Taxmann's Strategic Cost Management

Preface to Fifth Edition The fifth edition of the book has been thoroughly revised and enlarged keeping in view the requirements of students who are undergoing business management courses at higher level. The book is a comprehensive work on the subject, which meets the requirements of all levels of professional and academic courses. The book is very much useful for students who are preparing for MCom, MBA, MFM, CA, CMA, CS courses.

The entire subject is presented in thirty eight chapters. At the end of each chapter number of solved practical problems are given for self study. The book also consists important chapters relating to Operations Research in a very simplified manner understandable to students.

In a competitive business world, a business concern can survive and sustain only when it gives priority for cost consciousness. I hope the book is also very much useful for the professionals who are practising in cost management, which is being emerged as one of the major subjects like Financial Management.

I am thankful to the faculty and students who have suggested modifications. I am also thankful to the publishers and their staff in bringing this revised edition to you.

I thank you one and all.

25th October, 2017

mobile e-mail

RAVI M. KISHORE

9959517764 ravimulpuru@rediffmail.com

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About the Author Sri Ravi M. Kishore has studied Masters Degree in Commerce in Sri Venkateswara University, Tirupati and studied Bachelor of Laws in Acharya Nagarjuna University, Guntur. He is an Associate Member of the Institute of Cost Accountants of India, Kolkata and a Fellow Member of the Institute of Company Secretaries of India, New Delhi. He has studied Post-Graduate Diploma Course in Personnel Management in Annamalai University. He has also completed ISO 9000 Quality Management Systems Auditor Course conducted by Lloyd s Register Quality Assurance, London.

He has worked in medium and large manufacturing concerns for over fifteen years in senior level management positions handling Finance, Accounting and Secretarial Functions. Presently he is practising as a Management Consultant offering specialist services to the corporate sector.

He is actively involved in the academic field and in teaching profession for over past twenty years and has authored several books for Professional and Academic Courses in Finance, Accounting, Management.

Books from Author for CA, CMA, CS, MFM, MBA, MCom Courses 1

Strategic Management : Text and Cases

2

Cost Accounting (4th Edition)

3

Cost and Management Accounting (6th Edition)

4

Strategic Cost Management : Theory and Practice (5th Edition)

5

Financial Management : Theory, Problems and Cases (8th Edition)

6

Financial Management : Problems and Solutions (2nd Edition)

7

Advanced Management Accounting (For CA Final)

8

Strategic Financial Management (For CA Final)

9

Cost Accounting (For CA IPCC)

10

Financial Management (For CA IPCC)

11

Cost Accounting and Financial Management (For CMA Intermediate)

12

Cost and Management Accountancy (For CMA Intermediate)

13

Business Strategy and Strategic Cost Management (For CMA Final)

14

Strategic Performance Management (For CMA Final)

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Chapter Heads 1

Overview of Strategic Cost Management

2

Cost Concepts for Decision Making

3

Incremental, Relevant and Opportunity Cost Concepts

4

Activity Based Cost System

5

Target Costing

6

Backflush Accounting and Resource Consumption Accounting

7

Throughput Accounting

8

Breakeven and Volume - Cost-Profit Analysis

129

9

Application of Marginal Costing Technique

157

10

Cost Control Through Standard Costing

208

11

Cost Management with Setting Budgets

282

12

Product Pricing : Methods and Strategies

338

13

Responsibility Accounting and Divisional Profitability

14

Interdivisional Transfer Pricing

15

Management of Marketing and Distribution Cost

16

Productivity Management

17

Capacity Management

18

Employee Training, Relocation and Cost of Strike

19

Pareto Analysis and Theory of Constraints

20

Just In Time and Lean Manufacturing

1

28 43

66

94

120

408 437

452

463

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515

510

475

381

111

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Strategic Cost Management : Theory and Practice

21

Quality Management : Systems and Techniques

22

Project Life Cycle Costing

557

23

Product Life Cycle Costing

580

24

Balanced Score Card

25

Business Process Outsourcing

26

Benchmarking

27

Value Chain Analysis

28

Supply Chain Management

29

MRP, MRP II and ERP

30

Management Information Systems

31

Uniform Costing and Interfirm Comparisons

32

Cost Audit and Management Audit

33

Simulation Modelling

34

Learning Curve Theory

35

Network Analysis (PERT and CPM)

36

Assignment Problem

37

Transportation Problem

38

Linear Programing

597 605

610

Mathematical Tables 835

616 622

632 641

664

670 695

737

797

763

709

658

524

Contents Chapter 1

Overview of Strategic Cost Management Cost Management 1

Meaning, Phases, Benefits, Steps, Techniques

Costing of Product Characteristics or Attributes 3 Strategic Cost Management (SCM) 4 Meaning, Components

Role of Management Accountant in SCM 4 Strategic Total Cost Management 5 Strategic Cost Analysis 5 Cost Leadership Strategy 6 Cost Control and Cost Reduction : Meaning 7 Cost Control System

7

Cost Reduction System 8 Types of Cost Management Programs 8

Crash Programs, Planned Programs, Long-range Programs, Short-range Programs

Cost Control and Cost Reduction : Distinction 9 Precautions in Cost Management Programs 10 Value Engineering (VE) 10

Value of a Product, Meaning of VE, Steps in VE, Advantages, Impact on Profit

Phases of Value Engineering Job Plan 12 Value Analysis 12

Meaning, Methodology, Cost Reduction, Benefits, Value Analysis and Value Engineering: Distinction, Scope for Cost Reduction at Product Design Stage

Operations Research (OR) In Cost Reduction 14

Meaning of OR, OR Techniques, Areas of Application

Business Process Reengineering (BPR) 14 Meaning, Steps, Pitfalls

Reverse Engineering 15 Cause-Effect Diagram 16

Meaning, Applications, When to Use

Failure Mode and Effects Analysis (FMEA) 17 Meaning, When to Use

Function Analysis System Technique (FAST) 17 Simo-Chart 18

Types of Process Charts, Steps for Drawing Flow Diagram, Construction of Simo-Chart, Steps for Construction of Simo-Chart, Improving Present Method

String Diagram 19 Flexible Manufacturing Systems 20 Meaning, Benefits

Parametric Cost Control 20

Meaning and Techniques used

Lot Sizing 20

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Strategic Cost Management : Theory and Practice

Operations Management 20 Operations Strategy 21

Meaning, Strategy Decisions, Characteristics

Control System 21

System, Control System, Kinds of Control Systems, Basic Elements of Control System, Problems in Designing Control System

Management Control System (MCS) 23

Definition and Meaning of MCS, Characteristics of a Sound MCS, Steps in MCS

Feed Back Control System 24

Basic Components and Basic Principles

Strategic Control

25

Meaning, Management Control and Operational Control : Distinction

Theory Questions 26

.................................................................................................................................................................

Chapter 2

Cost Concepts for Decision Making Cost, Expense and Loss: Meaning Cost, Expense, Loss

28

Cost Classification 28

Meaning of Cost Classification, Categories of Cost

Classification of Costs for Decision-Making 29

Marginal Cost, Differential Cost, Opportunity Cost, Relevant Cost, Sunk Cost, Replacement Cost, Normal Cost, Abnormal Cost, Avoidable Cost, Unavoidable Cost, Pre-production Cost, Product Cost, Period Cost, Traceable Cost, Common Cost, Controllable Cost, Uncontrollable Cost, Short-run Cost, Long-run Cost, Past Cost, Future Cost, Explicit Cost, Implicit Cost, Book Cost, Shutdown Cost, Abandonment Cost, Urgent Cost, Postponable Cost, Conversion Cost, Capitalized Cost

Classification of Costs Based on Variability 32

Variable Cost, Fixed Cost, Semi-variable Cost or Semi-fixed Cost

Other Categories of Cost 33

Stepped up Costs, Specific and Common Fixed Costs, Committed Fixed Cost, Discretionary Fixed Cost, Engineered Cost, Managed Cost, Capacity Cost, Programed Cost

Levels of Variability of Costs 34 Importance of Behaviourwise Cost Classification 34 Methods of Splitting Semi-variable Costs 34

Industrial Engineering Method, Account Inspection Method, Scatter Graph Method, High and Low Method, Regression Analysis

Theory Questions 39 Practical Problems 40 .................................................................................................................................................................

Chapter 3

Incremental, Relevant and Opportunity Cost Concepts Incremental Costing 43

Incremental Cost and Incremental Costing : Meaning, Characteristics of Incremental Costing, Decisions Using Incremental Costing, Uses of Incremental Cost Analysis, Marginal Costing and Differential Costing : Distinction, Determination of Cost Indifference Point

Relevant Costing 48

Meaning of Relevant Costing, Features of Relevant Costs, Examples of Relevant Costs, Analysis of Relevant Costs With other Cost Concepts

Opportunity Costing 51

Meaning of Opportunity Costing

Contents

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Theory Questions 52 Practical Problems 53 .................................................................................................................................................................

Chapter 4

Activity Based Cost System Reasons for Emergence of ABC System 66 Activity Based Costing (ABC) : Meaning and Objectives 67

Meaning of ABC, Activity Based Cost System, Objectives of ABC

Steps in ABC System 68 Activity : Meaning and Categories 71

Meaning of Activity, Categories of Activity, Value Added and Non-value Added Activities : Distinction

Cost Pools, Cost Drivers and Cost Objects Cost Pools, Cost Drivers, Cost Object

72

Important Cost Pools and its Cost Drivers 72 Advantages and Limitations of ABC System 76 Advantages, Limitations

ABC System and Strategic Decision-Making 77 New Concepts in ABC 78

Activity Based Budgeting, Activity Based Management, Activity Based Accounting

Customer Costing 78

Meaning, Categories of Costs

Customer Profitability Analysis 79

Theory Questions 79 Practical Problems 81

.................................................................................................................................................................

Chapter 5

Target Costing Target Costing Concept 94

Introduction, Meaning, Basic Premises, Common Procedure, Major Components, Possibilities

Steps in Target Costing Approach 96 Benefits of Target Costing 96 Target Costing Methodology 97 Methods of Establishment of Target Cost 99

Subtraction Method, Addition Method, Integrated Method

Role of Management Accountant in Target Costing 100 Target Cost Management 100 Meaning, Features

Ascertainment of Total Target Cost 101 Cost Tables 101 Attributable Costing 101

Theory Questions 101 Practical Problems 102

.................................................................................................................................................................

Chapter 6

Backflush Accounting and Resource Consumption Accounting Backflush Accounting 111

Traditional Cost System, Just In Time Cost System, Backflush Accounting System, Backflush Accounting : Benefits and Problems, Variants of Backflush Accounting, Inventory Valuation in Backflush Accounting

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Strategic Cost Management : Theory and Practice

Resource Consumption Accounting (RCA) 115

Definition and Meaning of RCA, Methodology in Implementation of RCA, Advantages of RCA, Difficulties in Implementation of RCA

Theory Questions 117 Practical Problems 117 .................................................................................................................................................................

Chapter 7 Throughput Accounting Throughput Accounting (TA) : Meaning 120 Concepts in Throughput Accounting 120 Product Costing and Throughput Accounting : Distinction 121 Bottlenecks and Overhead Attribution 121 Problems of Throughput Accounting 122

Theory Questions 123 Practical Problems 123 .................................................................................................................................................................

Chapter 8 Breakeven and Volume-Cost-Profit Analysis Breakeven (BE) Analysis : Meaning and Assumptions 129

Meaning of BE Analysis, Assumptions and Limitations of BE Analysis

Formulas used in Breakeven Analysis and Marginal Costing Chapters 130 Cash Breakeven and Indifference Analysis 132 Cash Breakeven, Indifference Point

Profit/Volume Ratio 132

Meaning, Improvement Measures, Limitations, Construction of PV Chart, PV Chart in Multiproduct Situations

Margin of Safety (MOS) 133

Meaning, Formulas, Improvement Measures

Angle of Incidence (AOI) 134 Relationship Among BEP, MOS and AOI 134 Impact of Selling Price, Fixed Cost and Variable Cost on BEP 135 Cost-Volume-Profit (CVP) Analysis 135

Meaning, Assumptions, Procedure in CVP Analysis, Benefits of CVP Analysis

Curvilinear Breakeven Analysis 136

Theory Questions 137 Practical Problems 138 .................................................................................................................................................................

Chapter 9 Application of Marginal Costing Technique Absorption Costing 157

Meaning, Advantages, Limitations

Marginal Cost and Marginal Costing : Meaning 158 Contribution 158

Meaning of Contribution, Contribution and Profit : Distinction

Features of Marginal Costing 158 Marginal Costing : Advantages and Limitations 159 Absorption Costing and Marginal Costing : Distinction 160 Absorption Costing and Marginal Costing : Impact on Profit 160

Contents

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Hypothetical Statements of Cost and Profit 161 Absorption Costing and Marginal Costing : Best Choice 162 Impact of Inflation on Holding of Large Inventories 162 Practical Applications of Marginal Costing 162 Key or Limiting Factor Analysis 163 Meaning, Examples, Analysis

Profit Planning 163

Meaning, Possible Ways

Selection of Suitable Product/Sales Mix 164 Make or Buy Decisions 164 Need for Buy, Situations

Introduction of a New Product and Diversification Decisions 164 Alternative use of Production Facilities 164 Maintaining Desired Level of Profit 165 Discontinuance of a Product 165

Purpose, Important Points, Guiding Principles

Accept Special Offer Below Domestic Price, Submission of A Tender 165 Market Expansion and Contraction 165 Fixation of Selling Price 166 Fixation of Selling Price below Variable Cost 166 Temporary Shutdown of Operations 167

Reasons for Shutdown, Examples of Shutdown Costs, Application of Technique, Shutdown Point

Marginal Costing and Differential Costing : Distinction 167

Theory Questions 168 Practical Problems 169 .................................................................................................................................................................

Chapter 10

Cost Control Through Standard Costing Historical Costing 208

Meaning, Limitations, Emergence of Standard Costing

Standard Cost and Standard Costing 209

Standard, Standard Cost, Standard Costing, Suitability, Features, Objectives

Types of Standards 210

Current Standard, Ideal Standard, Expected Standard, Basic Standard, Normal Standard

Setting of Standards 211

Production Standards, Cost Standards, Precautions, Considerations, Persons Involved

Standard Cost for Direct Material 212 Quantity of Materials, Price of Materials

Standard Cost for Direct Labour 212

Standard Labour Time, Labour Rate Standard

Standard Costs for Overheads 212 Standard Hour 213 Important Terminology in Standard Costing 213 Prerequisites for Establishing Standard Cost System 214 Standard Cost and Estimated Cost : Distinction 215 Setting of Standards During Inflation 215 Responsibility for Setting Standards 216

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Strategic Cost Management : Theory and Practice

Standard Costing and Budgetary Control : Distinction 216 Standard Costing and Budgetary Control : Interrelation 217 Problems in Setting Standards 217 Advantages and Limitations of Standard Costing System 217 Reasons for Growing Importance of Overheads 218 Non-compatibility of Standard Costing with Activity Based Costing 219 Behavioural Considerations in Standard Costing 219 Meaning of Variance Analysis 219

Variance, Variance Accounting, Variance Analysis, Methodology, Causes of Variance, Classification of Variances, Interpretation of Variances, Adverse/Favourable

Controllable and Uncontrollable Variances 221 Direct Material Variances 221

Direct Material Cost Variance, Direct Material Price Variance, Direct Material Usage Variance, Direct Material Mix Variance, Direct Material Yield Variance

Direct Labour Variances 225

Direct Labour Cost Variance, Direct Labour Rate Variance, Direct Labour Efficiency Variance, Direct Labour Mix Variance, Direct Labour Yield Variance, Direct Labour Idle Time Variance, Direct Labour Net Efficiency Variance

Variable Production Overhead Variances 229

Variable Overhead Cost Variance, Variable Overhead Expenditure Variance, Variable Overhead Efficiency Variance

Fixed Production Overhead Variances 231

Fixed Overhead Cost Variance, Fixed Overhead Expenditure Variance, Fixed Overhead Volume Variance, Fixed Overhead Capacity Variance, Fixed Overhead Efficiency Variance, Fixed Overhead Calendar Variance, Fixed Overhead Revised Capacity Variance.

Sales Value or Turnover Variances 235

Sales Value Variance, Sales Value Price Variance, Sales Value Volume Variance, Sales Value Mix Variance, Sales Value Quantity Variance

Sales Margin or Profit Variances 237

Sales Margin Variance, Sales Margin Price Variance, Sales Margin Volume Variance, Sales Margin Mix Variance, Sales Margin Quantity Variance

Market Size and Market Share Variances 239 Accounting Procedure for Standard Cost 240 Partial Plan, Single Plan, Dual Plan

Accounting Procedure Under Single Plan 240 Accounting Procedure, Examples, Journal Entries

Partial Plan and Single Plan : Comparison 241 Methods of Disposal of Variances 241 Revision of Standards and Revision of Variance 242 Interdependence Between Variances 242 Planning and Operational Variances 243 Investigation and Control of Variances 243 Techniques of Investigation of Variances 243

Heuristics, Trend Analysis, Statistical Control Charts, Decision Theory Approach (Game Theory), Decision Tree Approach

Theory Questions 245 Practical Problems 245 .................................................................................................................................................................

Contents

Chapter 11

Cost Management with Setting Budgets Budget 282

Meaning, Features

Budgetary Control 283

Meaning, Features and Objectives

Prerequisites for Sound Budgetary Control System 283 Forecast and Budget : Distinction 284 Budgeting : Advantages and Disadvantages 284 Steps in Budgeting Process 285 Principal Budget Factor 286 Budget Centre 286 Budget Period 286

Meaning, Length of Budget Period, Distinction from Control Period

Budget Committee 287 Meaning, Functions

Budget Controller 287 Meaning, Functions

Budget Manual 287 Meaning, Contents

Classification of Budgets 288

Based on Coverage, Based on Capacity, Based on Conditions, Based on Time, Other Classification

Kinds of Budget 289 Sales Budget 289

Meaning, Factors Influencing

Production Budget 290

Meaning, Factors Influencing

Plant Utilization Budget 291 Direct Materials Usage Budget 291 Direct Materials Purchase Budget 292 Direct Labour Cost Budget 292 Manufacturing Overhead Budget 293 Administration Overhead Budget 294 Cost of Production, Ending Inventory and Cost of Goods Sold Budgets 294 Selling and Distribution Overhead Budget 295 Research and Development Expenses Budgets 296 Capital Expenditure Budget 296 Master Budget 296 Analysis of Cost Variances 296

Conventional Approach, Important Considerations, Limitations

Budgetary Control Ratios 297

Efficiency Ratio, Activity Ratio, Capacity Ratio, Calendar Ratio

Dangers of Single Budget System 297 Behavioural Aspects of Budgeting 298 Fixed Budget 298

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Strategic Cost Management : Theory and Practice

Suitability, Merits, Demerits

Flexible Budget 299

Meaning, Assumptions, Steps, Suitability, Format of Flexible Budget, Fixed Budget and Flexible Budget : Distinction, Merits, Demerits

Zero Base Budgeting (ZBB) 301

Meaning, Features, Traditional Budgeting and Zero Based Budgeting (ZBB) : Distinction, Requisites for Implementation of ZBB, Merits, Demerits

Rolling Budget 303

Meaning, Merits, Demerits

Planning and Control Budgets 303

Meaning, Planning Budget and Control Budget : Distinction

Critical Planning Variables 304 Meaning, Components

Responsibility Budgeting 304 Program Budgeting 304

Meaning, Program Budgeting and Conventional Budgeting : Distinction, Advantages, Disadvantages

Performance Budgeting 305

Meaning, Prime Concepts, Prerequisites, Purposes, Performance Budgeting and Traditional Budgeting : Distinction, Performance Budgeting and Program Budgeting : Distinction

Cash Budget 306

Meaning, Format of Cash Budget, Objectives, Points to be Considered in Preparation of Cash Budget, Cash Flow Statement and Cash Flow Budget : Distinction, Cash Budget and Profit and Loss Account : Distinction, Methods of Cash Budgeting

Theory Questions 309 Practical Problems 311

.................................................................................................................................................................

Chapter 12

Product Pricing : Methods and Strategies Product Pricing : Objectives and Steps 338

Objectives of Product Pricing, Steps in Product Pricing Process

Factors Influencing Product Pricing Policy 339 Impact of Market and Cost on Product Pricing 340

Important Factors in Product Pricing, Impact of Market on Pricing, Impact of Cost on Pricing

Pitfalls and Limiting Factors in Product Pricing 341 Management Accountant s Role in Price Fixation 341 Cost Plus Pricing Method 342

Meaning, Arguments in Favour of, Arguments Against

Marginal Cost Pricing Method 344

Meaning, Suitability, Arguments in Favour of, Arguments Against, Fixation of Price Below Variable Cost : Situations

Target Rate of Return Pricing Method 345 Meaning, Demerits

Added Value Pricing Method 346 Incremental Cost Pricing Method 348 Standard Cost Pricing Method 349 Opportunity Cost Pricing Method 350 Administered Pricing Method 350 Meaning, Objectives, Demerits

Customary Pricing Method 351

Contents

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Going Rate Pricing Method 351 Sealed Bid Pricing Method 351 Skimming Pricing Strategy 352 Meaning, Suitability

Penetration Pricing Strategy 352 Meaning, Suitability

Price Discrimination 353

Meaning, Situations, Dangers, Possibilities

Loss Leader Pricing 354 Pricing Under Inflation 354

Market Situation, Pricing Strategy

Pricing During Recession 355 Pricing Strategy for Established Products 355 Market Situation, Market Strategy

Pricing by Service Sector 355 Target Pricing 355 Price Cutting

356

Meaning, Conditions for Success, Suitability

Product Life-cycle in Pricing Established Products 356 Pricing Strategies at Decline Phase 357 Symptoms of Competitive Degeneration 357

Symptoms, Reasons for Erosion of Distinctiveness

Experience Curve in Product Pricing 357

Theory Questions 358 Practical Problems 358 .................................................................................................................................................................

Chapter 13

Responsibility Accounting and Divisional Profitability Responsibility Accounting : Meaning and Basic Principles 381

Meaning, Basic Principles, Difficulties in Introducing Responsibility Accounting

Benefits and Limitations of Responsibility Accounting 382 Requirements for Setting up of Responsibility Accounting 382 Responsibility Report 383

Specimen Responsibility Report, Important Points in Preparation of Responsibility Report

Cost Centre

384

Profit Centre

384

Meaning, Examples, Types of Cost Centre Meaning, Suitability, Advantages, Limitations, Profit Centre and Budget Centre : Distinction, Profit Centre s Performance Report

Investment Centre 386 Extent of Manager s Control Over Responsibility Centre 386 Revenue Centre 386 Divisional Income Statement 387 Divisional Profitability : ROCE Method 388

Meaning, How to Compute ROCE? Benefits, Limitations

Divisional Profitability : Residual Income Method 390

Meaning, Advantages, Disadvantages, Residual Income Statement, ROCE and RI Methods : Distinction, ROCE and RI Methods : Criticism

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Strategic Cost Management : Theory and Practice

Theory Questions 393 Practical Problems 394 .................................................................................................................................................................

Chapter 14

Interdivisional Transfer Pricing

Transfer Pricing System 408

Meaning, Objectives, Criteria for Transfer Pricing System, Requisites of Sound Transfer Pricing System, Benefits of Transfer Pricing Policy

Cost Based Transfer Pricing 410

Actual Cost of Production, Marginal Cost of Production, Full Cost, Full Cost Plus, Standard Cost, Standard Cost plus Lump Sum, Advantages, Limitations

Market Based Transfer Pricing 410

Meaning, Difficulties in Identification of Market Price, Advantages, Limitations

Negotiated Transfer Pricing 411 Meaning, Principles, Limitations

Opportunity Cost Transfer Pricing 412 Meaning, Determination, Limitations

Dual Transfer Pricing 413 Transfer Pricing when Unit Variable Cost and Selling Price are not Constant 413 Fixation of Transfer Price by Prorating Overall Contribution 413 Transfer Pricing : A General Rule 414 General Conflicts in Fixation of Transfer Prices 414 Proposals for Resolving Transfer Pricing Conflicts 414 International Transfer Pricing 415

Meaning, Aspects of International Transfer Pricing, Objectives for International Transfer Pricing

Theory Questions 416 Practical Problems 417 .................................................................................................................................................................

Chapter 15

Management of Marketing and Distribution Cost

Marketing and Marketing Cost : Meaning 437 Reasons for Inaccuracy of Marketing Cost 438 Marketing Cost Analysis 438 Meaning, Benefits, Approaches

Production Cost and Marketing Cost : Distinction 438 Difficulties in Marketing Cost Analysis 439 Distribution Function 440 Meaning, Activities, Costs

Distribution Cost Analysis 440 Ratios used in Marketing and Distribution Cost Analysis 441 Ratios for Advertising and Market Share 442 Market Segmentation 442

Meaning, Basic Variables, Policy Options, Advantages, Segmental Contribution Statement

Physical Distribution Management (PDM) 444 Determination of Level of Service 445 Channel Decisions 445 Warehouse Decisions 445

Contents

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Transport Decisions 446 Cost of Granting Credit 447 Cost of a Salesman 447 Evaluation of Salesman s Performance 448 Setting an Advertisement Budget 448 Methods of Setting Advertisement Budget

Cost Benefit Analysis of Advertising 449 Depot Numbers and Depot Location Decisions 450 Distribution Requirement Planning (DRP) 450 Maintenance of Safety Stock 450

Theory Questions 451 .................................................................................................................................................................

Chapter 16

Productivity Management Meaning of Productivity 452 Measurement of Productivity 452 Misconceptions in Measuring Productivity 453 Ratios in Measuring Productivity 453 Productivity Index and Total Productivity Index 454 Productivity of Materials

454

Productivity of Labour 454

Meaning, Factors Influencing Labour Productivity, Measuring of Labour Productivity

Productivity of Capital 455 Productivity of Other Factors 455 Productivity of Management Resources 456 Productivity and Profitability : Distinction 456 Productivity and Value Added 456 Productivity and Quality 457 Productivity and Cost Effectiveness 457 Higher Productivity and Reduced Cost 457 Importance of Human Factor in Productive Drive 457 Productivity Objectives 457 Productivity Plan 458 Productivity Audit 458 Advantages of Higher Productivity 458 Causes of Low Productivity 459 Criticism on Productivity Concept 460 Total Productivity Management (TPM) 460 Performance Management 460 Meaning, Techniques

Performance Measurement Reports 461 To Sales Manager, To Works Manager

Theory Questions 461 .................................................................................................................................................................

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Strategic Cost Management : Theory and Practice

Chapter 17

Capacity Management Capacity : Meaning and Examples 463 Levels of Capacity 463

Maximum Capacity, Practical Capacity, Normal Capacity, Capacity Based on Sales Expectancy, Actual Capacity Utilization, Idle Capacity, Excess Capacity

Normal Operating Capacity 465 Capacity Determination 465 Reliability Curve 465 Capacity Utilization 466 Idle Capacity Costs 466 Computation, Treatment

Peak Capacity and Effective Capacity 466 Need for Capacity Management 467 Capacity Planning 467 Long-term and Short-term Capacity Planning 468 Capacity Planning Techniques 468 Economies of Scale 469 Government Policy and Capacity Decisions 469 Relevant Range of Activity 470 Rectification of Imbalance of Production Facilities 470 Demand Stimulating Options 470 Adjustment of Capacity to Match Current Demand 471 Aggregate Planning 471

Meaning, Prerequisites, Trail and Error Process for Aggregate Planning

Aggregate Planning Strategies 472 Level Strategy, Chase Strategy

Management Coefficient Model 472 Buffer Management 472 VAT Analysis 472

Theory Questions 473 Practical Problems 473 .................................................................................................................................................................

Chapter 18

Employee Training, Relocation and Cost of Strike Employee Training 475

Need for Employee Training, Training Cost Evaluation, Difficulties in Evaluation, Benefits of Evaluation

Relocation of Factory and Employees 477 Labour Strike 481 Wage Incentive Schemes 484

Meaning, Objectives, Advantages, Limitations

Theory Questions 487 Practical Problems 488 .................................................................................................................................................................

Contents

Chapter 19

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Pareto Analysis and Theory of Constraints Pareto Analysis 510

Meaning, Usefulness, Practical Applications of Pareto Analysis

Theory of Constraints (TOC)

511

Meaning of TOC, Steps to Deal with Constraints, Key Measures of TOC, Methodology in Implementation of TOC, TOC and Cost Accounting Procedures

Theory Questions 513 Practical Problems 513 .................................................................................................................................................................

Chapter 20

Just In Time and Lean Manufacturing Just In Time (JIT) Or Lean Manufacturing System 515 Steps in JIT/Lean Manufacturing 515 Basic Steps for Implementation of JIT/Lean Production 516 Features of JIT 516 Methodology in Implementation of JIT 517 Merits and Demerits of JIT 519 Role of JIT in Elimination of Waste 520 JIT and Impact on Profitability 520 JIT and Competitive Advantage 521 JIT and Overhead Costs 521 Synchronous Manufacturing 521 Implementation of PRAISE : Remedies 521

Theory Questions 522 Practical Problems 522 .................................................................................................................................................................

Chapter 21

Quality Management : Systems and Techniques Need for Quality Consciousness 524 Meaning of Quality 525 Factors considered in Quality 525 Classification of Quality Costs 525

Prevention Costs, Appraisal Costs, Costs of Internal Failure, Costs of External Failure, Costs of Exceeding Requirements, Costs of Lost Opportunity

Optimization of Quality Costs 526 Quality Cost Reporting 527 Analysis of Quality Costs 528 Quality Costs : Comparison with an Iceberg 529 Impact of Quality on Cost, Price, Profit and Market Share 529 Important Terms in Quality Management 530

Quality Control, Quality Assurance, Total Quality Control, Statistical Quality Control, Statistical Process Control, Quality Audit

Total Quality Management (TQM) 530

Meaning, Basic Principles, Key Features, Six Cs of TQM, Steps in Implementation of TQM, Critical Success factors of TQM, Benefits of TQM

Zero Defect Programs or Right First Time 532 Meaning, Features, Basic Principles

Steps of Quality Improvement Suggested by Philip Crosby 533

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Strategic Cost Management : Theory and Practice

Four Ps of Quality Improvement 533 Taguchi Methodology 533 Shewhart Cycle

534

10-100-1000 Rule 534 Quality Function Deployment (QFD) 535 Meaning, Features, Methodology

Quality Circles 535

Meaning, Objectives, Benefits, Key Factors for Success, Support Actions

Kaizen 537

Meaning, Rules for Implementation, Traditional and Kaizen Environments : Distinction, Procedure for Implementation, Benefits, Reasons for Failure, Kaizen Costing, Kaizen Costing and Standard Costing : Distinction

World Class Manufacturing (WCM) 539 5s Concept 540

Concept, Meaning of Terms, Factors for Success, Benefits

Six Sigma 541

Meaning, Characteristics of Six Sigma and Its Assets, Methodologies of Six Sigma, DMAIC, DMADV, Factors Leading to Successful Implementation of Six Sigma

Statistical Control Charts 543 European Foundation for Quality Management (EFQM)

Theory Questions 546

544

Practical Problems 547 .................................................................................................................................................................

Chapter 22

Project Life Cycle Costing Life Cycle Costing (LCC) of a Project : Meaning 557 Elements of Life Cycle Costs 557 Information Required for LCC 558 Categories of Life Cycle Costs 558

Initial Costs, Operating Costs, Disposal Costs

Hidden Cost in Life Cycle 559 LCC Process 559 Cost Management in Life Cycle 559 Practical Applications of LCC 560 Benefits of LCC 561 Technology Life Cycle (TLC) 563 Industry Life Cycle 563 Terotechnology 564 Entrepreneurial Engineering 565

Theory Questions 566 Practical Problems 566 .................................................................................................................................................................

Chapter 23

Product Life Cycle Costing Product Life Cycle Costing (PLC) : Meaning 580 Characteristics of PLC

580

Essential Features of PLC 580

Contents

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Uses of PLC 581 Phases of PLC 581

Introduction Phase, Growth Phase, Maturity Phase, Decline Phase

Activities in PLC 583 Cost Associated With Different Stages of PLC 583 Cost Control and PLC 583 Marketing Strategies of PLC 584

Strategic Implications of PLC, Marketing Strategies During PLC, Strategies at Maturity Stage of PLC, Reasons for Short PLC, Extension of PLC, Irregularity of PLC, Turning Point Indices in PLC, Information Required to Study PLC, Integration of PLC with Other Business Portfolio Models, Importance of Product Life Cycle Costing

Experience Curve In PLC Costing 588 Economic Value Added to Customer (EVC) 589

Theory Questions 589 Practical Problems 589 .................................................................................................................................................................

Chapter 24

Balanced Score Card Balanced Score Card (BSC) : Meaning 597 Four Perspectives of BSC 597

Customers, Internal Business Processes, Learning and Growth, Financial

Stages in Developing BSC 599 Information Required Under BSC 599 BSC and Improvement of Strategic Performance 599 Performance Measures in BSC 600 Benefits and Limitations of BSC 600

Theory Questions 601 Practical Problems 601 .................................................................................................................................................................

Chapter 25

Business Process Outsourcing Business Process Outsourcing (BPO) : Meaning 605 Areas for BPO

606

Conventional Areas, Non-conventional Areas, Emerging Areas

Types of BPO 606

Contracting Out Activities, Outsourcing Services, In-sourcing, Co-sourcing, Benefit Based Relationship, Crowd Sourcing, Business Transformation Outsourcing (BTO)

Strategic Outsourcing 607 Strategic Outsourcing Models 607 Contracting and Outsourcing : Distinction 607 Outsourcing and BPO : Distinction 608 Benefits and Drawbacks of Outsourcing 608

Theory Questions 609 .................................................................................................................................................................

Chapter 26

Benchmarking Benchmarking : Meaning and Prerequisites 610

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Strategic Cost Management : Theory and Practice

Benchmarking and Industrial Espionage : Distinction 611 Process of Benchmarking 611 Types of Benchmarking 612 Merits and Demerits of Benchmarking 613 Bench Trending 614 Meaning, Steps

Theory Questions 614 .................................................................................................................................................................

Chapter 27

Value Chain Analysis Value and Value Chain : Meaning 616 Value Chain Analysis (VCA) Concept 616 Definition and Meaning, Steps

Activities in Porter s Value Chain 617

Meaning of Porter s VCA, Primary Activities, Secondary Activities

Porters Value Chain : Methodology and Requirements 618

Methodology, Requirements, Highlights, Competitive Advantage Through Value Chain

Benefits and Limitations of VCA 619 VCA and Traditional Management Accounting : Distinction 620 Industry Value Chain 620

Theory Questions 620 .................................................................................................................................................................

Chapter 28

Supply Chain Management Supply Chain Management (SCM) : Meaning and Features 622 Basic Components and Basic Concepts of SCM 623 SCM Process

624

Supply Chain Activities 624 Strategic, Tactical, Operational

Benefits of SCM 625 Important Points for Making Success of SCM 625 Lean Supply Chain 626 Importance of Information Technology in SCM

626

Logistics Management 626 Production Logistics 626 Impact of SCM on Return on Assets (ROA) 627 Total Solution Contract 627

Traditional Concept, TSC Concept, Benefits

Vendor Managed Inventory (VMI) 628 Concept, Benefits

Vendor Development (VD) 629

Concept, Methodology, Strategies, Benefits

Value Chain Management (VCM) 630

Kinds of Business Partners, Meaning of VCM, Methodology, Advantages

Theory Questions 630 .................................................................................................................................................................

Contents

Chapter 29

C-27

MRP, MRP II and ERP

Materials Requirement Planning (MRP) 632

Operating System, Information Provided, Aims, Objectives, Features, Prerequisites, Benefits

Data Requirement for MRP 634 Master Production Schedule (MPS)

634

Bill of Materials (BOM) 635 Inventory Status File 635 Methodology in MRP 635 Manufacturing Resources Planning (MRP II) 636 Meaning, Essential Elements

Enterprise Resource Planning (ERP) 637

Meaning, Characteristics, Features, Evaluation

ERP Applications 638 Benefits of ERP 638

Tangible Benefits, Intangible Benefits

Reasons for Failure of ERP 639 Functional Objective Search (FOS) 639

Theory Questions 640 .................................................................................................................................................................

Chapter 30

Management Information Systems

Management Information Systems (MIS) : Meaning and Objectives 641 Meaning, Information Needs, Successful Factors, Objectives

Prerequisites for Designing MIS 642 Types of Decisions 643

Programed Decisions, Non-programed Decisions

Limitations of MIS 643 Planned and Unplanned MIS 644 Approaches in MIS 644

Bottom-up Approach, Top-down Approach

Levels of MIS 645

Transaction Processing, Operational Level MIS, Tactical Level MIS, Strategic Level MIS

Pyramid Structure of MIS 646 Data Base Concept 646

Meaning, Characteristics, Key Attributes

Data Based Management System (DBMS) 647 Categories of DBMS

Decision Support Packages 648 Decision Support System (DSS) 648 Meaning, Characteristics, Applications

Executive Information System (EIS) 650

Meaning, Distinction From Other Systems, Features

Cost Management Information System (CMIS) 650 Business Performance Measurement System (BPMS) 650 Meaning, Uses, Features

Internet

651

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Strategic Cost Management : Theory and Practice

Intranet

651

Meaning, Advantages

Extranet 652 World Wide Web (WWW) 652 Internet and WWW : Distinction

Latest Concepts 652

Data Warehousing, Data Mining, Data Mapping, Data Visualization

Pull System of Information 653 Management Accountant s Role in Information 653 Information Economics Approach 654 Desirable Properties of Management Accounting Information 655 Uncertainty and Management Accounting Information 655 Information Technology and Management Accounting Information 656

Theory Questions 656 .................................................................................................................................................................

Chapter 31

Uniform Costing and Interfirm Comparisons Uniform Costing : Meaning and Objectives 658 Requisites for Installation of Uniform Costing 658 Uniform Cost Manual 659 Meaning, Contents

Benefits and Limitations of Uniform Costing 660 Interfirm Comparisons 660

Meaning, Prerequisites for Implementation, Problems in Interfirm Comparisons

Benefits and Limitations of Interfirm Comparisons 662

Theory Questions 663 .................................................................................................................................................................

Chapter 32

Cost Audit and Management Audit Cost Audit : Meaning and Purposes 664 Objectives of Cost Audit 664 Cost Audit and Financial Audit : Distinction 665 Social Objectives of Cost Audit 666 Advantages of Cost Audit 666 Management Audit 667

Meaning, Objectives, Scope, Weaknesses Revealed

Efficiency Audit 668

Meaning, Objectives, Parameters

Propriety Audit 668

Meaning, Answers to Questions, Standards of Propriety

Theory Questions 669 .................................................................................................................................................................

Chapter 33

Simulation Modelling Meaning of Simulation 670 Monte Carlo Simulation 670 Steps in Monte Carlo Simulation 670

Contents

C-29

Methods Used in Simulation 672 Applications of Simulation 672 Advantages of Simulation 672 Limitations of Simulation 673 Hertz Simulation Model

673

Theory Questions 673 Practical Problems 674 .................................................................................................................................................................

Chapter 34 Learning Curve Theory Operations Research 695

Meaning, Importance, Limitations, Branches

Learning Curve 696

Concept, Phases, Factors, Graphical Presentation

Learning Curve Table and Learning Curve Ratio

697

Applications of Learning Curve Concept 698 Limitations to Learning Curve Concept 699 Experience Curve 699

Theory Questions 700 Practical Problems 701 .................................................................................................................................................................

Chapter 35 Network Analysis (PERT & CPM) Network Analysis 709

Meaning, Objectives, Stages in Network Analysis

Characteristics of a Project

710

Conditions for Drawing Network Diagram 710 Program Evaluation and Review Technique (PERT) 710

Meaning, Steps, Dummy Activities, Advantages, Limitations and Assumptions

Critical Path Method (CPM) 715

Meaning, PERT and CPM : Distinction, Steps in Drawing CPM Diagram

Earliest and Latest Event Times 717 Kinds of Float 717

Float, Total Float, Free Float, Total Float and Free Float : Distinction, Independent Float

Uncertain Activity Durations 719 Network Crashing 724

Theory Questions 726 Practical Problems 726 .................................................................................................................................................................

Chapter 36 Assignment Problem Assignment problem : Meaning 737 Minimization of Objective Function : Hungarian Method 737 Unbalanced Assignment Problem 744 Maximize Objective Function 748

Theory Question 750 Practical Problems 750 .................................................................................................................................................................

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Strategic Cost Management : Theory and Practice

Chapter 37 Transportation Problem Transportation Problem 763

Meaning, Applications, Conditions

Stages in Transportation Problem Algorithm 763 Transportation Problem Table 764 Mathematical Formulation of TP 764 North-West Corner Rule 765 Least Cost Method 767 Vogel s Approximation Method (VAM) 770 Methods for Finding Optimal Solution 775 Stepping Stone Method 775 Modified Distribution Method (MODI) 779 Degeneracy in Transportation Problem 792

Theory Questions 796 .................................................................................................................................................................

Chapter 38 Linear Programing Linear Programing : Meaning 797 Practical Applications of LP 797 Application of LP in Accounting and Finance 798 Assumptions and Conditions of LP 799 Steps in LP 800 Constraints in LP 800 Limitations of LP 800 Standard Form of LP 800 Important Terms in LP 801 Graphical Solution Method 806

Steps, Advantages and Disadvantages

Simplex Method 815

Steps for Computation of Optimal Solution

Big-M Method 821 Degeneracy in LP 824 Two Phase Method 827 Dual Problem 830 Post-optimal Sensitivity Analysis in LP 831

Theory Questions 833 .................................................................................................................................................................

MATHEMATICAL TABLES 835

Cost Control Through Standard Costing

10

Learning Objectives After studying this chapter you are able to understand: n n n n n n n n n n n n n n n n n n n n

Historical Costing : Meaning and Limitations Standard Cost and Standard Costing : Meaning Features and Objectives of Standard Costing Types of Standards Setting of Standards Standard Cost for Direct Material Standard Cost for Direct Labour Standard Cost for Overheads Meaning of Standard Hour Important Terminology in Standard Costing Prerequisites for Establishing Standard Costing System Standard Cost and Estimated Cost : Distinction Setting Standards During Inflation Responsibility for Setting Standards Standard Costing and Budgetary Control : Distinction Standard Costing and Budgetary Control : Inter relation Problems in Setting Standards Advantages and Limitations of Standard Costing System Reasons for Growing Importance of Overheads Non-compatibility of Standard Costing with Activity Based Costing

Meaning

n n

n n n n n n n n n n n n n n n n n n

Behavioural Considerations in Standard Costing Meaning of Variance, Variance Accounting, Variance Analysis Causes, Classification and Interpretation of Variances Controllable and Uncontrollable Variances Direct Material Variances Direct Labour Variances Variable Production Overhead Variances Fixed Production Overhead Variances Sales Value or Turnover Variances Sales Margin or Profit Variances Market Size and Market Share Variances Accounting Procedure for Standard Cost Accounting Procedure Under Single Plan Partial Plan and Single Plan : Comparison Methods of Disposal of Variances Revision of Standards and Revision of Variances Interdependence Between Variances Planned and Operational Variances Investigation and Control of Variances Techniques of Investigation of Variances

Historical Costing

In this type of costing system, costs are ascertained only after they have been incurred. It is the process of accumulation of costs after they are incurred in a systematic manner. The amounts spent on material, labour and overheads are recorded and these expenses totalled together give a figure of cost of providing a particular product. The historical costs are used only for postmortem examination of actual costs incurred and it would be too late to control.

Limitations

The historical costing suffers from the following limitations : (a) Costs are known after they have incurred, which is not useful for taking corrective action in time.

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209

(b) Historical cost records does not provide for cost comparison, due to changes in business environment and situation. (c) It is very expensive to maintain detailed cost records (d) It will be duplication of financial accounting records. (e) The historical cost data will not be much useful in taking crucial decisions like price fixation, adoption of responsibility accounting concept, budgeting etc. (f) Historical cost data is always available late, which may not be much useful for even taking managerial decisions. (g) It does not help for future financial planning. (h) It is not preceded by planned costs which are a must for effective cost control.

Emergence of Standard Costing Historical cost accounting is not considered sufficient to supply required information for taking managerial decisions.

The emphasis of management on using cost as control device has brought the emergence of Standard costing. The technique of standard costing has been developed because of change in emphasis from cost ascertainment to cost control. Standard costing is a technique which helps management to control costs and business operations. It aims at eliminating wastes and increasing efficiency in performance through setting up standards or formulating cost plans.

Standard Cost and Standard Costing Standard The word standard means a benchmark or yardstick. A standard is a predetermined measurable quantity set in defined conditions against which actual performance can be compared, usually for an element of work, operation or activity.

Standard Cost The standard cost is a predetermined cost which determines in advance what each product or service should cost under given circumstances. Standard cost is the amount the firm thinks a product or the operation of a process for a period of time should cost, based upon certain assumed conditions of efficiency, economic conditions and other factors. A standard cost is a planned cost for a unit of product or service rendered. Standard costing is universally accepted as an effective instrument for cost control in industries. The predetermined costs based on technical estimate of material, labour and overhead for a selected period of time and for a prescribed set of working conditions.

Standard Costing Standard costing involves the setting of predetermined cost estimates in order to provide a basis for comparison with actual costs. Standard costing is a technique which uses standards for costs and revenues for the purpose of control through variance analysis. Standard costing is a technique of cost accounting which compares the standard cost of each product or service with actual cost to determine the efficiency of the operations so that any remedial action may be taken immediately. Standard costing means the preparation and use of standard costs, their comparison with actual costs, and the analysis of variance to their causes, and points of incidence.

Standard costing is a system of cost accounting which is designed to find out how much should be the cost of a product under the existing conditions. The actual cost can be ascertained only when production is undertaken.

The predetermined cost is compared to actual cost and a variance between the two enables the management to take necessary corrective measures. Although the terms budgeted and standard costs are sometimes used interchangeably, budgeted costs normally describe the total planned costs for a number of products.

Suitability Though standard costing system will be useful for all types of commercial and industrial undertakings but it will be more useful in those undertaking where production is standardized. With the use of standard costing the organization achieves the objectives in a planned and systematic manner. Standard costing can be used in direct costing, absorption costing, unit costing and process costing. It is not a method of costing but a system which can be fitted in any method. It will be of less use in Job costing system because every job has different specifications and it will be difficult to determine standard costs for every job.

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Features The important features of standard costing system are as follows : (a) Predetermine the standard costs. (b) Establish inputs for outputs. (c) Make it applicable to all routine aspects of an organization s operations. (d) Recording of actual cost. (e) Comparison between standard cost and actual cost. (f) Finding out variance. (g) Reporting of variance to management for taking appropriate action wherever necessary.

Objectives The implementation of standard costing will fulfil the following objectives : (a) To provide a formal basis for assessing performance and efficiency. (b) To control costs by establishing standards and analysis of variances. (c) To enable the principle of management by exception to be practised at the detailed, operational level. (d) To assist in setting budgets. (e) To enable standard costs as readily available substitutes (f) To assist in assigning responsibility for non-standard performance (g) To motivate staff and management. (h) To provide a basis for estimating. (i) To provide guidance on possible ways of improving performance.

Types of Standards Current Standard It is a standard established for use over a short period of time, related to current conditions. It reflects the performance which should be attained during the current period. The period of current standard is normally one year.

Assumption - It is presumed that conditions of production will remain unchanged during the period. In case there is any change in price or manufacturing conditions, the standards are also revised.

Disadvantage -The problem with this type of standard is that it does not try to improve on current levels of efficiency.

Classification-The current standard may be (i) ideal standard or (ii) expected standard.

Ideal Standard It is a standard which can be attained under the most favourable conditions. This represents a high level of efficiency. No provision is made, e.g., for shrinkage, spoilage or machine breakdowns. This is the standard based on the maximum efficiency under the most favourable conditions possible.

Assumptions (a) It is fixed on the assumption that favourable conditions will prevail and management will be at its best. (b) It is assumed that there is no wastage, no ideal time, no inefficiencies or other imperfections in the manufacturing process. (c) Both, internal and external, conditions should be favourable and only then ideal standard will be achieved.

Disadvantages

(a) Ideal standard is fixed on the assumption of those conditions which may rarely exist. (b) This standard is not practicable and may not be achieved.

Expected Standard This standard is based on the expected conditions. It is the target which can be achieved if expected conditions prevail. It can be attained if a standard unit of work is carried out efficiently, on a machine properly utilized or material properly used. Allowances are made for normal shrinkage, waste and machine breakdowns. All existing

Chapter 10 Cost Control Through Standard Costing 211

facilities are taken into consideration and expected changes are also taken into account while fixing the expected standard. An allowance is given for human error and normal deficiencies in fixing this standard. The expected standard is more realistic and attainable.

Disadvantage - This standard requires constant revision, otherwise the standard will be meaningless.

Basic Standard It is a standard established for an indefinite period which may be for a very long period from which a current standard can be developed. It is not adjusted to the present conditions. These standards are revised only on the changes in specification of material and technology of production process.

Advantage - It shows changes in trend of price and efficiency from year to year.

Disadvantage

(1) It has remained unaltered over a long period of time, it may be out of date.

(2) It is based on perfect performance which is rather impossible to attain.

(3) The deviation between standard cost and actual cost cannot be used as a yardstick for measuring efficiency.

Normal Standard It is the average standard which is anticipated and can be attained over a future period of time, preferably long enough to cover one trade cycle. Such standards are established on the basis of average estimated performances with reasonable degree of accuracy for a long period of time. It is a standard fixed based on average performance in the past. Past may contain details of inefficient performance.

Disadvantage

(1) A standard evolved on this basis is also not good for standard costing purposes.

(2) It may not be a useful device for the purpose of cost control.

Setting of Standards Production Standards Study of the technical and operational aspects of the manufacturing processes and methods etc. Review of existing costing system, cost records and forms in use. Decide the type of standard to be used. Based on the factors as stated above, the production and cost standards are to be set up.

Cost Standards Proper classification of accounts is a must so that the cost variances could be correctly accounted for. Reliability and accuracy of cost standards are the prerequisites for the success of standard cost system. Fixation of responsibility for setting cost/price standards and coordinate the complete work of establishment of standard costing system.

Precautions (a) Standards have to be set for each element of cost for each line of product manufactured or service supplied. (b) Standard cost shows what the cost should be keeping in mind the most favourable production conditions, and on the assumption that plant will operate at maximum possible efficiency. (c) The collaboration of all functional departments is a must in setting standards. (d) The quantities, price and rates, qualities or grades, terms of purchase, product substitution etc. have to be kept in mind while setting standards. (e) In order to enable an organization to setup or install standard costing system the management has to finalize and prescribe various forms, methods and systems, keeping in mind the nature, size and technicalities of the business and motivate responsible persons.

Considerations (a) Standard setting should be sufficiently refined to provide adequate information. (b) Both quantitative and qualitative information should be given proper attention. (c) Standard costing system should provide for opportunity costs and profit forgone.

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Persons Involved Production manager and Cost accountant should work together in setting up the production standards and for the establishment of standard costs. Production manager should determine the quality and quantity standards.

The Cost accountant should work out for the cost, price and usage standards.

Standard Cost for Direct Material The setting of standard for direct material involves two things :

Quantity of Materials

Before determining the quantity of materials, the quality and size of materials should be determined. The standard quality to be maintained should be decided. The quantity and quality of materials should be decided by the Engineering department by making used of historical data. An allowance for changing conditions should also be given for setting standards. While setting quantity standards, a proper consideration should be given to normal material wastages.

For this purpose, a number of test runs may have to be carried out to decide on normal process losses. Quantity usage standards are set on the basis of various test runs and guidelines provided by R&D department or Engineering department and specifications on the basis of past experience. The standards should also take into consideration allowances for acceptable level of waste, spoilage, shrinkage, seepage, evaporation, leakage, etc.

Price of Materials Price factor is controlled by external factors. The standard cost of materials will be decided in consultation with the purchase department. The cost of purchasing and storing of materials and inventory carrying costs should be taken into consideration. The factors like levels of inventory, discount policy, means of transport, cost of ordering material and follow-up, inventory carrying costs etc. should be considered before fixing price standard of materials.

The expected future price changes should be anticipated while setting up standard price. If the price changes during the period due to inflation, raise in prices of controlled items like cement, steel, etc., there is going to be wide variations. Material prices are fixed keeping in mind the terms of contract of purchase, nature of items and other relevant factors. Some organizations have regular system of purchases (rate contract) for the whole period/year at predetermined price irrespective of prevalent market rates.

Standard Cost for Direct Labour The setting of standard for direct material involves two things :

Standard Labour Time

Standard labour time indicates the time taken (hours) by different categories of workers for performing a particular job. The general principles followed for setting standard labour time will include past performance records, test run result, work study etc. The labour efficiency means the number of hours that the appropriate grade of worker will take to perform the necessary work. It is based on actual performance of worker or group of workers possessing average skill and using average effort while performing manual operations or working on machine under normal conditions. The standard time is fixed keeping in mind past performance records or work study. This is on the basis that is acceptable to the worker as well as the management.

Labour Rate Standard The labour rate standard refers to the expected wage rates to be paid for different categories of workers. The anticipation of expected changes in labour rates will be an essential factor. In case there is any agreement with the workers for payment of wage rates in the coming period then these rates should be used. If a premium or bonus scheme is in operation then anticipated extra payments should also be included. Where a piece rate system is used the standard cost will be fixed piece rate. This is basically dependent on the agreement with the labour unions or rate prevalent in the particular area or industry. The labour rate depends on different grades of labour.

Standard Costs for Overheads The purpose of setting overhead rates is to minimize overhead costs. The standard overhead rates are computed by dividing overhead expenses by direct labour hours or units produced. The standard overhead cost is obtained

Chapter 10 Cost Control Through Standard Costing 213

by multiplying standard overhead rate by the labour hours spent or number or units produced. The overheads are classified into fixed and variable overheads for computation of variances. It is necessary to determine the level of activity, based on that the amount of overhead will be calculated. The estimation on activity level will enable to determine the estimated production in units or labour hours spent. The overhead rates are determined with the following formula : Standard Variable Overhead Rate =

Budgeted Variable Overheads for Budget Period Budgeted Production in Units or Budgeted Hours for Budget Period

Standard Fixed Overhead Rate =

Budgeted Fixed Overheads for Budget Period Budgeted Production in Units or Budgeted Hours for Budget Period

Standard Hour In a business organization where only single product is manufactured, produced or dealt, it is simple to identify costs with that single product. But when a concern manufactures different varieties of products, it is difficult to aggregate production expressed in different units. To eliminate this difficulty, the production is expressed in a common measure called standard hour . A standard hour is a hypothetical hour representing the amount of work which should be performed in an hour under standard conditions. The standard hour is a unit of work and not of time. The quantum of work done in one hour is known as standard hour .

Example

A furniture company manufactures different varieties of products like Single bed cots, Double bed cots, tables, chairs, cabinets etc. The computation of standard hours of those products are illustrated as below: Products

Standard Hours per unit

Quantity produced

Output in Standard hours

Single cot beds

15

400

6,000

Double cot beds

22

600

13,200

Tables

8

1000

8,000

Chairs

5

1500

7,500

Cabinets

9

650

5,850

Important Terminology in Standard Costing The terminology used by CIMA, London on Standard costing systems are summarized as follows: Standard Hour/Minute

The quality of work achievable at standard performance, expressed in terms of a standard unit of work in a standard period of time.

Standard Time

It is the total time (hours and minutes) in which a task should be completed at standard performance i.e., basic time plus contingency allowance plus relaxation allowance.

Standard Unit of Work It is a unit of work consisting of basic time plus relaxation allowance and contingency allowance where applicable. The unit of work may be for labour output only, a combination of machine and labour output, or for a machine only.

Standard Performance of a Machine

It is the rate of output achievable by a machine on an average, under specified conditions over a given period of time. It may include the standard performance of the operator.

Standard Direct Material Cost

It is the predetermined cost price for a specified quality of material to be used at a standard material usage rate over a specified period.

Standard Material Usage Standard material usage is the quantity of material or rate of use required as an average, under specified conditions, to produce a specified quantity of output.

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Standard Direct Labour Cost

It is the planned average cost of direct labour for a specified amount of direct labour effort to be used at standard performance over a specified period. It is usually expressed as a cost per unit of time i.e., standard hour or standard minute.

Standard Overhead Cost It is the predetermined cost of overhead of a cost/revenue/profit centre over a specified period, using an agreed overhead absorption method. In Marginal costing, this will be in respect of variable overhead only.

Standard Performance - Labour

It is the rate of output which qualified workers can achieve on an average over the working day or shift, without over exertion, provided they adhere to the specified method and are motivated to apply themselves to their work.

Standard Production Cost - Total

It is the predetermined cost of producing or providing specified quantities of products or service at standard performance over a specified period.

Standard Production Cost - Unit

It is the predetermined cost of producing or providing specified quantity of a product or service at standard performance.

Standard Selling Price - Unit

It is a predetermined price for a product or service for a specified unit to be sold. A unit may consist of a single item or a batch of processed output.

Standard Price

It is a predetermined price fixed on the basis of specification of a product or service and of all factors affecting that price.

Standard Operating Profit - Unit

It is the predetermined profit from the sale of a specified unit of a product or service at the standard selling price.

Standard Profit-Total

It is the predetermined profit arising from the sale of actual quantities of products or services at standard selling prices, over a specified period.

Formula: Actual number of units sold × (Standard selling price p.u. - Standard cost p.u.)

Standard profit may be at the level of net profit, gross profit or combination. Profit which relates only to trading activities is often referred to as operating profit .

Prerequisites for Establishing Standard Cost System The establishment of a standard costing system involves the following steps: (a) Determination of Cost Centres - Cost centres are necessary for determining the costs. Cost centres enable the determination of costs and fixation of responsibility. (b) Classification and Codification of Accounts - Classification of accounts is necessary to meet a required purpose i.e. function, asset or revenue. Codes can be used to have a speedy collection of accounts. (c) Study the Technical Aspects - The predetermination of standards require to make a thorough analysis of technical aspects of the production process, to set the quantity standards i.e. standards in use of material and labour. (d) Determination of Type of Standard - The standard may be current standard, basic standard or normal standard. The current standard may be ideal standard or expected standard. It is necessary to determine the type of standard to be adopted in the beginning of the standard costing system. (e) Organization for Standard Costing - The success of standard costing system will depend upon the setting up of proper standards. For this purpose, a person or a committee is formed. Normally, the committee includes Production manager, Purchase manager, Marketing manager, HRD manager, Chief engineer and Cost accountant. The Cost accountant will act as a coordinator of different departments and supplies necessary information for determining standards and later on coordinates the costs of different departments. (f) Setting of Standards - The standard for direct material, direct labour and overheads are fixed. It may be expressed in quantity and its monetary measurements in standard costs. The standards should be set up in a systematic way so that they are used as a tool for cost control. (g) Modifications to Existing Financial Accounting System - It is more useful to modify the existing financial accounting system in collection of costs to suit the standard costing system, otherwise, it will be too much costly to have an independent standard cost accounting system.

Chapter 10 Cost Control Through Standard Costing 215

(h) Training of Staff - The installation and implementation of standard cost system requires trained, qualified and experienced staff. A qualified and experienced Cost Accountant should be assigned with responsibility to achieve desired objectives of standard costing system and he should be capable of coordinating with top management, other departments, staff and workers. (i) System Operating Costs - Sometimes the detailed cost system proposed to be installed may cause substantial installation and operating cost. The benefits from standard costing system should be more than the costs incurred on its installation and operation. The properly designed and installed system should meet the specific requirements of the concern and it should reduce all unnecessary paper work in the organization. (j) Regular Comparison and Analysis - There should be a system of regular comparison of actual costs with standard costs and analysis of variances. (k) Management By Exception Reporting - Only those variances which are outside certain tolerance limits are investigated and reported to management, thereby economizing on managerial time and maximizing efficiency. (l) Management Support - Management should be convinced of benefits by installation and operation of a standard costing system. The basic objective of the system is to provide necessary information to the internal management for the purpose of cost control. (m) Staff Support - The non-cooperation and resistance of other departments and staff can be overcome by explaining the simplicity and use of the standard cost system and ensure organization s cost management and to increase its profitability.

Standard Cost and Estimated Cost : Distinction Basis

Standard Cost

Estimated Cost

Predetermined Cost

It is a predetermined cost on a scientific basis taking into consideration all the factors relating to costs e.g., raw material consumption rate, labour efficiency, machine efficiency etc.

It is a predetermined cost based on past performance adjusted to the anticipated changes. No minute appraisal of each individual component cost.

Application

It is ascertained and applied when Standard costing system is in operation.

It can be used in any business situation or decision making which does not require accurate cost. It is used in Budgetary control system and Historical costing system.

Emphasis

Its emphasis is on what should be the cost.

Its emphasis is on the level of costs not to be exceeded.

Purpose

It is used for analysis of variances and cost control purposes.

It is used in decision making and selection of alternative with maximum profitability. It is also used in price fixation and tendering.

Variances

It is used as a regular system of accounts from which variances are found out.

The use of estimated cost as a statistical data only.

Setting of Standards During Inflation The inflationary tendency in the economy will cause fall in purchasing power of money thereby affects the accounting for real value. In inflationary conditions, the results shown in financial statements do not represent the correct view of activities carried on in the business concern. Any decision taken or estimates made without inflation would not be correct. Rate of inflation will have impact on future cash flows and profitability of the concern. Before any estimates made or standards set, the difference between money rate of interest and real rate of interest, the difference between them should be taken as rate of inflation.

The practical approach for adjusting inflation is as follows: (a) Predict the cash flows in nominal rupees and use the nominal discount rate. (b) Predict cash flows in real rupees and use a nominal discount rate.

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Responsibility for Setting Standards (a) Human Aspects - Human aspects of budgeting apply equally to standard costing. (b) Behavioural Aspects - There are strong behavioural and motivational factors involved in this process. (c) Involvement of Line Managers - The line managers who have to work with the standards must be involved in establishing them. (d) Determination of Cost Centres - The cost accountant has to determine the units of products to be made by producing cost centres and work to be performed by service cost centres. (e) Basis of Overhead Recovery - Overhead recovery rates has to be determined in advance and applied on that basis to product/cost centres. (f) Determination of Standard overhead Rates - After application of service cost centres rates to production cost centres, a standard overhead rate has to be determined for each production cost centre. (g) Responsibility Accounting -The purpose of setting standards is to fix yardsticks for measuring the performance of various activities and helps in responsibility accounting.

Standard Costing and Budgetary Control : Distinction Basis

Standard Costing

Budgetary Control

Predetermined Costs

It is a system of accounting where predetermined costs are used for analysis of variances and control of entire organization.

It is a planning exercise made by the management in setting budgets for forthcoming period and analysis of actuals with the budgeted figures and corrective action is initiated if any deviations are identified.

Scientific Determination

Standard costs are scientifically predetermined in respect of materials, labour and overheads.

It is based on engineering & technical data.

Standard costs are fixed for each unit i.e., standard hour, standard unit, standard labour mix, standard material mix etc.

Budgets are based on past performance adjusted to the anticipated changes in the future. It is a written plan covering projected activities of a firm for a definite time period.

It is a financial measure of target and achievement.

Quantitative/Monetary

Standard may be expressed both quantitative and monetary measures.

Budgets are mainly monetary terms.

Purpose

It is concerned with ascertainment and control of costs.

It is concerned with overall profitability and financial position of the concern.

Variance

Any variance - adverse or favourable, is investigated.

It puts emphasis more on excess over the budget.

Level of Cost

Its emphasis is on what should be the cost.

Its emphasis is on the level of costs not to be exceeded.

Element of Cost

It is determined for each element of cost.

It is determined for a specified period.

Control of Costs

It is related with the control of costs and it is more intensive in scope.

It is concerned with the operation of business as a whole and it is more extensive.

Cost Performance

It is introduced primarily to ascertain the efficiency and effectiveness of cost performance.

It is introduced to state in figures as approved plan of action relating to a particular period.

Whole or Departmental

Standards are usually limited to manufacturing activities only.

Budgets are set for all departments in an organisation.

Projection

Standard cost is a projection of Cost accounts.

Budget is a projection of Financial accounts.

Emphasis

Standard costs are used in tactical decisions like, product price fixation, computation of product cost, valuation of inventory etc.

Its emphasis on policy determination, achievement of goals, co-ordination of different departments and activities, delegation of authority and responsibility.

in

expressed

in

Chapter 10 Cost Control Through Standard Costing 217

Standard Costing and Budgetary Control : Interrelation Usually budgetary control is operated with a system of standard costing because both systems are interrelated but they are not interdependent. One cannot have perfect and effective system of budgetary control without standard costing. Standard costing cannot be implemented without proper budgetary control system. The budgetary control system and standard costing are both supplementary and complimentary to each other. The standard costing is useful for MIS, profit planning, inventory control, product pricing, managerial decision-making, cost control etc.

Both standards and budgets are concerned with setting performance and cost levels for control purposes. They are similar in principle although they differ in scope. Standards are unit concept i.e. they apply to particular products, to individual operations or processes. Budgets are concerned with totals they lay down cost limits for functions and departments and for the firm as a whole.

Problems in Setting Standards The problems to be faced in setting standards are as follows: (a) Inflation - Deciding how to incorporate inflation into planned unit costs. (b) Quality - Deciding on the quality of materials to be used, because a better quality of material will cost more, but perhaps reduce material wastage. (c) Mix - Deciding on the appropriate mix of component materials, where some change in the mix is possible. (d) Price Variations - Estimating materials prices where seasonal price variations or bulk purchase discounts may be significant. (e) Behavioural Problems - Managers responsible for the achievement of standards might resist the use of a Standard costing control system for fear of being blamed for any adverse variances. (f) Costs - The cost of setting up and maintaining a system for establishing standards.

Advantages and Limitations of Standard Costing System Advantages The benefits that can be reaped from adaptation of standard costing system are as follows : (a) Aid to Management - It aids business planning, budgeting and managerial decision-making. (b) Strengths and Weaknesses - Standard costing highlights areas of strengths and weaknesses. (c) Formulation of Policies - Standard costing facilitates the formulation of production policies for various products by providing predetermined costs of each element of cost on the basis of engineering specifications. (d) Coordination - It facilitates coordination between different functions such as purchasing, production, selling, accounting together while fixing standards. (e) Measure of Performance - It acts as an yardstick to measure operating performance by comparing the variances and also assists in controlling cost by taking corrective steps. (f) Increase in Efficiency - The setting of standards should result in the best resources and methods being used and thereby increase efficiency. (g) Valuation of Inventory and Setting Wage incentive Schemes - Standard costs can be used to value stock and provide a basis for setting wage incentive schemes. (h) Simplifies Book keeping - Standard costing simplifies book keeping, as information is recorded at standard, instead of a number of historic figures. (i) Allocation of Costs - It helps to trace/allocate manufacturing costs to each individual unit produced. (j) Management by Exception - Only those variances which are outside certain tolerance limits are investigated, thereby economizing on managerial time and maximizing efficiency. (k) Immediate Control Action - As soon as material is issued from stores to production it can be compared with the standard material which should have been used for the actual production.

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(l) Preparation of Tenders - When standard costing is in operation, estimation of product cost for tendering purposes becomes easy. (m) Price Fixation - Price can be fixed based on standard costs provided there is no wide variation. (n) Evaluation of Jobs - Introduction of Standard costing facilitates evaluation of jobs and introduction of incentives. (o) Estimation of Costs - It facilitates the estimating of the cost of new products with greater accuracy and estimation of profit. (p) Standardization - Standard costing helps in achieving standardization of products, operations and processes.

Limitations The standard costing system is subject to the following limitations : (a) Expensive - A lot of input data is required which can be expensive. The maintenance of the cost data base is expensive. (b) Repetitive Jobs or Processes - Standard costing is usually confirmed to organizations whose processes or jobs are repetitive. (c) Accuracy of Standards - Unless standards are accurately set any performance evaluation will be meaningless. (d) Environmental Uncertainty - Uncertainty in Standard costing can be caused by inflation, technological change, economic and political factors etc. Standards, therefore, need to be continually updated and revised. (e) Motivation of Workforce - It may be difficult to set standards at a level which both motivates the workforce and achieves corporate goals. (f) Difficult to Understand - Research evidence shows that overly elaborate variances are imperfectly understood by line managers and thus they are likely to be ineffective for control purposes. (g) Possibilities of Error - Virtually all aspects of setting standards involves forecasting and subjective judgments with inherent possibilities of error and argument. (h) Number of Variances - The usefulness of a number of variances relating to overheads, sales margins, mix and yield is questionable. (i) Analysis of Historical Data - All forms of Variance analysis are postmortem on past events. Obviously the past cannot be altered so the only value variances can have is to guide management if identical or similar circumstances occur in future.

Reasons for Growing Importance of Overheads There is an increase in overheads in the present scenario of industrialization, for which the following reasons can be highlighted : (a) Industrial Needs - Standard costing originated as a control system designed to serve the industrial conditions of the time and proved to be a sound management tool. (b) Change in Conditions - Conditions have changed dramatically and doubts have been raised about usefulness of standard costing in today s industrial environment. (c) Advanced Techniques - The world class manufacturers use computer assisted Advanced Manufacturing Technology (AMT) and Just-In-Time (JIT) production and purchasing methods. (d) Change in Objectives - In the present day industrial environment, there is a constant drive for : (i) improvement and excellence, (ii) elimination of all forms of waste, (iii) move towards zero defects and inventories, (iv) production according to demand rather than for stock. (e) Changes in Cost Patterns - As a consequence of the latest developments in production systems, there have been major changes in cost patterns. These can be summarized thus: (i) Direct labour now constitutes only a small proportion of costs, typically 5 to 15%, in modern factories. (ii) Most costs are now fixed in the short-run, including labour. In many factories, materials and power costs are the only variable costs. (iii) Overheads are a much higher proportion of total costs and need to be monitored and controlled much more closely than in the past.

Chapter 10 Cost Control Through Standard Costing 219

Non-compatibility of Standard Costing with Activity Based Costing The traditional Standard costing system is not compatible with Activity based costing system due to the following reasons: (a) Cost Pattern - Manufacturing costs represents a low proportion of total cost. (b) Ignorance of Selling costs - Product selling and distribution expenses are ignored for product costing purposes. (c) Overheads - ABC system addresses treatment of all overhead related costs linking with cost drivers and cost pools. (d) Material Cost - Material cost will be treated as direct costs both in ABC and Standard costing system, except that all costs incurred in bringing the product to its current state and location will be included in ABC system. (e) Labour Cost - Labour, as a basis for assigning manufacturing overhead, is irrelevant as it is significantly less than overhead and many overheads do not bear any relationship to labour cost or labour hours. (f) Cost of Technology - The cost of technology is treated as product cost and consequently expressed on a straight line basis, irrespective of use. (g) Service Costs - Service related costs like professional services, banking services, insurance services have increased considerably. (h) Customer Costs - Customer related costs like finance charges, discounts, selling and distribution costs, after sales service costs etc. are not related to product cost object. Customer profitability has become as crucial as product profitability. (i) Information Systems - Direct labour is also replaced to some extent by Information technology and systems.

These costs are treated similarly to organizational overheads and not related to products or other cost objects, such as customers. (j) Time Costs - Costs affected or driven by time (interest & inflation) have increased significantly. (k) Short-Term Focus - Short-term focus of financial year (12 months) is still intact, yet most products and technologies have life cycles exceeding many accounting periods. (l) Intensity of Competition - Increased competition brought about by increased productivity, economies of scale, better communication technology, improved transportation, better marketing skills, increased marketing costs. (m) Product Mix - Greater variety and diversity of products are not taken into consideration in traditional systems. (n) Customer Driven Market - The current market calls for production of goods and rendering of services desired by the customer/client, and not those thought proper by the supplier.

Behavioural Considerations in Standard Costing (a) Alignment of Individual Goals with Organizational Goals - Standard costing system should be developed in such a way that individuals are encouraged to behave in a manner which is consistent with overall goal of the organization. (b) Goal Congruence - There should be a goal congruence between the personnel goals and the organizational goal. Performance measures should encourage goal congruence. (c) Motivational Approach - Specific quantitative targets have a strong motivational approach, but careful consideration should be given to the degree of difficulty represented by target figures. (d) Participation - There should be appropriate participation of managers in preparation of budgets. (e) Flexible Attitude - This may result in bias and the same can be avoided by taking a flexible attitude while setting standards.

Meaning of Variance Analysis Variance It is the difference between planned, budgeted or standard cost and actual costs and similarly in respect of revenues. It represents a deviation of the actual result from the standard result. This should not be confused with the statistical variance which measures the dispersion of a statistical population.

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Variance Accounting It is a technique whereby the planned activities of an undertaking are quantified in budgets, standard costs, standard selling prices and standard profit margins. The differences between these and the actual results are compared.

The procedure is to collect, compare, comment and correct.

Variance Analysis It is the analysis of variances arising in a Standard costing system into their constituent parts. It is the process of analyzing variances by subdividing the total variance in such a way that management can assign responsibility for below the standard performance. It is the analysis and comparison of the factors which have caused the differences between predetermined standards and actual results, with a view to eliminating inefficiencies. It is an exercise, which involves efforts to isolate the causes of variances in order to report to management those situations, which can be corrected and controlled by timely action. There can be cost variances, profit variances, sales variances and operational and planning variances. A suitable analysis will reveal that some of the variances are controllable, while others are uncontrollable. By analyzing variances, origin and the causes of variances can be traced so that steps can be taken to reduce them. The conventional variance analysis is a postmortem exercise.

A detailed analysis of controllable variance helps the management to ascertain: (a) amount of variance, (b) the cause of variance, (c) the person responsible for its occurrence, and (d) the corrective action to be taken.

Methodology The methodology in implementation of variance analysis are as follows : Step 1

Standards of performance for each activity or each segment of cost (material, labour, overhead) should be set.

Step 2 Step 3

Step 5 Step 6

Setting of standards and construction of a budget based on them.

Organization structure with responsibility centres that can be identified with standard costs should be defined.

An information system to compile data on actual outcomes should be built up for comparison and analysis of variances.

Comparison of actual with budgeted outcomes.

Factoring the variance into individual components and investigation of the significant differences.

Step 7

The objective is to help management by exception to identify the cause for taking corrective action.

Step 4

Causes of Variance There are many possible causes for cost variances arising due to efficiencies and inefficiencies of operations, errors in standard setting, changes in exchange rates etc. The following are the important causes for variances: - It results from a human or mechanical failure to achieve an attainable income. (b) Prediction Deviation - It results from errors in specifying the parameter values in decision model. (c) Measurement Deviation - It arises as a result of error in measuring the actual outcome. (a)

Implementation Deviation

(d)

Model Deviation

(e)

Random Deviations

- It arises as a result of an erroneous formulation in a decision model.

- It is due to chance fluctuations of a parameter for which no cause can be assigned.

Classification of Variances Variances of Efficiency - These variances arise due to the effective or ineffective use of materials quantities, labour hours, once actual quantities are compared with the predetermined standards. (b) Variances of Price Rates - These variances arise due to change in unit material prices, standard labour hour rates and standard allowances for overheads. (c) Variances Due to Volume - These variances arise due to the effect of difference between actual activity and assumed level of activity, when the standard was set. (a)

Strategic Cost Management AUTHOR : PUBLISHER : DATE OF PUBLICATION : EDITION : ISBN NO : NO. OF PAGES : BINDING TYPE :

RAVI M. KISHORE TAXMANN JANUARY 2024 REPRINT 5TH EDITION 9789357784719 868 PAPERBACK

Rs. 1095 | USD 48

Description This book is a comprehensive and authentic textbook for those seeking a thorough understanding of strategic cost management in the modern business environment. It emphasises the importance of cost consciousness in the competitive business world, highlighting its role in the survival and sustainability of business concerns.

Structured into 38 well-organised chapters, the textbook discusses traditional and modern cost management techniques, ensuring a broad and updated coverage of the subject matter. Special attention is given to Operations Research, simplifying complex topics like Simulation Modeling, Learning Curve Theory, Assignment Problems, Transportation Problems, Linear Programming, and Network Analysis for easier student comprehension.

This book is tailored for students and professionals in higher-level business management courses. It is particularly beneficial for those preparing for M.Com., MBA, MFM, CA, CMA, and CS courses.

The Present Publication is the 5th Edition, authored by Ravi M. Kishore, with the following noteworthy features: u

u

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[Simple & Lucid Language] The content is presented to simplify complex concepts, making it accessible to students and professionals alike [Illustrations & Diagrams] The concepts within are elucidated through a multitude of illustrations and diagrams, making complex and advanced subjects more accessible A significant focus is given to Operations Research, presented in an easy-to-understand

manner u

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[Theory Questions] are included at the end of each chapter to aid in self-testing and reinforce learning [Practical Problems] Each chapter is fortified with numerous solved practical problems for self-study, enhancing the hands-on learning experience

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