TERMINOLOGY OF COST COS CLASSIFICATION BY ELEMENTS, VARIABILITY, CASH FLOW

Basic cost concept

In order to determine and take a dispassionate view about what lies beneath the surface of accounting figures, a financial analyst has to make use of different management accounting techniques. Cost techniques have a precedence over the other techniques since accounting treatment of cost is often both complex and financially significant. For example, if a firm proposes to increase its output by 10%, is it reasonable to expect total cost to increase by less than 10%, exactly 10% or more than 10%? Such questions are concerned with the cost behavior, i.e. the way costs change with the levels of activity. The answers to these questions are very much pertinent for a management accountant or a financial analyst since they are basic for a firms projections and profits which ultimately become the basis of all financial decisions. It is, therefore, necessary for a financial analyst to have a reasonably good working knowledge about the basic cost concepts and patterns of cost behavior. All these come within the ambit of cost accounting. Meaning of Cost Accounting Previously, cost accounting was merely considered to be a technique for the ascertainment of costs of products or services on the basis of historical data. In course of time, due to competitive nature of the market, it was realized that ascertaining of cost is not so important as controlling costs. Hence, cost accounting started to be considered more as a technique for cost control as compared to cost ascertainment. Due

to the technological developments in all fields, cost reduction has also come within the ambit of cost accounting. Cost accounting is, thus, concerned with recording, classifying and summarizing costs for determination of costs of products or services, planning, controlling and reducing such costs and furnishing of information to management for decision making. According to Charles T. Horngren, cost accounting is a quantitative method that accumulates, classifies, summarizes and interprets information for the following three major purposes: Operational planning and control Special decisions Product decisions According to the Chartered Institute of Management Accountants, London, cost accounting is the process of accounting for costs from the point at which its expenditure is incurred or committed to the establishment of the ultimate relationship with cost units. In its widest sense, it embraces the preparation of statistical data, the application of cost control methods and the ascertainment of the profitability of the activities carried out or planned. Cost accounting, thus, provides various information to management for all sorts of decisions. It serves multiple purposes on account of which it is generally indistinguishable from management accounting or so-called internal accounting. Wilmot has summarized the nature of cost accounting as the analyzing, recording, standardizing, forecasting, comparing, reporting and recommending and the role of a cost accountant as a historian, news agent and prophet. As a historian, he should be meticulously accurate and sedulously impartial. As a news agent, he should be up to date, selective and pithy. As a prophet, he should combine knowledge and experience with foresight and courage.

Objectives of Cost Accounting The main objectives of cost accounting can be summarized as follows: 1. Determining Selling Price Business enterprises run on a profit-making basis. It is, thus, necessary that revenue should be greater than expenditure incurred in producing goods and services from which the revenue is to be derived. Cost accounting provides various information regarding the cost to make and sell such products or services. Of course, many other factors such as the condition of market, the area of distribution, the quantity which can be supplied etc. are also given due consideration by management before deciding upon the price but the cost plays a dominating role. 2. Determining and Controlling Efficiency Cost accounting involves a study of various operations used in manufacturing a product or providing a service. The study facilitates measuring the efficiency of an organization as a whole or departmentwise as well as devising means of increasing efficiency. Cost accounting also uses a number of methods, e.g., budgetary control, standard costing etc. for controlling costs. Each item viz. materials, labor and expenses is budgeted at the commencement of a period and actual expenses incurred are compared with budget. This greatly increases the operating efficiency of an enterprise. 3. Facilitating Preparation of Financial and Other Statements The third objective of cost accounting is to produce statements whenever is required by management. The financial statements are prepared under financial accounting generally once a year or half-year and are spaced too far with respect to time to meet the needs of management. In order to operate a business at a high level of efficiency, it is essential for

management to have a frequent review of production, sales and operating results. Cost accounting provides daily, weekly or monthly volumes of units produced and accumulated costs with appropriate analysis. A developed cost accounting system provides immediate information regarding stock of raw materials, work-in-progress and finished goods. This helps in speedy preparation of financial statements. 4. Providing Basis for Operating Policy Cost accounting helps management to formulate operating policies. These policies may relate to any of the following matters: Determination of a cost-volume-profit relationship Shutting down or operating at a loss Making for or buying from outside suppliers Continuing with the existing plant and machinery or replacing them by improved and economic ones Concept of Cost Cost accounting is concerned with cost and therefore is necessary to understand the meaning of term cost in a proper perspective. In general, cost means the amount of expenditure (actual or notional) incurred on, or attributable to a given thing. However, the term cost cannot be exactly defined. Its interpretation depends upon the following factors: The nature of business or industry The context in which it is used In a business where selling and distribution expenses are quite nominal the cost of an article may be calculated without considering the selling and distribution overheads. At the same time, in a business where the

nature of a product requires heavy selling and distribution expenses, the calculation of cost without taking into account the selling and distribution expenses may prove very costly to a business. The cost may be factory cost, office cost, cost of sales and even an item of expense. For example, prime cost includes expenditure on direct materials, direct labor and direct expenses. Money spent on materials is termed as cost of materials just like money spent on labor is called cost of labor and so on. Thus, the use of term cost without understanding the circumstances can be misleading. Different costs are found for different purposes. The work-in-progress is valued at factory cost while stock of finished goods is valued at office cost. Numerous other examples can be given to show that the term cost does not mean the same thing under all circumstances and for all purposes. Many items of cost of production are handled in an optional manner which may give different costs for the same product or job without going against the accepted principles of cost accounting. Depreciation is one of such items. Its amount varies in accordance with the method of depreciation being used. However, endeavor should be, as far as possible, to obtain an accurate cost of a product or service.

Elements of Cost Following are the three broad elements of cost: 1. Material The substance from which a product is made is known as material. It may be in a raw or a manufactured state. It can be direct as well as indirect.

a. Direct Material The material which becomes an integral part of a finished product and which can be conveniently assigned to specific physical unit is termed as direct material. Following are some of the examples of direct material: All material or components specifically purchased, produced or requisitioned from stores Primary packing material (e.g., carton, wrapping, cardboard, boxes etc.) Purchased or partly produced components Direct material is also described as process material, prime cost material, production material, stores material, constructional material etc. b. Indirect Material The material which is used for purposes ancillary to the business and which cannot be conveniently assigned to specific physical units is termed as indirect material. Consumable stores, oil and waste, printing and stationery material etc. are some of the examples of indirect material. Indirect material may be used in the factory, office or the selling and distribution divisions. 2. Labor For conversion of materials into finished goods, human effort is needed and such human effort is called labor. Labor can be direct as well as indirect. a. Direct Labor

The labor which actively and directly takes part in the production of a particular commodity is called direct labor. Direct labor costs are, therefore, specifically and conveniently traceable to specific products. Direct labor can also be described as process labor, productive labor, operating labor, etc. b. Indirect Labor The labor employed for the purpose of carrying out tasks incidental to goods produced or services provided, is indirect labor. Such labor does not alter the construction, composition or condition of the product. It cannot be practically traced to specific units of output. Wages of storekeepers, foremen, timekeepers, directors fees, salaries of salesmen etc, are examples of indirect labor costs. Indirect labor may relate to the factory, the office or the selling and distribution divisions. 3. Expenses Expenses may be direct or indirect. a. Direct Expenses These are the expenses that can be directly, conveniently and wholly allocated to specific cost centers or cost units. Examples of such expenses are as follows: Hire of some special machinery required for a particular contract Cost of defective work incurred in connection with a particular job or contract etc.

Direct expenses are sometimes also described as chargeable expenses. b. Indirect Expenses These are the expenses that cannot be directly, conveniently and wholly allocated to cost centers or cost units. Examples of such expenses are rent, lighting, insurance charges etc. 4. Overhead The term overhead includes indirect material, indirect labor and indirect expenses. Thus, all indirect costs are overheads. A manufacturing organization can broadly be divided into the following three divisions: Factory or works, where production is done Office and administration, where routine as well as policy matters are decided Selling and distribution, where products are sold and finally dispatched to customers Overheads may be incurred in a factory or office or selling and distribution divisions. Thus, overheads may be of three types: a. Factory Overheads They include the following things: Indirect material used in a factory such as lubricants, oil, consumable stores etc. Indirect labor such as gatekeeper, timekeeper, works managers salary etc.

Indirect expenses such as factory rent, factory insurance, factory lighting etc. b. Office and Administration Overheads They include the following things: Indirect materials used in an office such as printing and stationery material, brooms and dusters etc. Indirect labor such as salaries payable to office manager, office accountant, clerks, etc. Indirect expenses such as rent, insurance, lighting of the office c. Selling and Distribution Overheads They include the following things: Indirect materials used such as packing material, printing and stationery material etc. Indirect labor such as salaries of salesmen and sales manager etc. Indirect expenses such as rent, insurance, advertising expenses etc.

Elements of Cost Direct material Direct labor Direct expenses Overheads Factory overheads Selling and distribution overheads Office and administration overheads Indirect material Indirect labor Indirect expenses Indirect material Indirect labor Indirect expenses Indirect material Indirect labor Indirect expenses Components of Total Cost 1. Prime Cost Prime cost consists of costs of direct materials, direct labors and direct expenses. It is also known as basic, first or flat cost. 2. Factory Cost Factory cost comprises prime cost and, in addition, works or factory overheads that include costs of indirect materials, indirect labors and indirect expenses incurred in a factory. It is also known as works cost, production or manufacturing cost.

3. Office Cost Office cost is the sum of office and administration overheads and factory cost. This is also termed as administration cost or the total cost of production. 4. Total Cost Selling and distribution overheads are added to the total cost of production to get total cost or the cost of sales. Various components of total cost can be depicted with the help of the table below: Components of total cost Direct material Direct labor Direct expenses Prime cost plus works overheads Works cost plus office and administration overheads Office cost plus selling and distribution overheads Cost Sheet Cost sheet is a document that provides for the assembly of an estimated detailed cost in respect of cost centers and cost units. It analyzes and classifies in a tabular form the expenses on different items for a particular period. Additional columns may also be provided to show the cost of a particular unit pertaining to each item of expenditure and the total per unit cost. Cost sheet may be prepared on the basis of actual data (historical cost sheet) or on the basis of estimated data (estimated cost sheet), depending on the technique employed and the purpose to be achieved.

The techniques of preparing a cost sheet can be understood with the help of the following examples.

Cost Sheet Format 1 Opening stock of raw materials Add-- purchase

Less-- closing stock of raw material Value of raw materials consumed Wages

Prime cost Factory overheads Add-- opening stock of work in progress Less-- closing stock of work in progress Factory cost Add-- Administration overhead Cost of production of goods manufactured Add--opening stock of finished goods Less-- closing stock of finished goods Cost of production of goods sold Add-- selling and distribution overheads Cost of sales Profit Sales

Cost Sheet Format 2 Raw materials Production wages Direct expenses Prime cost Add--works overheads: Unproductive wages Factory rent and taxes Factory lighting Factory heating

Motive power Directors fees (works) Factory cleaning Estimating expenses Factory stationery Loses tools written off Water supply Factory insurance Depreciation of plant and machinery Works cost

Add-- office overhead Directors fees (office) Sundry office expenses Office stationery Rent and taxes (office) Office insurance Legal expenses Depreciation of office building Bank charges Office cost Add-- selling and distribution overheads Rent of warehouse Depreciation on delivery vans Bad debts Advertising Sales department salaries Commission on sales

Upkeep of delivery vans Total cost Classification of Cost Cost may be classified into different categories depending upon the purpose of classification. Some of the important categories in which the costs are classified are as follows: 1. Fixed, Variable and Semi-Variable Costs The cost which varies directly in proportion with every increase or decrease in the volume of output or production is known as variable cost. Some of its examples are as follows: Wages of laborers Cost of direct material Power The cost which does not vary but remains constant within a given period of time and a range of activity inspite of the fluctuations in production is known as fixed cost. Some of its examples are as follows: Rent or rates Insurance charges Management salary The cost which does not vary proportionately but simultaneously does not remain stationary at all times is known as semi-variable cost. It can also be named as semi-fixed cost. Some of its examples are as follows: Depreciation Repairs

Fixed costs are sometimes referred to as period costs and variable costs as direct costs in system of direct costing. Fixed costs can be further classified into: Committed fixed costs Discretionary fixed costs Committed fixed costs consist largely of those fixed costs that arise from the possession of plant, equipment and a basic organization structure. For example, once a building is erected and a plant is installed, nothing much can be done to reduce the costs such as depreciation, property taxes, insurance and salaries of the key personnel etc. without impairing an organizations competence to meet the long-term goals. Discretionary fixed costs are those which are set at fixed amount for specific time periods by the management in budgeting process. These costs directly reflect the top management policies and have no particular relationship with volume of output. These costs can, therefore, be reduced or entirely eliminated as demanded by the circumstances. Examples of such costs are research and development costs, advertising and sales promotion costs, donations, management consulting fees etc. These costs are also termed as managed or programmed costs. In some circumstances, variable costs are classified into the following: Discretionary cost Engineered cost The term discretionary costs is generally linked with the class of fixed cost. However, in the circumstances where management has predetermined that the organization would spend a certain percentage of its sales for the items like research, donations, sales promotion etc., discretionary costs will be of a variable character.

Engineered variable costs are those variable costs which are directly related to the production or sales level. These costs exist in those circumstances where specific relationship exists between input and output. For example, in an automobile industry there may be exact specifications as one radiator, two fan belts, one battery etc. would be required for one car. In a case where more than one car is to be produced, various inputs will have to be increased in the direct proportion of the output. Thus, an increase in discretionary variable costs is due to the authorization of management whereas an increase in engineered variable costs is due to the volume of output or sales. 2. Product Costs and Period Costs The costs which are a part of the cost of a product rather than an expense of the period in which they are incurred are called as product costs. They are included in inventory values. In financial statements, such costs are treated as assets until the goods they are assigned to are sold. They become an expense at that time. These costs may be fixed as well as variable, e.g., cost of raw materials and direct wages, depreciation on plant and equipment etc. The costs which are not associated with production are called period costs. They are treated as an expense of the period in which they are incurred. They may also be fixed as well as variable. Such costs include general administration costs, salaries salesmen and commission, depreciation on office facilities etc. They are charged against the revenue of the relevant period. Differences between opinions exist regarding whether certain costs should be considered as product or period costs. Some accountants feel that fixed manufacturing costs are more closely related to the passage of time than to the manufacturing of a product. Thus, according to them variable manufacturing costs are product costs

whereas fixed manufacturing and other costs are period costs. However, their view does not seem to have been yet widely accepted. 3. Direct and Indirect Costs The expenses incurred on material and labor which are economically and easily traceable for a product, service or job are considered as direct costs. In the process of manufacturing of production of articles, materials are purchased, laborers are employed and the wages are paid to them. Certain other expenses are also incurred directly. All of these take an active and direct part in the manufacture of a particular commodity and hence are called direct costs. The expenses incurred on those items which are not directly chargeable to production are known as indirect costs. For example, salaries of timekeepers, storekeepers and foremen. Also certain expenses incurred for running the administration are the indirect costs. All of these cannot be conveniently allocated to production and hence are called indirect costs. 4. Decision-Making Costs and Accounting Costs Decision-making costs are special purpose costs that are applicable only in the situation in which they are compiled. They have no universal application. They need not tie into routine-financial accounts. They do not and should not conform the accounting rules. Accounting costs are compiled primarily from financial statements. They have to be altered before they can be used for decision-making. Moreover, they are historical costs and show what has happened under an existing set of circumstances. Decision-making costs are future costs. They represent what is expected to happen under an assumed set of conditions. For example, accounting costs may show the cost of a product when the operations are manual

whereas decision-making cost might be calculated to show the costs when the operations are mechanized. 5. Relevant and Irrelevant Costs Relevant costs are those which change by managerial decision. Irrelevant costs are those which do not get affected by the decision. For example, if a manufacturer is planning to close down an unprofitable retail sales shop, this will affect the wages payable to the workers of a shop. This is relevant in this connection since they will disappear on closing down of a shop. But prepaid rent of a shop or unrecovered costs of any equipment which will have to be scrapped are irrelevant costs which should be ignored.

6. Shutdown and Sunk Costs A manufacturer or an organization may have to suspend its operations for a period on account of some temporary difficulties, e.g., shortage of raw material, non-availability of requisite labor etc. During this period, though no work is done yet certain fixed costs, such as rent and insurance of buildings, depreciation, maintenance etc., for the entire plant will have to be incurred. Such costs of the idle plant are known as shutdown costs. Sunk costs are historical or past costs. These are the costs which have been created by a decision that was made in the past and cannot be changed by any decision that will be made in the future. Investments in plant and machinery, buildings etc. are prime examples of such costs. Since sunk costs cannot be altered by decisions made at the later stage, they are irrelevant for decision-making. An individual may regret for purchasing or constructing an asset but this action could not be avoided by taking any subsequent action. Of course,

an asset can be sold and the cost of the asset will be matched against the proceeds from sale of the asset for the purpose of determining gain or loss. The person may decide to continue to own the asset. In this case, the cost of asset will be matched against the revenue realized over its effective life. However, he/she cannot avoid the cost which has already been incurred by him/her for the acquisition of the asset. It is, as a matter of fact, sunk cost for all present and future decisions. Example JPS Ltd. purchased a machine for Rs 30,000. The machine has an operating life of five years without any scrap value. Soon after making the purchase, management feels that the machine should not have been purchased since it is not yielding the operating advantage originally contemplated. It is expected to result in savings in operating costs of Rs. 18,000 over a period of five years. The machine can be sold immediately for Rs. 22,000. To take the decision whether the machine should be sold or be used, the relevant amounts to be compared are Rs. 18,000 in cost savings over five yea$ and Rs. 22,000 that can be realized in case it is immediately disposed. Rs. 30,000 invested in the asset is not relevant since it is same in both the cases. The amount is the sunk cost. Jolly Ltd., therefore, sold the machinery for Rs. 22,000 since it would result in an extra profit of $. 4,000 as compared to keeping and using it. 7. Controllable and Uncontrollable Costs Controllable costs are those costs which can be influenced by the ratio or a specified member of the undertaking. The costs that cannot be influenced like this are termed as uncontrollable costs. A factory is usually divided into a number of responsibility centers, each

of which is in charge of a specific level of management. The officer incharge of a particular department can control costs only of those matte$ which come directly under his control, not of other matte$. For example, the expenditure incurred by tool room is controlled by the foreman incharge of that section but the share of the tool room expenditure which is apportioned to a machine shop cannot be controlled by the foreman of that shop. Thus, the difference between controllable and uncontrollable costs is only in relation to a particular individual or level of management. The expenditure which is controllable by an individual may be uncontrollable by another individual. 8. Avoidable or Escapable Costs and Unavoidable or Inescapable Costs Avoidable costs are those which will be eliminated if a segment of a business (e.g., a product or department) with which they are directly related is discontinued. Unavoidable costs are those which will not be eliminated with the segment. Such costs are merely reallocated if the segment is discontinued. For example, in case a product is discontinued, the salary of a factory manager or factory rent cannot be eliminated. It will simply mean that certain other products will have to absorb a large amount of such overheads. However, the salary of people attached to a product or the bad debts traceable to a product would be eliminated. Certain costs are partly avoidable and partly unavoidable. For example, closing of one department of a store might result in decrease in delivery expenses but not in their altogether elimination. It is to be noted that only avoidable costs are relevant for deciding whether to continue or eliminate a segment of a business. 9. Imputed or Hypothetical Costs These are the costs which do not involve cash outlay. They are not included in cost accounts but are important for taking into consideration while making management decisions. For example, interest on capital is

ignored in cost accounts though it is considered in financial accounts. In case two projects require unequal outlays of cash, the management should take into consideration the capital to judge the relative profitability of the projects. 10. Differentials, Incremental or Decrement Cost The difference in total cost between two alternatives is termed as differential cost. In case the choice of an alternative results in an increase in total cost, such increased costs are known as incremental costs. While assessing the profitability of a proposed change, the incremental costs are matched with incremental revenue. This is explained with the following example:

The technique of differential costing which is based on differential cost is useful in planning and decision-making and helps in selecting the best alternative. In case the choice results in decrease in total costs, this decreased costs will be known as detrimental costs.

11. Out-of-Pocket Costs Out-of-pocket cost means the present or future cash expenditure regarding a certain decision that will vary depending upon the nature of the decision made. For example, a company has its own trucks for transporting raw materials and finished products from one place to another. It seeks to replace these trucks by keeping public carriers. In making this decision, of course, the depreciation of the trucks is not to be considered but the management should take into account the present expenditure on fuel, salary to drive$ and maintenance. Such costs are termed as out-of-pocket costs. 12. Opportunity Cost Opportunity cost refers to an advantage in measurable terms that have foregone on account of not using the facilities in the manner originally

planned. For example, if a building is proposed to be utilized for housing a new project plant, the likely revenue which the building could fetch, if rented out, is the opportunity cost which should be taken into account while evaluating the profitability of the project. Suppose, a manufacturer is confronted with the problem of selecting anyone of the following alternatives: a. Selling a semi-finished product at $. 2 per unit b. Introducing it into a further process to make it more refined and valuable Alternative (b) will prove to be remunerative only when after paying the cost of further processing, the amount realized by the sale of the product is more than $. 2 per unit. Also, the revenue of $. 2 per unit is foregone in case alternative (b) is adopted. The term opportunity cost refers to this alternative revenue foregone. 13. Traceable, Untraceable or Common Costs The costs that can be easily identified with a department, process or product are termed as traceable costs. For example, the cost of direct material, direct labor etc. The costs that cannot be identified so are termed as untraceable or common costs. In other words, common costs are the costs incurred collectively for a number of cost centers and are to be suitably apportioned for determining the cost of individual cost centers. For example, overheads incurred for a factory as a whole, combined purchase cost for purchasing several materials in one consignment etc. Joint cost is a kind of common cost. When two or more products are produced out of one material or process, the cost of such material or process is called joint cost. For example, when cottonseeds and cotton fibers are produced from the same material, the cost incurred till the split-off or separation point will be joint costs.

14. Production, Administration and Selling and Distribution Costs A business organization performs a number of functions, e.g., production, illustration, selling and distribution, research and development. Costs are to be curtained for each of these functions. The Chartered Institute of Management accountants, London, has defined each of the above costs as follows: i. Production Cost The cost of sequence of operations which begins with supplying materials, labor and services and ends with the primary packing of the product. Thus, it includes the cost of direct material, direct labor, direct expenses and factory overheads. ii. Administration Cost The cost of formulating the policy, directing the organization and controlling the operations of an undertaking which is not related directly to a production, selling, distribution, research or development activity or function. iii. Selling Cost It is the cost of selling to create and stimulate demand (sometimes termed as marketing) and of securing orders. iv. Distribution Cost It is the cost of sequence of operations beginning with making the packed product available for dispatch and ending with making the reconditioned returned empty package, if any, available for reuse. v. Research Cost

It is the cost of searching for new or improved products, new application of materials, or new or improved methods. vi. Development Cost The cost of process which begins with the implementation of the decision to produce a new or improved product or employ a new or improved method and ends with the commencement of formal production of that product or by the method. vii. Pre-Production Cost The part of development cost incurred in making a trial production as preliminary to formal production is called pre-production cost. 15. Conversion Cost The cost of transforming direct materials into finished products excluding direct material cost is known as conversion cost. It is usually taken as an aggregate of total cost of direct labor, direct expenses and factory overheads. Cost Unit and Cost Center The technique of costing involves the following: Collection and classification of expenditure according to cost elements Allocation and apportionment of the expenditure to the cost centers or cost units or both Cost Unit While preparing cost accounts, it becomes necessary to select a unit with which expenditure may be identified. The quantity upon which cost can

be conveniently allocated is known as a unit of cost or cost unit. The Chartered Institute of Management Accountants, London defines a unit of cost as a unit of quantity of product, service or time in relation to which costs may be ascertained or expressed. Unit selected should be unambiguous, simple and commonly used. Following are the examples of units of cost: (i) Brick works (ii) Collieries (iii) Textile mills (iv) Electrical companies (v) Transport companies (vi) Steel mills Cost Center According to the Chartered Institute of Management Accountants, London, cost center means a location, person or item of equipment (or group of these) for which costs may be ascertained and used for the purpose of cost control. Thus, cost center refers to one of the convenient units into which the whole factory or an organization has been appropriately divided for costing purposes. Each such unit consists of a department, a sub-department or an item or equipment or machinery and a person or a group of persons. Sometimes, closely associated departments are combined together and considered as one unit for costing purposes. For example, in a laundry, activities such as collecting, sorting, marking and washing of clothes are performed. Each activity may be considered as a separate cost center and all costs relating to a particular cost center may be found out separately. Cost centers may be classified as follows: Productive, unproductive and mixed cost centers

Personal and impersonal cost centers Operation and process cost centers Productive cost centers are those which are actually engaged in making products. Service or unproductive cost centers do not make the products but act as the essential aids for the productive centers. The examples of such service centers are as follows: Administration department Repairs and maintenance department Stores and drawing office department Mixed costs centers are those which are engaged sometimes on productive and other times on service works. For example, a tool shop serves as a productive cost center when it manufactures dies and jigs to be charged to specific jobs or orders but serves as servicing cost center when it does repairs for the factory. Impersonal cost center is one which consists of a department, a plant or an item of equipment whereas a personal cost center consists of a person or a group of persons. In case a cost center consists of those machines or persons which carry out the same operation, it is termed as operation cost center. If a cost center consists of a continuous sequence of operations, it is called process cost center. In case of an operation cost center, cost is analyzed and related to a series of operations in sequence such as in chemical industries, oil refineries and other process industries. The objective of such an analysis is to ascertain the cost of each operation irrespective of its location inside the factory. Cost Estimation and Cost Ascertainment Cost estimation is the process of pre-determining the cost of a certain

product job or order. Such pre-determination may be required for several purposes. Some of the purposes are as follows: Budgeting Measurement of performance efficiency Preparation of financial statements (valuation of stocks etc.) Make or buy decisions Fixation of the sale prices of products Cost ascertainment is the process of determining costs on the basis of actual data. Hence, the computation of historical cost is cost ascertainment while the computation of future costs is cost estimation. Both cost estimation and cost ascertainment are interrelated and are of immense use to the management. In case a concern has a sound costing system, the ascertained costs will greatly help the management in the process of estimation of rational accurate costs which are necessary for a variety of purposes stated above. Moreover, the ascertained cost may be compared with the pre-determined costs on a continuing basis and proper and timely steps be taken for controlling costs and maximizing profits. Cost Allocation and Cost Apportionment Cost allocation and cost apportionment are the two procedures which describe the identification and allotment of costs to cost centers or cost units. Cost allocation refers to the allotment of all the items of cost to cost centers or cost units whereas cost apportionment refers to the allotment of proportions of items of cost to cost centers or cost units Thus, the former involves the process of charging direct expenditure to cost centers or cost units whereas the latter involves the process of charging indirect expenditure to cost centers or cost units. For example, the cost of labor engaged in a service department can be

charged wholly and directly but the canteen expenses of the factory cannot be charged directly and wholly. Its proportionate share will have to be found out. Charging of costs in the former case will be termed as allocation of costs whereas in the latter, it will be termed as apportionment of costs. Cost Reduction and Cost Control Cost reduction and cost control are two different concepts. Cost control is achieving the cost target as its objective whereas cost reduction is directed to explore the possibilities of improving the targets. Thus, cost control ends when targets are achieved whereas cost reduction has no visible end. It is a continuous process. The difference between the two can be summarized as follows: i. Cost control aims at maintaining the costs in accordance with established standards whereas cost reduction is concerned with reducing costs. It changes all standards and endeavors to improve them continuously. ii. Cost control seeks to attain the lowest possible cost under existing conditions whereas cost reduction does not recognize any condition as permanent since a change will result in lowering the cost. iii. In case of cost control, emphasis is on past and present. In case of cost reduction, emphasis is on the present and future. iv. Cost control is a preventive function whereas cost reduction is a correlative function. It operates even when an efficient cost control system exists. Installation of Costing System The installation of a costing system requires careful consideration of the following two interrelated aspects: Overcoming the practical difficulties while introducing a system

Main considerations that should govern the installation of such a system Practical Difficulties The important difficulties in the installation of a costing system and the suggestions to overcome them are as follows: a. Lack of Support from Top Management Often, the costing system is introduced at the behest of the managing director or some other director without taking into confidence other members of the top management team. This results in opposition from various managers as they consider it interference as well as an uncalled check of their activities. They, therefore, resist the additional work involved in the cost accounting system. This difficulty can be overcome by taking the top management into confidence before installing the system. A sense of cost consciousness has to be instilled in their minds. b. Resistance from the Staff The existing financial accounting staff may offer resistance to the system because of a feeling of their being declared redundant under the new system. This fear can be overcome by explaining the staff that the costing system would not replace but strengthen the existing system. It will open new areas for development which will prove beneficial to them. c. Non-Cooperation at Other Levels The foreman and other supervisory staff may resent the additional paper work and may not cooperate in providing the basic data which is essential for the success of the system.

This needs re-orientation and education of employees. They have to be told of the advantages that will accrue to them and to the organization as a whole on account of efficient working of the system. d. Shortage of Trained Staff Costing is a specialized job in itself. In the beginning, a qualified staff may not be available. However, this difficulty can be overcome by giving the existing staff requisite training and recruiting additional staff if required. e. Heavy Costs The costing system will involve heavy costs unless it has been suitably designed to meet specific requirements. Unnecessary sophistication and formalities should be avoided. The costing office should serve as a useful service department. Main Considerations In view of the above difficulties and suggestions, following should be the main considerations while introducing a costing system in a manufacturing organization: 1. Product The nature of a product determines to a great extent the type of costing system to be adopted. A product requiring high value of material content requires an elaborate system of materials control. Similarly, a product requiring high value of labor content requires an efficient time keeping and wage systems. The same is true in case of overheads. 2. Organization

The existing organization structure should be distributed as little as possible. It becomes, therefore, necessary to ascertain the size and type of organization before introducing the costing system. The scope of authority of each executive, the sources from which a cost accountant has to derive information and reports to be submitted at various managerial levels should be carefully gone through. 3. Objective The objectives and information which management wants to achieve and acquire should also be taken care of. For example, if a concern wants to expand its operations, the system of costing should be designed in a way so as to give maximum attention to production aspect. On the other hand, if a concern were not in a position to sell its products, the selling aspect would require greater attention. 4. Technical Details The system should be introduced after a detailed study of the technical aspects of the business. Efforts should be made to secure the sympathetic assistance and support of the principal members of the supervisory staff and workmen. 5. Informative and Simple The system should be informative and simple. In this connection, the following points may be noted: (i) It should be capable of furnishing the fullest information required regularly and systematically, so that continuous study or check-up of the progress of business is possible. (ii) Standard printed forms can be used so as to make the information detailed, clear and intelligible. Over-elaboration which will only

complicate matte$ should be avoided. (iii) Full information about departmental outputs, processes and operations should be clearly presented and every item of expenditure should be properly classified. (iv) Data, complete and reliable in all respects should be provided in a lucid form so that the measurement of the variations between actual and standard costs is possible. 6. Method of Maintenance of Cost Records A choice has to be made between integral and non-integral accounting systems. In case of integral accounting system, no separate sets of books are maintained for costing transactions but they are interlocked with financial transactions into one set of books. In case of non-integral system, separate books are maintained for cost and financial transactions. At the end of the accounting period, the results shown by two sets of books are reconciled. In case of a big business, it will be appropriate to maintain a separate set of books for cost transactions. 7. Elasticity The costing system should be elastic and capable of adapting to the changing requirements of a business. It may, therefore, be concluded from the above discussion that costing system introduced in any business will not be a success in case of the following circumstances: 1. If it is unduly complicated and expensive 2. If a cost accountant does not get the cooperation of his/her staff 3. If cost statements cannot be reconciled with financial statements

4. If the results actually achieved are not compared with the expected ones Methods of Costing Costing can be defined as the technique and process of ascertaining costs. The principles in every method of costing are same but the methods of analyzing and presenting the costs differ with the nature of business. The methods of job costing are as follows: 1. Job Costing The system of job costing is used where production is not highly repetitive and in addition consists of distinct jobs so that the material and labor costs can be identified by order number. This method of costing is very common in commercial foundries and drop forging shops and in plants making specialized industrial equipments. In all these cases, an account is opened for each job and all appropriate expenditure is charged thereto. 2. Contract Costing Contract costing does not in principle differ from job costing. A contract is a big job whereas a job is a small contract. The term is usually applied where large-scale contracts are carried out. In case of ship-builders, printers, building contractors etc., this system of costing is used. Job or contract is also termed as terminal costing. 3. Cost Plus Costing In contracts where in addition to cost, an agreed sum or percentage to cover overheads and fit is paid to a contractor, the system is termed as cost plus costing. The term cost here includes materials, labor and expenses incurred directly in the process of production. The system is used generally in cases where government happens to be the party to

give contract. 4. Batch Costing This method is employed where orders or jobs are arranged in different batches after taking into account the convenience of producing articles. The unit of cost is a batch or a group of identical products instead of a single job order or contract. This method is particularly suitable for general engineering factories which produce components in convenient economic batches and pharmaceutical industries. 5. Process Costing If a product passes through different stages, each distinct and well defined, it is desired to know the cost of production at each stage. In order to ascertain the same, process costing is employed under which a separate account is opened for each process. This system of costing is suitable for the extractive industries, e.g., chemical manufacture, paints, foods, explosives, soap making etc. 6. Operation Costing Operation costing is a further refinement of process costing. The system is employed in the industries of the following types: a. The industry in which mass or repetitive production is carried out b. The industry in which articles or components have to be stocked in semi-finished stage to facilitate the execution of special orders, or for the convenience of issue for later operations The procedure of costing is broadly the same as process costing except that in this case, cost unit is an operation instead of a process. For example, the manufacturing of handles for bicycles involves a number of operations such as those of cutting steel sheets into proper strips

molding, machining and finally polishing. The cost to complete these operations may be found out separately. 7. Unit Costing (Output Costing or Single Costing) In this method, cost per unit of output or production is ascertained and the amount of each element constituting such cost is determined. In case where the products can be expressed in identical quantitative units and where manufacture is continuous, this type of costing is applied. Cost statements or cost sheets are prepared in which various items of expense are classified and the total expenditure is divided by the total quantity produced in order to arrive at per unit cost of production. The method is suitable in industries like brick making, collieries, flour mills, paper mills, cement manufacturing etc. 8. Operating Costing This system is employed where expenses are incurred for provision of services such as those tendered by bus companies, electricity companies, or railway companies. The total expenses regarding operation are divided by the appropriate units (e.g., in case of bus company, total number of passenger/kms.) and cost per unit of service is calculated. 9. Departmental Costing The ascertainment of the cost of output of each department separately is the objective of departmental costing. In case where a factory is divided into a number of departments, this method is adopted. 10. Multiple Costing (Composite Costing) Under this system, the costs of different sections of production are combined after finding out the cost of each and every part manufactured. The system of ascertaining cost in this way is applicable where a product comprises many assailable parts, e.g., motor cars,

engines or machine tools, typewrite$, radios, cycles etc. As various components differ from each other in a variety of ways such as price, materials used and manufacturing processes, a separate method of costing is employed in respect of each component. The type of costing where more than one method of costing is employed is called multiple costing. It is to be noted that basically there are only two methods of costing viz. job costing and process costing. Job costing is employed in cases where expenses are traceable to specific jobs or orders, e.g., house building, ship building etc. In case where it is impossible to trace the prime cost of the items for a particular order because of the reason that their identity gets lost while manufacturing operations, process costing is used. For example, in a refinery where several tons of oil is being produced at the same time, the prime cost of a specific order of 10 tons cannot be traced. The cost can be found out only by finding out the cost per ton of total oil produced and then multiplying it by ten. It may, therefore, be concluded that the methods of batch contract and cost plus costing are only the variants of job costing whereas the methods of unit, operation and operating costing are the variants of process costing. Techniques of Costing Besides the above methods of costing, following are the types of costing techniques which are used by management only for controlling costs and making some important managerial decisions. As a matter of fact, they are not independent methods of cost finding such as job or process costing but are basically costing techniques which can be used as an advantage with any of the methods discussed above. 1. Marginal Costing

Marginal costing is a technique of costing in which allocation of expenditure to production is restricted to those expenses which arise as a result of production, e.g., materials, labor, direct expenses and variable overheads. Fixed overheads are excluded in cases where production varies because it may give misleading results. The technique is useful in manufacturing industries with varying levels of output. 2. Direct Costing The practice of charging all direct costs to operations, processes or products and leaving all indirect costs to be written off against profits in the period in which they arise is termed as direct costing. The technique differs from marginal costing because some fixed costs can be considered as direct costs in appropriate circumstances. 3. Absorption or Full Costing The practice of charging all costs both variable and fixed to operations, products or processes is termed as absorption costing. 4. Uniform Costing A technique where standardized principles and methods of cost accounting are employed by a number of different companies and firms is termed as uniform costing. Standardization may extend to the methods of costing, accounting classification including codes, methods of defining costs and charging depreciation, methods of allocating or apportioning overheads to cost centers or cost units. The system, thus, facilitates interfirm comparisons, establishment of realistic pricing policies, etc. Systems of Costing It has already been stated that there are two main methods used to determine costs. These are:

Job cost method Process cost method It is possible to ascertain the costs under each of the above methods by two different ways: Historical costing Standard costing Historical Costing Historical costing can be of the following two types in nature: Post costing Continuous costing Post Costing Post costing means ascertainment of cost after the production is completed. This is done by analyzing the financial accounts at the end of a period in such a way so as to disclose the cost of the units which have been produced. For instance, if the cost of product A is to be calculated on this basis, one will have to wait till the materials are actually purchased and used, labor actually paid and overhead expenditure actually incurred. This system is used only for ascertaining the costs but not useful for exercising any control over costs, as one comes to know of things after they had taken place. It can serve as Guidance for future production only when conditions in future continue to be the same. Continuous Costing

In case of this method, cost is ascertained as soon as a job is completed or even when a job is in progress. This is done usually before a job is over or product is made. In the process, actual expenditure on materials and wages and share of overheads are also estimated. Hence, the figure of cost ascertained in this case is not exact. But it has an advantage of providing cost information to the management promptly, thereby enabling it to take necessary corrective action on time. However, it neither provides any standard for judging current efficiency nor does it disclose what the cost of a job ought to have been. Standard Costing Standard costing is a system under which the cost of a product is determined in advance on certain pre-determined standards. With reference to the example given in post costing, the cost of product A can be calculated in advance if one is in a position to estimate in advance the material labor and overheads that should be incurred over the product. All this requires an efficient system of cost accounting. However, this system will not be useful if a vigorous system of controlling costs and standard costs are not in force. Standard costing is becoming more and more popular nowadays. Summary 1. Cost accounting is a quantitative method that accumulates, classifies, summarizes and interprets information for operational planning and control, special decisions and product decisions. 2. Cost may be classified into different categories depending upon the purpose of classification viz. fixed cost, variable cost and semi variable cost. 3. Costing can be defined as the technique and process of ascertaining costs.

2 > DISTINCTION AND RELATIONSHIP AMONG FINANCAIL ACCOUNTING, COST ACCOUNTING AND MANAGEMENT ACCOUNTING COST ACCOUNTING DEFINITION: Cost accounting is the process of accounting per cost from the point at which expenditure is incurred or committed to the establishment of it ultimate relationship with cost centre and cost unit. In its widest usage it embraces the preparation of statistical data, the application of cost control method and ascertainment of the profitability of activities carried out or plan. The main purpose of cost accounting is to provide detail cost information to management that is internal user, cost accounting means using double entry system.

OBJECTIVES OF COST ACCOUNTING: 1. Ascertainment of cost: This is the primary objective of the cost accounting. For cost ascertainment of different techniques and system of costing are used different circumstances. 2. Control of cost:

Cost accounting aim at improving at serving the needs of management in conducting the business with almost the efficiency. Cost data provide the guideline to for various managerial decisions like make or buy, selling below cost, utilization of ideal plant capacity, and introduction of new product. Etc. 3. Determination of selling price: Cost accounting provides the cost establishment the basis of which selling price of the product or service may be fixed. In period of depression of product cost accounting guides in deciding the extent to which the selling price may be reduce to meet the situation. 4. Guide to business policy: Cost accounting aims at serving the needs of management conducting the business with the efficiency. Cost data provide the guidance to the management for various managerial decisions like make or buy, selling below the cost and utilization of ideal plant capacity etc. 5. Measuring and Improving the performance: Cost accounting measures the efficiency, classification and analysis the cost data and then suggests the various steps in improving the performance so that profitability of firm increases.

In order to realize these objectives the data provided by the cost accounting may have to reclassify, reorganize and the supplemented by the other relevant business data from the outside the formal cost accounting system.

LIMITATIONS OR OBLIGATIONS AGAINST THE COST ACCOUNTING: Despite the fact that development of cost accounting in one of the most significant steps to improve the performance certain objectives are raise against its introduction, these are follow: 1. It is unnecessary: It is argue that maintenance of the cost record is not necessary and involve the duplication of work. It is the least on the premise that good number of concern are functioning prosperously with out any system of costing. This must be true. But in the present world of completion to conduct the business with efficiency the management need to know the detail cost information for its decision making. Only cost accounting system can serve this need

of the management and thus help in more efficient to conduct the business. 2. It is expensive: It is pointed out that installation of cost system is quite expensive which only large concern can afford. It is also argue that installation of system will incurred additional expense which will lead to diminution of the profits. It should not prove that a burden on the finance of the company. 3. It is Inapplicable: Another argument sometimes put forward is that methods of costing are not applicable to many types of industry. A cost system must be specially design to meet the need of the business. All types of activities that manufacturing and non manufacturing should consider the use cost accounting. 4. It is failure: The failure of cost system in some concern is quoted as an argument against its introduction in other undertakings. If a system does not produce the desire result it is wrong to jump to the conclusion that the system is fault. The reason for its failure should be proved. In order to make the

system success the utility of system should be explained and the cooperation of the employee should be sought by convincing them the system is for the betterment of all.

FINANCIAL ACCOUNTING: Definition: Accounting to the American Institute of Certified Public Accountant financial accounting is an art of recording, classifying, and summarizing the transaction in a significant manner and in terms of money and event which are in part at least financial character and interpreting the result thereof The definition brings out the following attributes of financial accounting: Event and transaction of financial In nature are recorded whereas the non financial event and transaction are not recorded. It is a total process of commencing from recording of a transaction and ending with communication of summary of entire business effort.

 It finally include interpretation of financial business result so as to enable all the concern user to take appropriate decision beneficial to them.

PRIMARY OBJECTIVES OF FINANCIAL ACCOUNTING: Basically financial objective is an objective oriented discipline which focuses on enabling the decision making by all the concern user of financial accounting information. Following are the specific objectives of financial accounting To maintain the record of all the accounting transaction in appropriate book. It calculates the result of business operations conducted during specific period. To ascertain the financial position of business as on particular date. To analyses the detail the profitability and current financial position of business To communicate the financial accounting information to various user in proper form.

Accounting Concept: Accounting concept are the necessary assumption or conditions upon which the accounting is base. Following are the accounting concepts: 1. Entity Concept: As per the concept of entity the business and businessman are treated as separate entity. A businessman provides capital to business then it is considered as liability of a business repayable to businessman at the end of the business. It helps keep the private affairs of the businessman away from the business transaction. It applicable to all forms of business organization. 2. Going concern: it is assumed that business organization will continue its activities for fairly long period unless and until it enter the state of liquidate, hence in the book of account the depreciation is provided on the fixed asset considering their expected life.

3. Dual aspect concept:

Every transaction has two effect while recording to the books of account. For e.g. if goods purchased for cash is goods coming in to the business and cash is going out from the business. It should be two effect debit and credit. 4. Cost concept: This concept suggest that the asset should be recorded at cost only. Here cost means price at the time of purchased of asset. If cant be recorded at realizable value or current sale price or current market price or any replacement value. 5. Money measurement concept: In accounting everything is recorded in terms of money, event or transaction which cannot be express in monitory value are not recorded in the book of account even if they are significant for the business. 6. Accrual concept: It refers to the system or method whereby revenue and express are identified with the specific period of time, generally an accounting year.

It indicates that the transaction of particular period are recorded in the books of accounts even if they are not paid or received in cash. 7. Periodicity concept: According to this concept the accounting internal is a period of 12 months for which the business result are measure though the business continues to operate. This help to organization understand the project and financial position of the business and enable it to take appropriate action fo correcting the deviation if any. 8. Matching concept: Generally project making is one of the very important objectives of the business organization which keep them busy with their business activities. Hence as per the matching concept there is period matching of a cost and revenue to find out the project and liability of concern. While matching the revenue and expense concept of accrual plays important role as well as the expense and revenue the specifies period is taken into consider while ascertaining project.

9. Realization concept:

According to this concept the project should be accounted for only when it is actually realized. Revenue is recognize only when the sale takes place or service are rendered. Sale is considered to be a made when the property in the goods is passed to buyer and he is liable to pay.

10

Verifiable evidence concept:

According to this concept all accounting transaction should be evidenced and supported by objection document. Such supporting document provides the basis for making accounting entries and for making verification by the auditor later on.

MANAGEMENT ACCOUNTING: Accounting is the process of identifying, measuring, communicating the monitory information to permit judgment and decision by user of information. The business accounting system consists of three parts: Financial accounting Cost accounting

 Management accounting

The accounting information specifically prepared to aid manager is called management accounting.

Definition: Management accounting is the process of identifying, measurement, accumulation, Interpretation and communication of information that assist manager to take specific decision.

The institute of management account describes management account as, The internal business building role of accounting and finance professionals who design, implement and manage internal system that support effective decision an plan an decontrols the organizational operation

ADVANTAGES OF MANAGEMENT ACCOUNTS:

The advantages of management account are as follow: 1. Increase efficiency: Management accounting increases the efficiency of operation of a company. Everything in done in management accounting with scientific system for evaluation and comparing the performance. With this we find deviation and we will take decision on this basis. Other employee also motivated with this because if their performance will be favorable, hey get reward of this. Thus management accounting increases efficiency. 2. Maximize the profit: Using the management accounting budgetary control and various tools company can easily succeed to reduce both operational and capital expenditure. After this company can reduce price and then company can earn super profit. 3. Simplify the financial statement: For taking different managerial decision management account provide deep technical report with simple interpretation in which mention the fact of financial statement after this companies management officer understand and they will use this for companies progress.

4. Control of business cash flows: We all know that cash in hand is better than In fix asset, if there is emergency to pay the loan. So management account deeply where is it going, to check on misuse of money will surely control of business cash flows. 5. Business Critical decision: To take business critical decision now management accounting will become more powerful. Global management accountants are coming for join on one plate form for taking all business critical decision.

Misconception about management accounting: Many business owners confuse management accounting with cost accounting. Management accounting encompasses a wide variety of tools and techniques. Cost accounting specific function directly related to allocating business costs to goods and services. Manufacturing and production companies are the primary users of cost accounting. Business men in all industries can use the other portions of management accounting for improving performance.

Scope of management accounting: Management has a very wide scope. It includes not only financial accounting and cost accounting but also all types of internal financial controls, internal audit, tax accounting, office services, cost controls and other methods and control procedures. Thus scope of management accounting interlaid includes the following:

1) Financial accounting: Financial accounting provides basic historical data which helps management to forecast and plan its financial activities for the future period. Thus for an effective and successful management accounting. There should be a proper and well designed financial accounting system.

2) Cost accounting: Many of the techniques of cost control have standard costing and budgetary control and techniques of profit planning and decision making have managerial costing, CUP analysis and differential cost analysis are used by the management accounting. 3) Budgeting and forecasting: In order to plan business activities for the future, forecasting and budgeting play a very significant role. Forecasting helps in the preparation of

budgets and budgeting helps management account in exercising budgetary control. 4) Tax Planning: In order to take advantage of various provisions of tax laws, management accountant has to depend upon tax accounting and planning to minimize the tax liabilities and save more funds for the business. 5) Reporting to management: For effective and timely decisions there should be a system of prompt and reporting to management. Both routine and special reports are prepared for submission to top management, middle order management and operating level management depending upon their requirements. 6) Cost control procedures: Any system of management accounting is incomplete without effective cost control procedures like inventory control, labor control, overhead control and budgetary control.

THE RELATIONSHIP BETWEEN MANAGEMENT ACCOUNTING, COST ACCOUNTING AND FINANCIAL ACCOUNTING? FINANCIAL-The object of financial accounting is to find out the profitability and to provide

information about the financial position of the concern. Two important statements of financial accounting are Income and Expenditure Statement and Balance Sheet. COST-Cost accounting is one of the important elements of accounting information about the problems of internal managerial control. Financial accounts are unable to meet information needs about the cost structure of a product. MANEGEMENT-Cost accounting helps the internal management by directing their attention on inefficient operations and assisting in a day-to-day control of business activities. Management accounting is the process of identification, measurement, accumulation, analysis, preparation, interpretation and accumulation of financial information used by management to plan, evaluate, and control within an organization and to assure appropriate use of and accountability for its resources.

GCFAFINANCIAL ACCOUNTING AND MANAGEMENT ACCOUNTING-COMPARISON. Basis Financial accounting Management

accounting External and internal users Financial accounting is mainly intended for external user like investors, shareholders, creditors, Govt, and authorities etc. Management accounting information is mainly meant for internal user, i.e. management. It is based on double entry system.

Accounting method It is based on double entry system for recording business transactions Analysis of cost and Financial accounting profit show the profit/ loss of the business as a whole. It does not show the cost and profit for individual product, processes or departments, etc.

Management accounting provides detailed information about individual product, plant, department or any other responsibility centre.

Past and future data

It is concerned with recording transaction which has already taken place. Financial reports I.e. profit and loss account and balance sheet are prepared on year to year basis

It is future oriented and concentrates on what is likely to happen in future. Management accounting reports are prepared frequently i.e. these may be monthly, weekly or even daily, depending on managerial requirements. Management accounting may apply monetary or non monetary units of measurement.

Periodic and continuous reporting

Monetary and non- Financial accounting monetary provides measurement information in term of money only.

COST ACCOUNTING AND MANAGEMENT ACCOUNTING COMPARISON.

Basis Scope

Cost accounting Scope of cost accounting is limited to providing cost information for managerial uses.

Management accounting It provides all type of information, i.e Cost accounting as well as Financial accounting Information for managerial uses. Main emphasis is on planning, controlling and decision making to maximize profit. It is based on data derived from Cost accounting, Financial accounting and other sources. Management account is generally placed at higher level of hierarchy than the cost accountant.

Emphasis

Main emphasis is on cost ascertainment and cost control to ensure maximum profit. It is based on data derived from Financial accounts.

Data base

Status in organization

Cost accountant is placed at a lower in hierarchy than the Management accountant.

3> BUDGETARY CONTROL FUNCTIONAL BUDGETS, CASH BUDGETS, MASTER BUDGETS

Meaning and Definition of Budget

Budget refers to a plan relating to a definite future period of time expressed in monetary and/or quantitative terms. In relation to business, a budget is a formal expression of the expected incomes and expenditures for a definite future period. The Chartered institute of Management Accountants (C.I.M.A.) London, has defined a budget as "a financial and/or quantitative statement, prepared prior to a defined period of time, of the policy to be pursued during that period for the purpose of attaining a given objective." It may include income, expenditure and employment of capital. In this words of Gorden Shillinglaw, a business budget is "a pre-determined detailed plan of action, developed and distributed as a guide to current operations and as a partial basis for subsequent evaluation of performance." According to Brown and Howard , "A budget is a pre-determined statement of management policy During a given period which provides a standard for comparison with the results actually achieved."

Budgeting
The act of preparing budget is called budgeting. In the words of J. Batty, "the entire process of preparing the budgets is known as budgeting."

Meaning and definition of Budgetary Control

Budgetary control is a system of controlling costs through preparation of budgets. Budgeting is thus only a part of the budgetary control. According to C.I.M.A", London, budgetary control is the establishment of budgets relating to the responsibilities of executives of a policy and the continuous comparison of the actual with the budgeted results, either to secure by individual action the objectives of the policy or to provide a basis for its revision.

In other words of Brown and Howard budgetary control system is a system of controlling costs which includes the preparation of budgets, co-coordinating the department and establishing responsibilities, comparing actual performance with the budgeted and acting upon results to achieve maximum profitability.

Characteristics of budgetary control

1. Establishment of budgets for each function / development of the organization. 2. Comparison of actual performance with the budgets on a continuous basis. 3. Analysis of variation of actual performance from that the budgeted performance to know the reason thereof. 4. Taking suitable remedial action, where necessary. 5. Revision of budget in view of changes in conditions.

Objective of budgetary control

The following are the main objectives of Budgetary Control System. 1. Planning:- A budget provides a detailed plan of action for a business over a definite period of time. Detailed plans are drawn up relating to production, sales, raw material requirements' labour needs, advertising and sates promotion performance, research and developmentactivities, capital additions, etc. Planning helps in anticipating many problems long before they may arise and solutions can be sought through careful study. Thus most business emergencies can be avoided by planning. In brief, budgeting forces managements to think ahead, to anticipate and prepare for the situation.

2. Co-ordination:- Budgeting aids managers in co-coordinating their efforts so that objectives of the organization as a whole harmonies with the objectives of its

divisions. Effective planning and organizing contribute a lot in achieving coordination. There should be co-ordination in the budgets of various departments. For example, the budget of sales should be in co-ordination with the budget of production. Similarly, the production budget should be prepared in coordination with the purchase budget, and so on"

3. Communication:- a budget is a communication device. The approval budget copies are distributed to all management personnel which provides not only adequate understanding and knowledge of a programmers and policy to be followed but also alerts about the restrictions to be adhered to. It is not the budget itself that facilitates communication, but the vital information is Communicated in the act of preparing budgets and participation of ail responsible individuals in this act. 4. Motivation:- a budget is a useful device for motivating manager to perform in a line with a company objectives. If individuals actively participated in the preparation of budget, it acts as a strong motivating force to achieve the target. 5. Control:- Control is necessary to ensure that plans and objectives as a laid down in the budget are being achieved. Control, as applied to budgeting, is a systematic efforts to keep the management inform of whether the planned performance is being achieved or not. For this purpose, a comparison is made between plan and actual performance. The difference between the two is reported with the management for taking corrective action. 6. Performance evaluation:-A budget provides a useful means of informing manager how well they are performing in meeting targets. They have previously helped to set. In many companies there is a practicing of rewarding employee on the basis of their achieving the budget target of promotions of a manager may be linked to its budget achievement record.

 Advantage of budgetary control

Budgetary control provides the following advantage 1. It increase production efficiency, eliminates waste and controls the cost. 2. Budgetary control aims at maximization of profits through careful planning and control. 3. It means that working capital is available for the efficient operation of the business. 4. It directs capital expenditure in the most profitable direction. 5. A budget motivates executive to attain the given goal. 6. A budgetary control system creates necessary conditions for the introduction of standard costing technique. 7. A budgetary control system assist in delegating of authority and assignment of responsibility 8. Budgeting also aids in obtaining bank credit.

Limitation of Budgetary control:Budgetary control system suffered from certain limitation and those using the system should be fully aware of them. The main limitations are:1. The budget plan is based on estimates:- budget are based on forecasts and forecasting cannot be an exact science. Absolute accuracy, therefore, is not possible in forecasting and budgeting. The strength and weakness of a the budgetary control system depends to a large extent, on the accuracy with estimates are made. Thus, while using the system, the fact that budget is based on estimates must be kept in view. 2. Danger of rigidity:- A budget programme must be dynamic and continuously deals with the changing business conditions. Budget will lose much of their usefulness if they acquire rigidity and are not revised with the changing circumstances.

3. Budgeting is only a tool of management :- budgeting cannot take the place of management but is only a tool of management. The budget should be regarded not as a master, but as a servant. Sometime it is believed that introduction of a budget programmes is alone sufficient to ensure its success execution of budget will not occur automatically. Participate enthusiastically in the programme for the realization of the budgetary goals. 4. Opposition from staff:- employee may not like to be evaluated and thus oppose introduction of budgetary control system. As such, inefficient managers may try to create difficulties in the way of introducing and operating this system. 5. Expensive technique:- The installation and operation o budgetary control system is a costly affair as it requires the employment of specialization staff and involves other expenditure which small concern may find difficult to incur. However it is essential that the cost of introducing and operating a budgetary control derived there from.

Functional budgets

A functional budget is one which related to a particular function of the business. E.g. Sales budget, production budget, purchase budget etc. These are components of master budget. Specific functional budget to be prepared in business vary form organization to organization. The common type of functional budget are, are as follows.

Type of functional budgets : Sales budget Production budget

Production cost budget Purchase cost budget Labour budget Production overhead budget Selling and distribution cost budget Administration cost budget Cash budget Capital expenditure budget.

1.Sales Budget
In most companies, the sales budget is not only the most important but also the most difficult budget to prepare. The importance of this budget arises form the fact that if sales figures are incorrect, then practically all other budget will be affected. The difficulties in the preparation of this budget arises because it is not easy to estimate customer demand, particularly when new product is introduced. The sales budget is a planned statement of planned sale in term of quantity and value. It forecasts what the company can reasonably expect to sell to its customer during the budget period. The sale budget can be prepared to show sales classified according to products, Salesmen, customer, territories and periods etc.

Factors considers in forecasting sales:There are few factors which affect to the forecasting of the sales. 1. Past sales:- analysis of the past sales show the trends to data and any seasonal or cyclical fluctuation. It is therefore, not difficult to suggest future trends form the analysis of the past sales. 2. Reports by salesman:- The salesman are in close touch with the market and thus they may be required to prepare detailed estimate of sales that they are likely to make in their respective area during the budget period. 3. Company condition:- Any change in policies and methods of the company and their effects an sales should be considered.

Examples:- Additional spending on advertising introduction of new channels of distributions, introduction of new product etc. 4. Business conditions:- Any changes in economic condition and that in related business activities and their effect on company sales should be considered. Information should be obtained about competing industries to assess the strength of competitions. 5. Special conditions:- In the preparation of sales budget any new external development things place should also be considered. Example:- when an industry manufactures product for another industry. It will be necessary to analysis the trend of sales in that industry 6. Market analysis:- some companies depend upon market analysis and research to mean the potential demand for their product. Such as analysis reports on the state of the fashion trends, the type of product design required.

2.Production Budget
The productions budget is a plan of production for the budget period. It is first drown up in quantity of each product and when the remaining budgets have been cost are translated into money terms, what in effect because a production cast budget. The principle consideration involved in budgeting production area. Sales budgets:- when sales is the principle budget factors, the production budget will be based on the volume of sales forecast by the sales budgets. b. Inventory policy:- The management decision regarding quantities needed in stock at all time to meet customer requirements is an important factors. In decision on the inventory policy and, factors like storage facilities, risk of price change etc. c. Production capacity:- The production capacity of each department should be worked cut and budget figures should be within these limits such as

I. II. III.

Purchase of additional plant machinery Introduction of additional shifts. Introduction of overtime working.

d. Management policy:- production policy of the management plays an important role in budgeting production. Example:- management may decide to buy a particular component part form outside instead of manufacturing its, this will influence production budget

3.Production Cost Budget

This budget shows the estimated cost of production. The production budget show the quantities of production. These quantities of production are expressed in term of cost in production cost budget. The cost of production is shown in details in respect of material cost, labour cost and factory overhead. Thus production cost budget is based upon production budget, material cost budget, labour cost budget and factory overhead budget, it is also a detailed plan sharing the number of units that must be produced during a period in order to meet both sales and inventory.

4.Purchase Budget
Careful planning of purchase offers one of the most significant areas of cost saving in many companies. The purchases managers should be direct responsibility for preparing a detailed plan of purchase for the budget period and for submitting the plan in the form of a purchase budget.

Factors of purchase budget

a) Opening and closing stocks to be maintained as it well affect material requirement. b) Maximum and minimum stock quantities c) Economic order quantities d) Financial resources available

e) Purchase orders placed the budget period against which supplies will be received during the period under consideration. f) Policy of the management regarding materials or component to be manufactured within the business as distinct from those purchased from outside.

5.Labour Budget
The labour budget represents the forecast of labour requirements to meet the demands of the company during the budget period. This budget must be limited with production budget and production cost budget. The method of preparing labour budget is like this. The standard direct labour hours of each grade of labour required for each unit of output and standard wages rate for each grade of labour are ascertained. Multiplication of units of finished goods to be labour is normally a fixed amount. So should be easy to calculate in total for the period.

Purpose of labour budget

The labour budget serves the following purpose:a) To estimate the labour cost of production. b) To determine the direct labour hence the number and grade of workers required to meet the production requirements. c) To provide the personnel department with personnel requirement so that it may plan recruitment activities. d) To provide data for determination of cash requirement for payment of wages. e) To provide data for management control of labour cost.

6.Production Overhead Budget

After budgeting of material and labour cost, next logical step is to prepare a budget for production overheads. The production overhead budget represents the forecast of all the production overheard (fixed, variable and semi-variable) to be incurred during the budget period. The fact that overheads include many dissimilar types of expenses creates considerable problems in: (a) The allocating of production overheads to products manufactured, and (b) Control of production overheads. The production overhead budget involves the preparation of overhead budgets for each department of the factory as it is desirable to have estimates of manufacturing overheads prepared by those individuals who have the responsibility for incurring them. The budget expenses for each sub-period during the budget period should be indicated and the classification of expenses should be the same as used by the accounting department.

7.Selling and distribution cost budget

This is closely related to sales budget and represent the forecast of all cost incurred I selling and distributing the company product during the budget period as a general rule the sales budget and the selling and distribution cost budget are prepared simultaneously since each has a definite impact on the other.

8.Administration cost budget

This budget represent forecast of all administration expenses like directors fees. Managing director salary, office lighting, heating and air conditioning etc. Most of these expenses are fixed. So should not be too difficult to forecast.

9.Capital expenditure budget

This budget represents the expenditure on all fixed assets. During the budget period. It includes such items as new building, machinery. Land and intangible items like patents etc.

10. Cash budget

The cash budget is one of the most important and one of the last to be prepared. It is detailed estimate of cash receipts from all sourced and cash payment for all purpose and resultant cash balances during the budget period. It makes certain that the business has sufficient cash available to meet its needs as and when these arise. It is a device for business to ensure solving and provides a basis for planning and financing required to any deficiency in cash budget thus plays an important role in the financial management of a business undertaking.

Purposes:The main purpose of cash budget is outlined below:a) It ensures that sufficient cash is available when required. b) It includes cash excess and shortages so that action may be taken in time to invest any excess cash or in borrow funds to meet any shortages c) It established a sound basis for credit. d) It shows whether capital expenditure may be financed internally. e) It establishes a sound basis for control of cash position. Preparation of cash budget:There are three methods of preparing cash budget:a) Receipts and payment method. b) Adjusted profit and loss method. c) Balance sheet method

A) Receipts and payment method:This methods is usually used for short term forecast and is much more detailed them for other two methods.

The cash budget begins with the opening balance of cash in hand and at bank to this will be added the cash receipts from various sources and from the will be deducted all payment of cash will be delegated all payment of cash whether on capital OR Revenue account. The results figures is closing cash balance. Cash balance. Cash receipts in most situation arise from cash sales, collection from debtors, interest on investment and loan sale of capital assets and miscellaneous sources in the case of credit sales, adjustment should be made for lime lag between the point of sale and relation of cash. Cash payments are made for raw materials purchase, direct labour, out of pocket expenses capital expenditure projects, dividends etc. The period of credit appropriate to the payment concerned should be taken into account.

Illustration:A company is expecting to have Rs. 25000 cash in hand on 1 stApril 2010 and it requires you to prepare cash budget for the three months, April to June 2010 the following information is supplied to you.

Months February March April May June

Sales 70,000 80,000 92,000 100,000 120,000

Purchase 40,000 50,000 52,000 60,000 55,000

Wages 8000 8000 9000 10,000 12,000

Expenses 6000 7000 7000 8000 9000

Other information:-

a) Period of credit allowed by suppliers is 2 months. b) 25% of sales is for cash and the period of credit allowed to customer for credit sale is one month. c) Delay In payment of wages and expenses one month. d) Income tax Rs. 25000 is to be paid in June 2010

Solution:Particular Opening balance Receipts:Cash sales Debtors Total (A) Payment:Creditors Wages Expenses Income tax Total (B) Closing balance (A-B) April 25,000 May 53,000 June 81,000 Total 25,000

23,000 60,000 108,000

25,000 69,000 147,000

30,000 75,000 186,000

78,000 204,000 307,000

40,000 8000 7000 55,000 53,000

50,000 9000 7000 66,000 81,000

52,000 10,000 8000 25,000 95,000 91,000

142,000 27,000 22,000 25,000 216,000 91,000

B) Adjusted profit and loss method:This method is suitable for long term cash forecast. It is based on the view that is the profit that is the source of cash in the business. The profit as per profit and loss accounts is converted into cash figures by preparing an adjusted profits and loss a/c. All these items of income and expenditure clike department provisions

etc.which do not involve and inflow an out flow of cash are adjusted in the forecasted profit figure to arrives at the figure of cash made available by profit. The following table is a cash budget under this method showing the various items that requires adjustment in the profit figure for finding out the cash position at the end of a particular period.

Cash budget for the period..

Particular Opening balance Additions:Budgeted net profit Depreciation Provision Sale of plant. Issue of capital and debenture Reduction in debtors Reduction in stocks Accrued expenses Income in liabilities Total additions Total cash available Deduction:Dividends Payment Capital profit Increase in January February March Total

stocks Increase debtors Increase liabilities

in in

Total deduction Closing balance of cash

The adjusted profit and loss method is often termed as cash flow statement because it converts the profit and loss account into a cash forecast. The main difference between this method and the receipts and payment method is that where as the farmer considers non-cash items for adjustments in the profit figure. The latter takes into account only cash transactions. It will be a appreciated that under the adjusted profit and loss method. The equation that profit =cash will hold good if there were no credit transactions capital transactions, depreciation, stocks fluctuation or appropriations of profit abut such a situation can not exist in practice.

C) Balance sheet methods

This method is also used for forecasting cash requirement for long periods and is rather similar to adjusted profit and loss account method discussed above. Under this method, a budgeted balance sheet is prepared with all items of assets and liabilities expecting cash or bank balance. The two sides of the balance sheet are then totaled and the balancing figure is taken as cash. If the liabilities are more

than assets. This reveals a balance of cash and bank and if assets exceeds liability this reveals a bank overdraft. Thus under the adjusted profit and loss method cash figure is computed by a cash flow statement and the same figure is computed as a balancing figure under the balance sheet method.
\

Master budget
When all the functional budgets have been prepared, these are summaised into what is known as a master budget' Thus a master budget is a consolidated summary of all the functional budgets. According to C"I'M.A., London, "master budge!Is- a summarybudgetincorporatingitscomponent functional budgets and which is formally approved, adopted and employed ." A master budget has two parts (i) operating budget, i.e., budgeted profit and loss account and (if) financial budget, i.e., budgeted-balance sheet. Thus, a projected profit and loss account and a balance sheet together constitute a master budget. The master budget is, prepared by the budget director (or budget officer) and is presented to the budget committee for approval. If approved, it is submitted to the Board of Directors for final approval' The Board may make certain amendments/alterations before it is finally approved.

4 > FLEXIBLE BUDGETING ZERO BASED BUDGETING RESPONSIBILITY AND PERFORMANCE BUDGETING BUDGET
Budget is the most widely used and highest rated management tool of cost reduction and control. It is a tool that helps managers in planning and controlling functions. Planning is the key to good management as it involves taking or looking systematically at the future. Business budgets help managers in developing financial plan to guide them in allocating their resources over a specific future

period. Control is the process of measuring and correcting actual performance to ensure that plans for implementing the chosen course of action are carried out.

CHARACTERISTICS OF BUDGET 1. Budget is primarily a planning device but it also serves a basis for performance evaluation and control. 2. Budget is prepared either in money terms or in quantitative terms in both. 3. Budget is prepared for definite future period. 4. Purpose of budget is to implement the policies formulated by management for attaining the given objectives.

BUDGETARY CONTROL
Budgetary Control system is a system of controlling costs which includes the preparation of budgets co-coordinating the departments and establishing responsibilities, comparing actual performance with the budgeted and acting upon results to achieve maximum profitability

CHARACTERISTICS OF BUDGETARY CONTROL:

1. Establishment of budgets for each functions/departments of organization. 2. Analysis of variation of actual performance with the budgets on a continuous basis. 3. Taking suitable remedial actions, where necessary. 4. Revision of budgets in view of changes in conditions.

ADVANTAGES OF BUDGETARY CONTROL

1. Budgeting compels managers to think ahead to anticipate and prepare for changing conditions. 2. Budgeting co-ordinates the activities of various departments and functions of the business. 3. It increases production efficiency, eliminates waste and control the costs. 4. It pinpoints efficiency or lack of it.

5. Budgetary controls aims at maximization of profits through careful planning and control.

TYPES OF BUDGETARY CONTROL:

Based on the level of activity or capacity utilization, budget are classified into fixed budget and flexible.

FIXED BUDGET.
A fixed budget is one which is prepared keeping in mind one level of output. It is defined as a budget. Which is designed to remain unchanged irrespective of level of activity changed. A fixed budget is prepared on assumption that output and sales can be estimated with the fair degree of accuracy. This means that in those conditions where sales and output cannot be accurately estimated, fixed budget does not suit.

FLEXIBLE BUDGET.
In contrast to fixed budget flexible budget is defined as, Which is designed to change in relation to the level of activity attained. 1. The underlying principle of flexible budget is that a budget is of little use unless cost and revenue are related to actual volume of production. 2. Flexible budget has been developed with the objective of changing the budget figures to correspond with the actual output achieved 3. Thus, a budget might be prepared for various levels of activity, say 70%, 80%, 90%, and 100% capacity utilization.

4. Then, whatever level of output actually reached, it can be compared with an appropriate level. Flexible budgets are prepared in those companies, where it is extremely difficult to forecast output and sales with accuracy. 1. Where nature of business is such that sales are difficult to predict. E.g. Demand for luxury goods is quite unpredictable. 2. Where sales are affected by weather conditions. E.g. Soft drinks industry, woolen garments etc. 3. Where sales are affected by changes in fashion. E.g. Readymade garments. 4. Where company frequently introduces new products. 5. Where large part of output is intended for exports. .

Flexible Budget
In contrast to a fixed budget a flexible budget is one which is designed to change in relation to the level of activity attained. The underlying principle of flexible budget is that a budget is little use unless cost and revenue are related to the actual volume of production flexible budgeting has been developed with the objective of changing the budget figures to correspond with the actual output achieved. Thus a budget might be prepared for various level of activity say 70% , 80% and 100% capacity utilization. Then whatever the level of output actually reached, it can be compared with an appropriate level. Flexible budgets are prepared in those companies where it is extremely difficult to forecast output and sales with accuracy, such a situation may arise in following cases.

1. Where nature of business I such that sales are difficult to predict. E. g . demand for luxury goods is quite unpredictable. 2. Where sales are affected by weather conditions . e. g. soft drink industry , woolen garment etc.

3. Where sales are affected by changes in fashion. E. g. readymade garments. 4. Where company frequently introduces new product. 5. Where large part of output is intended for export. Sum on flexible budget Particular capacity(Rs.) A Variable overheads Indirect labour Stores including spares B Semi-variable overheads Power Repairs and maintenance C Fixed overheads Depreciation Insurance Salaries Total overheads Estimated direct labour hours hrs. At 80%

12,000 4,000 20,000 2,000 11,000 3,000 10,000 62,000 1,24,000

ANS.. Particular At 70% capacity At 80% capacity

Variable overheads Indirect labour Stores including spares

10,500 3,500

12,000 4,000

Semi-variable overheads Power fixed variable Reparis & maintenance fixed variable Fixed overheads Depreciation Insurance salaries Total overhead Estimated direct labour hours

6,000 12,250 1,200 700

6,000 14,000 1,200 800

11,000 3,000 10,000

11,000 3,000 10,000

58,150 1,08,500

62,000 1,24,000

Working note :
Direct labour cost at 70% = 12,000*70/80 = Rs. 10,500 at 90% = 12,000*90/80 = Rs. 13,500 Similar calculation for other variable item, i.e. stores. Power - fixed = 2000*30/80 = 6,000 , 20,000-6,000 = 14,00 variable at 70% = 14,000*70/80 = Rs. 12,250 at 90% = 14,000*90/80 = Rs. 15,750 Similar calculation for repairs and maintenance Direct labour hours at 70% = 1,24,000*70/80 = 1,08,500

at 90% = 1,24,000*90/80 = 1,39,500

Uses of flexible budgets

The figure in flexible budgets is adaptable to any given set of operating conditions. It is therefore more realistic than a fixed budget which is true only in one set of operating conditions. Flexible budgets are also useful from control point of view. Actual performance of an executive should be compared with what he should have achieved under different circumstance.

Performance Budgets
Performance budget is also a recent development which tries to overcome the limitations of traditional budgeting. In traditional system of budgeting as used in business enterprises and government departments, the main defect is that the control of performance in terms of physical units and the related cost is not achieved. This is that the control of performance in terms of physical units and the related costs is not achieved. This is because in such budgeting money concept is given more importance performance budgeting is a relatively new concept which focuses on functions program and activities. In other word in case of traditional budgeting both input and output are mostly measured in monetary unit while performance budgeting lays emphasis on achievement of physical targets. Performance budgets are established in such a manner that each item of expenditure related to a specific responsibility Centre is closely linked with the performance of that Centre. Thus performance budgeting lays stress on activities and programs. It tries to answer questions like what is to be achieved. How is it to be achieved when is it to be achieved etc. The government of India has now decided to introduce performance budgeting in all its departments in a phased manner. An example of performance budgeting in government system of accounting may be that generally expenditure is classified under the heads the heads like pay and allowances, transport, repair, and

maintenance, etc. in performance budgeting the classification of expenditure may be setting up of a steel mill, construction of a railway station, computerization of railway booking system, purchase of an aircraft carrier, etc. and other physical targets. When work on these activities is started funds are obtained against these physical targets. Reports are then prepared for any under-spending or overspending which are then analyzed for corrective action to be taken.

Steps in Performance Budgeting

1.Establishment of responsibility Centre First of all responsibility centers are established. A responsibility Centre is a segment of an organization where an individual manager is held responsible for the performance of the segment. 2.Establishement of performance targets For each responsibility Centre targets are set in terms of physical performance to be achieved. For example, for sales department which is a responsibility Centre targets may be set in terms of number of units to be sold during the budget period. For production department the target would then be the number of units to be produced. 3. Estimating financial requirements In this steps the financial support needed to achieve the physical target is estimated. In other words, the amount of expenditure involved under various heads to meet the physical performance is forecasted. 4.Comparison of actual with budgeted performance This is a usual step in budgetary control to evaluate the actual performance. 5.Reporting and action Variances from budgeted performance are analyzed and reported for corrective action to be taken.

Zero Base Budgeting

ZBB is a recent development in the area of management control system and is steadily gaining importance in the business world. Before preparing a budget a base is determined from which the budget process begins. Conventionally current years budget is taken as the base or the starting point for preparing the next years budget the figures in the base are changed as per the plan for the next year. This approach of preparing a budget is known as conventional or incremental budgeting since the budgeting process is concerned mainly with the increase or changes in operation that are likely to occur during the budget period. Zero based budgeting is not based on the incremental approach and previous figures are not adopted as base. Zero is taken as the base and budget is developed on the basis of likely activities for future period. A unique feature of ZBB is that it tries to help management answer the question Suppose we are to start our business from the scra.th, on what activities would we spent out money, and to what activities would we give the highest priority

Features of zero based budgeting

All budget items, both old and newly fresh items are both considered as a fresh. Amount to be spent on each budgetary items is totally justified. Detailed analysis of each budgetary program Linked to corporate goals Managers participates at all levels Advantages Justified activities on cost benefits ZBB discards current position in favor Inefficient, loss making operations identified Psychological push to employees

 Educational process Cost behavior patterns observed closely Disadvantages Enormous increase in paper work Managers may resist new ideas and changes Dangers in short term gains Tendency to regard any activity Managers needs to be given proper training Rise in conflicts, due to un-proper decision packages

RESPONSIBILITY BUDGET
When the operating budget of a firm is constructed in terms of Responsibility areas it is called the Responsibility Budget. Such a budget shows the plan in terms of persons responsible for achieving them. It is used by the management as a control device to evaluate the performance of executives who are in charge of various cost centre. Their performance is compared to the targets (budgets), set for them and proper action is taken for adverse results, if any. The kings of responsibility areas depend upon the size and nature of business activities and organizational structure. Defination Horngren has defined responsibility accounting as A system of a accounting that recognizes various responsibility centres throughout the organization and reflects the plans and actions of each of these centre by assigning particular revenues and costs to the one having the pertinent responsibility.

Types of Responsibility areas/ centre. 1. Cost/ Expense centre : It is defined by C.I.M.A. (chartered Institution of Management Association) London as a production or service location, function, activity or item of equipment whose costs may be attributed to cost units. A responsibility centre is a cost centre where the manager is

accountable for the costs that are under his control but not for its revenues. Only these costs are charged to cost centre which are controllable by the manager of the cost centre. For example, the maintenance department of a hotel may be a cost centre because the maintenance manager is responsibility only for the costs. 2. Profit Centre : According to C.I.M.A., London, a profit centre is a part of a business accountable for costs and revenues. It may be called a business centre, business unit, or strategic business unit. Thus a responsibility centre is a profit centre where the manager is accountable for sales revenue as well as costs. The difference between revenues and costs is profit. For example, A unit of a company is a profit centre it is responsible for sale as well as production in that unit. 3. Investment Centre : It is defined by C.I.M.A., London as a profit centre whose performance is measured by its return on capital employed. Thus a responsibility centre is an investment centre where is manager is responsible for sale revenues and costs and in addition is responsible for some capital investment decision relation to working capital management. Capital structure and capitalization, etc. his performance is measured in terms of profit as related to capital base.

Features of responsibility centre. 1. Responsibility centres are created. 2. A plan is prepared in the form of budget or standards for each responsibility centre. 3. The performance of the responsibility centre is evaluated by comparing actual results with those budgeted in the regular monthly reports. 4. Variance between actual and budgeted performance are analyzed so as to fix responsibility. 5. Corrective and preventive action is taken, wherever possible.

Responsibility Budget

Responsibility budget can define as it is a method of collecting and reporting both budgeted and actual costs and revenue by divisional managers responsible for them. It means Responsibility Budgeting business activities are identified with person rather than products or function and responsibility assigned to the manager best placed to effect control. Advantages of Responsibility Budget Responsibility for any adverse performance is clearly identified. As a result, the individual manager may find it difficult to shift the responsibility to any other manager. The Morale of the manager is high because of their active participation in decision making. Responsibility budget provide increase job satisfaction and greater motivation to put in their best effort. It helps to quick reporting of performance oriented result of management of various levels. Manager of responsibility centres get an opportunity to gain valuable managerial skill. Responsibility Budget facilitates stricter control on costs and revenues. Responsibility Budget is often focused on the lowest level manager who have the most day-to-day influence on costs, where a person can significantly influence the amount cost through his own action.

5 >RESPONSIBILITY ACCOUNTING COST CENTRES PROFIT CENTRES AND INVESTMENT CENTRES

RESPONSIBILITY ACCOUNTING

INTRODUCTION :The term responsibility accounting refers to the accounting process that reports how well managers have fulfilled their responsibility. It is also known as activity or profitability accounting , it is an information system that personalises control reports by accumulating and reporting cost and revenue information accounting to defined responsibility areas within a

company. Responsibility accounting systems are tailored to organization structure so that revenue and costs are accumulated and reported by centres of responsibility within the organization. Responsibility accounting is closely related with the goal of controllability. It implies that individuals in an organization should be made responsible for any elements which they can control system. It is a basic component of good control system. And it has close link with the size of organization. Responsibility accounting proves extremely useful for big and diversified organizations. It has no scope in a small organization because in such a business all decision making is centralized at one place and one individual. As companies grow in size, they tend to decentralise because decentralization for large and diversified companies are necessary for better management.

DEFINITION :According to Horngren Responsibility accounting is, A system of accounting that recognizes various responsibility centres throughout the organization and reflects the plans and actions of each of these centres by assigning particular revenues and costs to the one having the pertinent responsibility. It is also defined as, That segregates revenues and costs into areas of personal responsibility in order to assess performance attained by persons to whom authority has been assigned. MEANING :Responsibility accounting is a method of accumulating and reporting both budgeted and actual costs and revenues by divisional managers responsible for them. It means in responsibility accounting, business activities are identified with persons rather than products or functions and responsibility is assigned to the manager best placed to effect control. The idea of responsibility accounting is that managers will be held responsible only for those items over which they can exercise a significant amount of control.

Features of Responsibility Accounting The basic method of control in responsibility accounting is the same as used in budgetary control and standard costing are created. i) ii) Responsibility centre are created. A plan is prepared in the form of budgets or standards for each responsibility centre.

iii) iv) v)

The performance of responsibility centre is evaluated by comparing actual result with those budgeted in the regular monthly reports. Variance between actual and budgeted performance are analysed so as to fix responsibility. Corrective and preventive action is taken wherever possible.

Advantages Of responsibility Accounting The following advantages accrue from a system of responsibility accounting. I) Responsibility for any adverse performance is clearly identified. As a result, the individual manager may find it difficult to shift their responsibility to any other manager. The moral of the manager is high because of their activity participation in decision making. Responsibility accounting provides increased job satisfaction and greater motivation to put on their best efforts. It helps in quick reporting of performance oriented result of management of various levels. Managers of responsibility centers get an opportunity to gain valuable managerial skill. Responsibility accounting facilitates stricter revenues.

II) III) IV) V) VI)

Pre-requisites for responsibility accounting:

It is base on certain assumption It should be big company divisionalised organizational structure and where area of responsibility are well defined at different level of the organization There are clearly set goal and target for each responsibility centre Manager actively participate in establishing the budget which there performance is measured Accounting system generate correct information for each responsibility centre The manager are held responsible for those activities over which they exercise significant degree of control Manager must be try to attain the goal and objective Goal for each area of responsibility should be attainable with efficient performance Performance should be timely and should contain significant information relating to the responsibility centre.

Responsibility reporting system:

 It involves preparation for report for each level of responsibility in the company organization chart Begins with the lowest level of responsibility and moves low level to high level Permit management by exception at each level of responsibility

Responsibility Centre
In order that the managers are held responsible, they must have clearly defined areas of responsibility. Each such area of responsibility is referred to as a responsibility centre. A responsibility centre is a division of the organisation for which a manager is held responsible. CIMA, London has defined responsibility centre as a segment of the organisation, where an individual manager is held responsible for its segments performance. In other words, of Horngren, a responsibility centre is a part, segment or sub-unit of an organisation whose manager is accountable for a specified set of activities. Example of a responsibility centre in a company running a chain of hotels may be one hotel whose manager will be accountable for its performance. A responsibility centre is like a small business to achieve the objectives of a large organisation. For an organisation to be successful, the activities of its responsibility centres must be coordinated. An important criterion for creating

a responsibility centre is that the unit of organisation should be separate and identifiable for the purpose of its evaluation. It should also be understood that for creating responsibility centre, it is not necessary that organisation must be decentralised because responsibility centres can be found in both centralised and decentralised organisations. Types of Responsibility Centres: For management control purposes, responsibility centers are classified into the following five categories:

1. 2. 3.

The main three responsibility centres that are to be discussed are: Cost centre Profit centre Investment centre.

Name of Centre 1. Cost Centre

Meaning And Examples Cost center is a responsibility centre for which costs are accumulated. Example of Cost centre: A production centre or a service department. Profit center is a responsibility centre for which both costs and revenues are accumulated. Example of profit centre: Individual department of retail store. Investment center is a responsibility centre for which costs, revenues and Investment in assets are accumulated. Example of investment centre: Subsidiary company.

2. Profit Centre

3. Investment Centre

Cost centre:
Definition by CIMA, London: A production or service location, function, activity or item of equipment whose costs may be attributed to costs units. A responsibility centre is a cost centre where the manager is accountable for the costs that are under his control but not for its revenues. Only those costs are charged to cost centre which are controllable by the manager of the cost centre. For example, the maintenance department of a hotel may be a cost centre because the maintenance manager is responsible only for costs. Based on managers ability to meet budgeted goals for controllable costs. Results in responsibility reports which compare actual controllable costs with flexible budget data Include only controllable costs in reports No distinction between variable and fixed costs

A cost centre is the smallest segment of activity or the area of responsibility for which costs are accumulated. Cost centres are created for accounting / ascertaining costs and their control. Such centres make all possible efforts to minimise costs. Standard amount of costs to be incurred by each cost centre is predetermined. The performance of each cost centre is evaluated by comparing the actual amount with the standard / budgeted amount. Success towards the achievement of cost standards speak about the performance of cost centre executives. While judging the performance of managers of cost centres, it is essential to differentiate between controllable costs and uncontrollable costs. In practice it would not be so easy to do so. This is one of the demerit of cost centres. Seldom an individual can have complete control over all the factors that may influence a given cost element. By this criteria, no cost can be theoretically classified as a controllable.

The Difference between Cost Centre and Cost Unit.

Cost centres are the smallest segment of activity or area of responsibility for which costs are accumulated or ascertained. I.C.M.A., England defines cost centre are the 'allocation, person or item of equipment for which cost may be ascertained and used for the purpose of cost control'. Cost centres are the natural division of the organisation in to convenient units for the purpose of cost ascertainment and control. These are the department of the organisation, but sometimes a department may also contain several cost centres. Cost unit is device for the purpose of breaking up cost in to smaller sub-divisions. I.C.M.A., England defines, cost unit is 'a unit of quantity of product, service, or time in relation to which cost may be ascertained or expressed'. Ordinarily cost unit is the expression in the form of count, weight, dimension etc. Cost unit is the unit of measurement of different types of products. For example, ton in case or coal, Yards in case of cloth, Liter in case of petrol etc.
Cost centre Cost unit 1. A cost centre is the smallest segment or 1. A cost unit is a quantitative unit of product or activity or area of responsibility for which service in relation to which costs are expressed costs are ascertained. and ascertained. 2. A cost centre is one segment of the total 2. A cost unit is the unit of expressing cost and is, organisation. as such, a part related to the production or service. 3. A cost centre helps to determine costs by 3. Cost unit is used for the sub-division of costs location, person, etc. which may be attributed to the products or services. 4. A cost centre is devised before applying the 4. Application of cost units arise after the cost unit. functions of devising cost centres are over. 5. A concern which even produces only one product or renders only one service may have several cost centres. 5. A cost unit is assigned to one distinct product or service.

Profit Centre:
According to C.I.M.A., London, A profit centre is a part of a business accountable for costs and revenues. It may be called a business centre, business unit or strategic business unit. A profit centre is a business unit or department which is treated as a distinct entity enabling revenues and expenses to be determined so that profitability can be measured. A profit centre is a section of a company treated as a separate business. Thus, profits or losses for a profit centre are calculated separately. A profit centre manager is held accountable for both revenues and costs (expenses), and therefore, profits. What this means in terms of managerial responsibilities is that the manager has to drive the sales revenue generating activities which leads to cash inflows and at the same time control of cost (cash outflows) causing activities. This makes the profit centre management more challenging than the cost centre management.

Usually different profit centres are separated for accounting purposes so that the management can follow how much profit each centre makes and compare their relative efficiency and profit. Examples: A retail store, a sales organization and consulting organization whose profitability can be measured. A profit centre is created as a result of decentralisation of operations to measure the performance of the divisional executives. Each profit centre has a profit target and also enjoys authority to adopt such policies as are necessary to achieve its targets. Merits and Demerits of Profit Centre: Merit: The chief merit of profit centre is that it makes its managers responsible for the profit performance achieving the budgeted amount of profit during a period. Under profit centre concept the whole organisation is divided into a number of divisions, the performance of each division is measured in terms of both the income that is earned and the costs that are incurred. Managers in each division have freedom in making decisions. They need not obtain approval from corporate headquarters for every expenditure. Demerit: The main demerit in the working of this system is the incapability of executives to determine suitable transfer price amicably.

Investment Centre:
Definition by CIMA, London: A profit centre whose performance is measured by its return on capital employed. Where a divisional manger of a company is allowed some discretion about the amount of investment undertaken by the division, assessment of results by profit alone (as for a profit centre) is clearly inadequate. The profit earned must be related to the amount of capital invested. Such divisions are sometimes called investment centers for this reason. Performance is measured by Return on Capital Employed, often referred to as Return on Investment and other subsidiary ratios, or by Residual Income (RI). An investment center is a profit centre with additional responsibilities for capital investment and possibly for financing, and whose performance is measured by its return on investment.

Managers of subsidiary companies will often be treated as investment centers Managers, accountable for profits and capital employed. Within each subsidiary, the major divisions might be treated as profit centers with each divisional manger having the authority to decide the process and output volumes for the products or services of the division. Within each division, there will be departmental Managers section Managers and so on, who can all be treated as cost center Managers. All Managers should receive regular, periodic Performance reports for their own areas of responsibility. The amount of capital employed in an investment center should consist only of directly attributable fixed assets and working capital. Subsidiary companies are often required to remit spare cash to the central treasury department at group head office. And so directly attractable working capital would normally consist of stocks and less creditors, but minimal amounts of cash. If an investment center is apportioned a share of head office fixed assets, the amount of capital employed in these assets should be recorded separately because it is not directly attractable to the investment centre. Return on investment (ROI) The performance of an investment center is usually monitored using either or both of return on investment (ROI) also known as return on capital employed (ROCE) and residual income (RI). ROI is generally regarded as the key performance measure. There are two main reasons for its widespread use. a. It ties in directly with the accounting process, and is identifiable from the profit and loss account and balance sheet. b. Even more importantly, ROI is the only measure of performance available (apart from residual income) by which the return on investment for a division or company as a single enter unit (or collection of assets) can be measured. Return on investment (ROI) as return on capital employed (ROCE) shows how much profit has been made in relation to the amount of capital invested is calculated as profit / capital employed) x100% Measuring ROI ROI can be measured in different ways, a. Profit after depreciation as a % of net asset employed. This is probably by the most common method, but it does present a problem. If an investment center maintains the same annual profit, and keeps the same asset without a

policy of regular fixed asset replacement, its ROI will increase year by year as the asset gets older. This can give a false impression over time. b. Profit after depreciation as a % of gross assets employed. Instead of measuring ROI as return on net assets, we could measure it as return gross assets. This would remove the problem of ROI increasing over time as fixed assets get older. However, using book values to measure ROI has its disadvantages.

Most important of these is that measuring ROI as return on gross assets ignores the age factor, and does not distinguish between old and new assets.

Older fixed assets usually cost more to repair and maintain, to keep them running. An investment centre with old assets may therefore have its profitability reduced by repair costs, and its ROI might fall over time as its assets get older and repair costs get bigger. Inflation and technological change alter the cost of fixed assets. If one investment centre has fixed assets bought ten years ago with a gross cost of $1 million, and another investment centre, in the same area of business operations, has fixed assets bought very recently for $1 million, the quantity and technological character of the fixed assets of the two investment centre are likely to very different.

Sum:
Xpro India Ltd. Has three divisions. It is considering to make additional investment in one of these divisions. The relevant information is given below: Division 1 Rs. Division 2 Rs. Division 3 Rs.

Additional Investment

500000

500000

500000

Net profit on 70000 additional investment

65000

85000

Current ROI

15%

16%

14%

The cost of capital is 12%. In which division should the investment be made?

Solution:

 ROI Method: [Return On Investment] ROI on new investment = Net Profit/Additional investment*100 Current ROI X 70000/500000*100 Division Y 65000/500000*100 Z 85000/500000*100

=14% 15%

=13% 16%

=17% 14%

Conclusion: Investment should be made in division Z because ROI on additional investment is higher at 17% against its current ROI of 14%. In division X and Y, ROI on additional investment is less than current ROI. Thus additional investment in Division X and Y should not be accepted. RI Method:[Residual Income] X Rs. 500000 70000 60000 Divisions Y Rs. 500000 65000 60000 Z Rs. 500000 85000 60000

Additional Investment Net Profit Less: Cost of Capital @12% on investment Residual Income (RI)

10000

5000

25000

Conclusion: Additional investment should be made in division Z as it gives the highest residual income.
Comparison between job cost accounting and Process cost accounting: The following table will show the difference between job costing process costing:

Job Costing
1. Production is made by specific orders. 2. The different jobs may be independent of each other 3. Each job or order is allotted a number and cost are collected against the same job number.

Process costing
1. Union production in continuous flow. 2. Being manufactured in a continuous flow, product lose their individual identity. 3. The unit cost of a process, which is computed By dividing the total cost for the period by the Total output, is an average cost of the period.

4. Job costing is computed when the job is complete cost

4. Process cost are calculated at the end of the

Period 5. There is generally no transfer from one job to another Another unless it is necessary to transfer surplus manufactured work or excess production. 6. As each product until is different and production is not continuous more managerial attention is needed if proper control is to be exercised. 6. Process production can be standardized and control of the process activity is comparatively Easier. 5. Costs are transferred from one process to

process until goods are completely

Advantages and disadvantages of process costing : The following are some of advantages and disadvantages of process costing : Advantages 1. process cost can determined periodically at short intervals. Where Predetermined overhead rate are used. Unit cost can be computed weekly or even daily. This is not possible in job costing, particularly when job run for a long period. 2. The cost finding method is simpler and less expensive that in job costing. 3.Managerial control is possible by evaluating the performance of each process. 4. Allocation for expenses to process can be easily made and costs become accurate. 5. Price Quotation may be made without difficult with the standardization of process. Standard costing can be established easily in process types of manufacturer. Disadvantages.

1. Costs obtained at the accounting period are only historical and are of mush use for effective control.

2.

For the purpose of computing unit cost of Continuous process, work in progress is required to be ascertained at the end of an accounting period. This is done mostly on estimated basis, which introduced further inaccuracies. 3. Where different products come out of one and the same process. The common cost are prorated to Various cost unit. Such cost of individual are not reliable as they may at best be taken to be only approximation. 4. Average cost are not always accurate and There is some time wide scope for errors. an errors In One average cost will be carried through All the process to the valuation of work in Process and finished goods. 5.When more than one type of product is manufactured. A division of the cost elements is necessary and the computation of average cost is more difficult.

The fundamental principles of process cost accounting are (a) Cost of material, wages and expenses are collected for each process or operation in a period. (b) Adequate records are kept in respect of output and scrap of each process or operation during the period. (c) The cost per finished output of each process is obtained by dividing the total cost incurred during the period by the number of unit produced during the after period giving due regard to losses and amount recovered from scrap. (d) As product pass from one process to another the accumulated cost of output of a process is transferred to the next process just like raw material of that process.

Computation of process cost on the basis of the following fundamental principles is easy where there is neither any work-in-process at various stages of completion nor any process loss. However existence of work-in-process as well as process loss is very common and as a result of which the problems met by a cost accountant in relation the process costing are(a) Normal or abnormal losses or gain (b) Opening and closing work-in-progress at various stages of completion as regard material, labour and overhead. Moreover there may be process losses or gains. (c) Inter Process Profit.