proper decisions at right time.

(4) It is not true or exact cost : Cost ascertained by the cost

accountant is not a true or exact cost because the cost statements are

mainly on the basis of estimations and omission of certain items ofincomes and expenses therein.

Objections against cost accounting :

1. It is unnecessary : Maintenance of cost records is unnecessary. It

is a duplication of work. Because, already records are maintained

under the financial accounting. It gives profits or loss. Even some of

the industries are functioning prosperously without any costing

system.

2. It is expensive : Installation of a costing system is quite expensive.

It is an additional expenditure to the management. In addition to the

financial accounting records, separate cost accounting records are tobe maintained. This causes to increased expenditure.


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9 Use of

Statistical

Techniques

9 Use of statistical techniques

like chart graph etc is very

less

9 Charts, Graphs, diagrams, are

used in this system for

infomsatory reports to

management.

The following examples shows the difference between cost and

financial accounts.

Illustration : 1 The following data relating to Mallikarjun company for

the year ending 31-12-1990.

Rs. Rs.

Materials : Product A 10000 Wages : Product A 7000

Product B 5000 Product B 4000

Product C 3000 18000 Product C 4000 15000

Manufacturing Expenses 1000 each product.

Salaries: Product A 2000 Selling Exp.:Product A 5000

Product B 2500 Product B 2500Product C 1500 6000 Product C 500 8000

Sales A Rs. 35,000 B Rs. 12,000 and C Rs. 13,000. You are

required to show how the profit or loss ascertained in cost, and

financial accounts.

Solution :

Ascertainment of profit or loss as per financial Account Trading

and Profit & Loss a/c

Particulars Rs. Particulars Rs.

To Materials 18,000 By Sales 60,000

To Wages 15,000

To Manufacturing expenses 3,000

To Gross profit 24,000

60,000 60,000

To Salary 6,000 By Gross profit 24,000

To Selling expenses 8,000

To Net profit 10,000

24,000 24,000

Systems of costing : In costing systems the different ways areadopted for charging costs to the product or service or Job.

The following are the different systems of costing :

(1) Historical costing (2) Standard costing

(3) Estimated costing (4) Continuous costing

(1) Historical costing : In historical costing, first of all expenses are

incurred then the cost of product or service is ascertained. It is similar

to post mortem examination. It is also known as Post costing or Actual

or traditional costing.

Advantages :

(1)It is an accurate costing system.


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(2)It is the most suitable system for cost plus contract costing.(3)It helps to make comparison of costs of different periods.Disadvantages :

(1)It is not suitable to the management for control of costs(2)It does not provide any measures for assessing the efficiency of the

costing department.

(2) Standard Costing : It is a pre-determined costs. It means cost is

ascertained in advance on the basis of standard costs. Such standard

costs are useful for comparision of actual costs with standard costs

and if there is way variance between these costs the necessary steps

can be taken to find out the reasons for such variance.

Advantages :

(1)It helps for comparision of Actual costs with Standard costs.(2)It helps for evaluating the efficiency of a concern.(3)It helps for formulating the policies for cost control.(4)It helps for fixing the selling price of the product.(3) Estimated costing : In this system the costs are estimated well in

advance by taking into consideration the probable changes in costs of

materials, labour and overheads in future. Accordingly the costs are

estimated on the basis of past experience and forecasts.

Advantages :

(1)It helps for preparation offenders, quotations and budgets.(2)It helps for compa

overview of management control systems

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