Costing & Management Tools for Effective Management for better... · Costing & Management Tools for...

Presentation by

CMA Sirish Vasant Mohite

Navi Mumbai Chapter

CMA Sirish Vasant Mohite1

Costing & Management Tools for Effective

& Efficient Financial Decisions

Understanding Cost & Profits

Costs & Break Even

Costs & Break Even

Profit & Margins

Objectives of the Discussion


Understanding the Problems faced in Implementing Costing Strategies

Change in Thought Process not for Looking at Cost from static but from Dynamic “Point of View”

Igniting Thought Process on Cost

Using Costing Tools & Techniques to lay down Strategies

Need for being both “Introvert” & “Extrovert” for implementing good Cost Management Techniques

Modern Complex Corporate World

Agenda


“COST” Dynamics


Problems in Cost Management Implementation

Possible Approaches for Positive Cost Management

Some Tools for Decision Making in Purchase Price

Cost Volume Relationship-Leverage- Financing Decisions

Major Strategies for Controlling Human Capital Costs

Utilization of Costing Tools and Techniques

Managing the Management

Current Complex Corporate World

“COST” Dynamics


Continuous C

ObservationO

Strategically S

Thinking T


1. COST -

A Static View -Value of amount spent and accounted

/ recorded.

A dynamic View - Continuous Observation & Strategic

Thinking on it.

Role is not determination of Cost which the Proprietor

knows but managing it to improve profits.

It is about Critical Observation on its Movement both

downward and upward.

“COST” Dynamics


Remember the Childhood 3 W’s

What happened to the cost?

When did it happen ?

Why it happened ?



Today's businesses are under constant pressure to reduce costs yet

many find it hard to do so in a sustainable fashion. 9 out of 10 cost

reduction programs fail to achieve their targets, and the gains that are

achieved appear to be short lived.

The increasing interdependencies faced by companies - internally

between functions and externally with suppliers, customers and other

stakeholders - help to make the management of cost a highly complex

issue that can only be addressed at a strategic level.

Creating a cost-aware culture is the goal of most if not all of the

companies the EIU surveyed, as they strive to respond to downward

pressure on prices, intensifying competition, pressure from shareholders

and the need to find cash to fund growth



Cost strategies are failing

2. On average companies are achieving only 59 percent of expected

savings, and just eight percent of businesses reach or exceed their

targets for cost saving initiatives.

3. One of the single biggest barriers to achieving these targets is the

lack of adequate processes to drive cost reduction.

4. Respondents gave their companies roughly a ‘C+’ rating overall in

cost reduction, and until business raises its game, the saving will not

flow.

1. Four out of five survey participants see an efficient cost structure as

a source of long-term competitive advantage. But in practice, cost

initiatives often disappoint.



Cost drivers are not clear or transparent

2. This knowledge is vital in helping to ensure that cost cutting is

targeted in the right places, and that the success of cost management

initiatives is properly measured.

3. Unfortunately, many companies do not have a clear view of what

drives costs: indeed, less than half of businesses surveyed make costs

and profitability of individual units transparent across their enterprise.

4. In addition to improving efficiencies, IT has a major role to play in

providing better quality information to support this goal.

1. Companies need more insight into what drives cost in their business



Revenue growth has eroded cost discipline

2. One result is that companies are setting themselves low targets: the

average business in the survey currently aims to reduce costs by only

about two percent per annum. This research helps to show that

companies must retain cost discipline during periods of growth or, in

the words of one executive interviewed for this report, “it will come

back to bite you.”

1. 42 percent of respondents admitted that revenue growth had led

their businesses to take the eye off the ball on cost, even though two-

thirds of respondents say. That cost reduction requires extraordinary

focus.




Cost strategies are too cautious

2. Improving process efficiency, by far the most popular approach to

finding savings, can yield significant benefits but only if it is conducted

rigorously.

3. Survey respondents indicated that offshoring provided the greatest

savings of a range of techniques, but this remains one of the least

popular strategies.

4. Of course offshoring can be painful and politically sensitive, but

companies must be prepared to adopt major changes to their business

model - including offshoring where applicable - in order to remain

competitive.

1. Companies can too often pick the easy option for cost initiatives,

rather than the one which will yield most savings.


Cost discipline is not embedded in the culture

2. Nevertheless, companies that achieve a sustainable competitive

advantage are often those that embed cost discipline into the culture.

3. A clear strategy and careful communication is vital to the success of

any corporate project, but becomes even more so in cost cutting

initiatives where employees may (quite understandably) feel

threatened by change.

1. It is hard to get people excited about cost management initiatives.




Understanding Business Process

Identifying Key factors & Control Checks for Material & Norms

By Interaction with the Technical & Marketing Team

Take Note of Process Norms , Business Situations , Waste Norms

Refer if possible Industry Norms

Methods Applying the Costing Techniques & Tools

Combination of Marginal Costing, Standard Costing Budgeting Differential / Incremental Costing


Understanding Organization

Management Style

• (The devil is in the details)

Manage What You Measure

• Understanding Dashboards and Metrics

• Reading vs. Truly Understanding Reports vs. TakingCorrective Action

Getting the Right Advice

• Professional Advisors

• Board of Advisors

• Coaches and Mentors

• Outsourcing Services Providers



Cost Management should be done across all Functions depending on the quantum of cost.

Immediate action on Cost which one can see is not worth spending / incurring and framing policies to avoid such costs.

Sensitising Cost Awareness among all Departments by asking them to submit a note on the Thought process taken up by them for reduction in Cost .- Cost Reduction is not an area of Costing Dept. but all Departments.

Remember you have to cut the fat and not the muscles



Penny-wise vs. pound foolish(Act with integrity and don’t be short-sighted or cut corners … it will come back to haunt you).

Communication is critical (most vendors, lenders, etc. will work with you if you communicate early and often)

Understanding your “pain points” and inefficiencies

Company capitalization (debt-to-equity ratio and borrowing costs)

Conducting “want vs. need” analysis on your current expenses.


17 CMA Sirish Vasant Mohite

• Managing Vendor and

Customer Relationships

• Outsourcing IT

applications (ex. Network

Alliance), benefits, sales

financial management,

etc.

• Centralizing for

purchasing, advertising,

etc.

• Joint Ventures and

strategic alliances

• Employee incentives and

rewards for cost-cutting

initiatives

• Bootstrapping

• Cash flow management

• Managing employee

retention and turnover

costs

• Budgeting, planning,

forecasting

• Estimates and price

quotes

• Corporate restructuring,

recapitalization and

reorganization

• Competitive bidding and

RFP’s for vendor needs

• Grassroots and guerilla

sales and marketing

techniques

• PR vs. Advertising Costs

• Customer referral,

retention and loyalty

systems

• Barter networks

Types of Strategies

Relationship driven Cost Management

Techniques

Financial & Management Driven Cost Management

Techniques

Market- Driven Cost Management Techniques



Margina

l

Costing

Standard

Costing &

Budgetin

g

Identify

Cost

Drivers

80 20 rule

/ ABC

Analysis Action Points

Cost

Volume

Profit

Relationsh

ip

Leverag

e

Analysi

s

Quantity Price Mix Yield Variable

Cost Material

Variances

Analysis Energy Operatin

g

Packing

Cost

Identification Others Financial

Sales

Allocation

Combine

d

Apportionment

Fixed

Cost

Study

Each

Head

Salary

Rent

Insurance

Travelling



Fixed vs. Variable Costs

Debt-service costs

Infrastructure and Systems Costs

Human Capital Costs Salaries Benefits Healthcare costs

Advertising and Promotional Costs

Overhead and Administrative Costs

Research and Development Costs

***The type of cost you are trying to manage

will dictate the strategy



ROCE Tool -- for Reduction in Profit Margin & thereby Reducing Contract / Pur

Price

Differential Costing- Negotiation Tool on Contract Prices for Various Volumes.

Reporting on Payback in terms of Return on Investment to make it catchier.

What are the Cost Drivers – ie driving the Cost. Focus on it.

Some Tools for Decision Making in Purchase Price

ROCE MODEL

Return on Capital Employed Profit Margin Turnover

PBIT Sales Capital

Capital PBIT Sales

Profit Margin 15 5 2.5

No. of Days Capital Block 60 60 45

Turnover 6 6 8

Return on Investment 90 30 20

Units Quote Revenue VC FC Total Cost

1,000 100 100000 80000 20000 100000

2,000 90 180000 160000 20000 180000

1000 80000 80000 80000

Per Unit Difference 80

4000 200 800000 320000 20000 340000

85


Differential Costing- Exercise

Exercis

e

Question :

Incremental/Differential Costing

Exercise Installed Capacity 100000 Units

Utilisation 70%

FOB cost per unit after taking Credit of Export

Incentives is as Under

Capacity Utilisation 70 80 90 100

FOB cost per unit after taking Credit of Export

Incentives 97 92 87 82

Marketing Office has Following Export Orders Units

Rate/ unit of

FOB

From A- 5000 Rs 55

From B 10000 Rs 52

From C 10000 Rs 51

Should the Company accept any or all the

Export Orders ?

SVM CEP Case Studies Final 15.10.16.xlsx


Differential Costing- Exercise

Solution :

Statement Showing Incremental Cost / Unit

% No of Uts Incremental Cost / Unit Total Cost Incremental Incremental

Utilisation Units Cost Cost/ Unit

1 2 3 4 5 6 7=6/3

70 70000 0 97 6790000

80 80000 10000 92 7360000 570000 57

90 90000 10000 87 7830000 470000 47

100 100000 10000 82 8200000 370000 37

Acceptance Rejection of Offer -

Source Qty % Capacity Total Cost Incremental Revenues Profit / Loss

Utilisation

A 5000 75 285000 275000 -10000

B 10000 80 570000 520000 -50000

C 10000 80 570000 510000 -60000

AB 15000 85 805000 795000 -10000

BC 20000 90 1040000 1030000 -10000

CA 15000 85 805000 785000 -20000

ABC 25000 95 1225000 1305000 80000

All Three Offers to be accepted in toto.Exercis

e



Cost Volume Relationship-Leverage- Financing Decisions

Units10% Increase in

Sales

10%

Increase in

PBIT

Install Capacity Nos 10,000 10,000 10,000 10,000

Utilized Capacity Nos 7000 3500 7700 7000

Selling Price Per Unit 10 10 10 10

Variable Cost Per Unit 6 6 6 6

Fixed Cost Rs 14000 14000 14000 14000

Interest Rs 3500 3500 3500 3500

Sales Rs 70000 35000 77000 70000

Varaibel Cost Rs 42000 21000 46200 42000

Contribution Rs 28000 14000 30800 28000

Fixed Cost Rs 14000 14000 14000 14000

PBIT Rs 14000 0 16800 20.00% 15400

Interest Rs 3500 3500 3500 3500

PBT Rs 10500 -3500 13300 26.67% 11900 13.33%

Contb/Sales Ratio 0.40 0.40 0.40

Breakeven Point FC/ CS 35000 35000 35000

Very Risky Optimium Risky Risk Averse

OL Cont/PBIT 2 8 2 2 8

FL PBIT/PBT 1.33 8 2 8 1

Combined Leverage 2.67 64 4 16 8

Financing Decisions OL FL

Very Risky High High

Good Low Low

Good Low High

No Risk High Low


Major Strategies for Controlling Human Capital Costs

Employees vs. Independent Contractors

Hiring the right first time and rewarding

loyalty(significantly reduces turnover/replacement

costs)

Outsourcing payroll processing, benefits,

taxes, etc

Telecommuting and virtual office


Classification of Cost

COST

Time Based:

Historical

Current

Budgeted Controllability Based:

Controllable

Non controllable

Normality Based:

Normal

Abnormal

Association Based:

Period

ProductDecision Making based:

Relevant

Irrelevant

Nature Based:

Variable

Fixed

Semi-variable

Function Based:

Production

Administration

Selling

Distribution

R&D

Conversion

Pre-production

Elements Based:

Materials

Labor

Expenses

Payment Based:

Explicit

Implicit


Utilization of Costing Tools and Techniques- Very Basics

Marginal Costing Standard Costing

Budgeting Control Inter- Firm Comparison

Combination of all techniques


Relevant Cost Analysis- Materials

Materials

Already Available or Ordered To be purchased

Current Replacement

Cost is relevant as

Incremental Cost

Net Realizable Value is

relevant as Opportunity

Cost

Purchase Price

being out of

pocket cost is

relevant

Regularly Used Rarely used


Relevant Cost Analysis- Labour

Situation Relevant Cost

1. Labour Force already available

a) Excessive Labour force- no retrenchment policy.

b) Excessive Labour force- reduction in idle time cost

c) Used for special contract necessitates replacement.

d) Yielding contribution in a different department

a) NIL

b) NIL

c) Replacement Cost i.e. wages of new

workers.

d) Variable Cost + Opportunity Cost

( Contribution foregone)

2. Workers to be appointed. Out of pocket cost i.e. wages of new

workers is relevant

3. Labour shortage situations Variable Cost + Opportunity Cost

( Contribution foregone)


Marginal Costing

Classification of total cost into Fixed, Variable & Semi-variable.

Why : For controlling over expenses, budgeting & estimates & decision making.

Contribution = Sales- Variable Costs. This contributes to the recovery of fixed cost & thereby profits.

Profit= Contribution- Fixed Cost

PV Ratio = Ratio of contribution to sales.

Breakeven Point = No profit , No loss. Only Fixed cost recovered.

Margin of Safety = Total sales- breakeven sales.

Shutdown Point= Level of operation below which it is not justifiable to pursue operation/production i.e.

contribution insufficient to recover avoidable fixed cost.

Non-cost consideration in shutdown point : Loss of market share, goodwill, strange labour

management relationship ,etc.

Utility of Marginal Costing :

• Breakeven analysis

• Pricing Decision

• Business Decisions


Marginal Costing

Breakeven Point Sales = Fixed Cost / PV Ratio

Breakeven Point quantity = Fixed Cost / Contribution per unit


Marginal Costing- Exercise

Question :

Exercis

e

Marginal Costing

Exercise 1 New Product Devleoped

Units Rate/ Unit

Details Sales Estimated

15000-

20000 20

Sales Estimated

24000-

36000 18

Variable Manf Cost/ unit < 20000 16.5

Fixed Cost < 20000

Rs 48500/

month

Variable Manf Cost/ unit >20000 15.5

Fixed Cost

Rs 64500/

month

Market Survey Fees Rs 40000

New Product Devleopement Rs 60000

Utilisation of Once Rented Place

Rs 5600/

month

Determine Potential Profitablity at Various Levels

Recommendation relating to Price &

Volume of Output to be set



Solution :

Exercis

e

Estimated Sales

Solution 15000 20000 24000 36000

SP/ Unit/ Rs 20.00 20.00 18.00 18.00

VC / Unit/ Rs 16.50 16.50 15.50 15.50

Contb/ Unit/ Rs 3.50 3.50 2.50 2.50

Total Contribution 52500 70000 60000 90000

Manufacturing Fixed Cost 48500 48500 64500 64500

Opportunity Cost 5600 5600 5600 5600

Total Fixed Cost 54100 54100 70100 70100

PBIT -1600 15900 -10100 19900

BEP Units - Fixed Cost / Contb per Unit 15457 15457 28040 28040

Margin of Safety Units -457 4543 -4040 7960

Observa

tion Minimum Units for Break Even Point 15457

Profits only at Operational Level 20000 36000

At 24000 level you have to sell additional units of 10400 to maintain

Profit of Rs 15900 i.e. 34,400 10400

So Selling Price of Rs 20 is less riskier than Sales Price of Rs 18

If confident of Sales than Operational Level of 36000 is affordable

@ Selling Price of Rs 18

Sunk Cost viz Market Survey & New Product Development are not relevant in the

above decision Making Process

Marginal Costing- Exercise



Key Factor Principles

Key Factor : Resource availability < Requirement.

Idle Resource : Resource availability > Requirement. Both Mutually exclusive

For Key Factor : Availability= Normal Resource Availability at normal cost. Extended availability

at extra cost is not considered.

For Key Factor : Requirement = Maximum Resource Requirement i.e resources required to

achieve maximum production & profit.

Key Factor should be consumed in full and not kept idle because if kept idle will erode/decrease contribution.

Minimum production : Resources should be allocated independent of key factor ranking.

For additional resource requirements : Key Factor Priority to be used.

For multiple key factors- Single Product Decision : Only One Key Factor is relevant.

For multiple key factors- Multi-Product Decision : LPP techniques may be adopted for resource allocation.


Activity Based Costing (ABC)

Meaning

• Identification of cost with each

cost driving activity and making it

as the basis for appointment

/assignment of costs over different

cost objects/jobs/products/

customers/services.

Cost Object & Cost Driver

• Cost Object- Item for which cost

measurement is required.

• Cost Driver- Factor that causes a

change in the cost of an activity.

Cost Drivers are classified as -

• a) Resource Cost Driver- Measure

of quantity of resources

consumed by an activity & used to

assign the cost of a resource to

an activity/cost pool.

• b) Activity Cost Driver- Measure of

frequency and intensity of

demand, placed on activities by

cost objects & used to assign

activity costs to cost objects.

Stages in ABC

• Identify various activities within

the firm into – Primary &

Secondary.

• Relate the overheads to activities

using Resources Cost Drivers

• Apportion costs of support

activities over primary activities.

• Determine activity cost drivers for

each activity/ cost pool.

• Compute ABC Rate = Total cost of

activity (Cost Pool) / Activity Cost

Driver

• Assign Costs to cost objects using

formula – Resources consumed x

ABC rate


Activity Based Costing (ABC)

Steps in Installation of ABC System

• Identification of Objectives

• Identification of Costs for ABC

• Process Specification

• Activity Definition

• Activity Driver Selection

• Costing

• Staff Training

• Review & follow Up

Business Application of ABC

1. Cost Reduction

2. Activity Based Budgeting

3. Business Process Re- Engineering

4. Benchmarking

5. Performance Management


ACTIVITY (1) ACTIVITY COST

POOL (2)

COST DRIVER

( 3 )

QUANTITY( 4 ) ABC

RATE(5)=2/4

Set Up Set Up Cost +

Apportionment of

Machine

Operation &

Maintenance Cost

( AMOM)

No of Production

Runs

Stores Receiving Store Receiving +

AMOM

Requisitions Raised

Inspection Inspection cost +

AMOM

No of Production

Runs

Material Handling Material Handling

+AMOM

Orders Executed

Examples of Cost Drivers

Activity Based Costing- Exercise

Question :

Exercis

e

Activity Based Costing

Activity Based Costing A B C Total

Exercise

4 Choclate Manufacturing Co

Wants to move from Conventional Repiorting to Activity Based Costing

Inspection Cost per month 73000

Machie Repair & Maintenance per month 142000

Dye Cost per month 10250

Selling Ocerheads per month 162000

Prime Cost / Unit 12 9 8

Selling Price/ Unit 18 14 12

Gross Production ( units / Production Run 2520 2810 3010

No of defectives units / Production Run 20 10 10

Inspection - No of hrs / Production Run 3 4 4

Dye Cost / Production Run Rs 200 300 250

No, of Machine Hrs / Production Run 20 12 30

Sales No of Units / month 25000 56000 27000

Additional Notes

No accumulation of Inventory

Manufacturing & Selling Oveheads apportioned on No of

Units Sold

Advertisement Expenditure in Selling Overheads Cost Nil 83000

Special Packing included in 'Selling Overheads Cost 54000

Show Profitability Statement Under Conventional &

Activity Based Costing System?

37


Solution :

Exercis

e


Solution 3

A B C Total

Units Sold 25000 56000 27000 108000

Price /Unit 18 14 12

Sales Value 450000 784000 324000 1558000

Prime Cost /Unit 12 9 8

No. of Units / Run 2520 2810 3010

Prime Cost 302400 505800 216720 1024920

Gross Margin 147600 278200 107280 533080

Inspection Cost Rs 73000 30:80:36 15000 40000 18000 73000

Machine Maintenance Rs 142000 200:240:270 40000 48000 54000 142000

Dye Cost 2000 6000 2250 10250

Production Overheads 57000 94000 74250 225250

Selling & Distribution Overheads 56000 27000 83000

Packing 54000 54000

Other Overheads Rs 25000 25:56:27 5787 12963 6250 25000

Total Selling & Distribution Overheads 5787 122963 33250 162000

38


Solution :

Exercis

e


Conventional Accounting System

A B C Total

Sales Units 25000 56000 27000 108000

Gross Margin 147600 278200 107280 533080

Production Overhead 52141 116796 56313 225250

Selling Overhead 37500 84000 40500 162000

Total Overheads 89641 200796 96813 387250

Net Margin 57959 77404 10468 145830

Ranking 2 1 3

Activity Based

System

Sales Units 25000 56000 27000 108000

Gross Margin 147600 278200 107280 533080

Production Overheads 57000 94000 74250 225250

Selling Overhead 5787 122963 33250 162000

Total Overhead 62787 216963 107500 387250

Net Margin 84813 61237 -220 145830

Ranking 1 2 3

39


Solution :

Exercis

e


Working

1 Gross Production / Unit Run 2520 2810 3010

2 Defectives/ Run 20 10 10

3 Good Units 2500 2800 3000

4 Sales Good Units 25000 56000 27000

5 No of Production Runs 10 20 9

6 Gross Production 1 x 5 25200 56200 27090

7 Prime Cost / Unit 12 9 8

8 Prime Cost 302400 505800 216720 1024920

9 Inspection hrs / Run 3 4 4

10 Inspection Hours 9x5 30 80 36

11 Machine Hours /Run 20 12 30

12 Machine Hours 11 x 5 200 240 270

13 Dye Cost / Run 200 300 250

14 Dye Cost 13x5 2000 6000 2250 10250

40



Standards are benchmarks or “norms” for

measuring performance. In managerial accounting,

two types of standards are commonly used.

Quantity standards

specify how much of an

input should be used to

make a product or

provide a service.

Price standards

specify how much

should be paid for

each unit of the

input.

Standard Costing


DirectMaterial

Deviations from standards deemed significant

are brought to the attention of management, a

practice known as management by exception.

Type of Product Cost

Am

ou

nt

DirectLabor

ManufacturingOverhead

Standard

Standard Costing


Should we use

ideal standards that

require employees to

work at 100 percent

peak efficiency?

Engineer Managerial Accountant

I recommend using practical

standards that are currently

attainable with reasonable and

efficient effort.

Setting Standard Costs


Accountants, engineers, purchasing

agents, and production managers

combine efforts to set standards that encourage

efficient future operations.

Being Introvert as well as Extrovert

Setting Standard Costs


Variance Analysis Cycle

Receive Explanations

Take Corrective

Actions

Conduct next period’s

operations

Prepare standard cost performance

report

Analyze Variances

Identify Questions

210 kgs. 210 kgs. 200 kgs.

× × ×

Rs 4.90 per kg. Rs 5.00 per kg. Rs 5.00

per kg.

= Rs 1,029 = Rs 1,050 = Rs 1,000

Price variance

Rs 21 favorable

Quantity variance

Rs 50 unfavorable

Actual Quantity Actual Quantity Standard Quantity× × ×

Actual Price Standard Price Standard Price


Material Variances Summary

Standard Costing- Exercise

Question :

Standard Costing

Exercise

Budget Actual

Single Product Manufacturing

Output Units 6000 6400

Rs in "000

Actual Sales ( Rs 000) 1500 1596 Wage Rate

Direct Material 240 270

Direct Wages 360 416

Variable Overheads 600 648

Total Variable Cost 1200 1334

Market Demand for Qtr 60000

Co's Market Share 12%

Standard Actual

Direct Materil Price / Kg 8 7.5

Direct Labour Rate / hr 6 6.4

Calculate

Gross Margin Sales

Sales Price

Variance

Market Size Variance Direct Material Usage & Price Variance

Market Share Variance Direct Labour Efficiency & Rate

Volume Variance

Variable Overhead Effficiency & Expense

Variance

Exercis

e



Solution :

1 Market Size Variance

Budgeted Market Share %( Actual Industry Sales in Units - Budgeted Industry

Sales in Units) x Budgeted Contribution Margin / Unit

0.12(60000-6000/0.12)*50

0.12(10000)*.50

1200*50

6000( F)

2 Market Share Variance

(Actual Market Share% - Budgeted Market Share %) X(Actual Industry Sales in

Units) x Budgetted Contribution / Unit

(.10666-0.12 x 60000*50

6400-7200*50

40000 (A)

3

Gross Margin Sales Volume

Variance (Actual Qty - Budgeted Qty)x Budgeted Margin / Unit

(6400-6000)*50

20000 (F)

4 Gross Margin Sales Price Variance (Actual Margin Per Unit - Budgeted Margin Per Unit) x Actual Units Sold

(65-50)*6400

96000 (F)

5 Direct Material Usage Variance ( Standard Quantity - Actual Quantity) x Standard Price / Kg

(32000-36000) x 8

32000 (A)

Direct Material Price Variance ( Standard Price/ Kg- Actual Price / Kg ) x Actual Qty of Material Used

(8-7.50) x36000

18000 ( F) Exercis

e



Exercis

e

6 Direct Labour Efficiency Variance

(64000-65000) x6

6000 ( A )

Direct Labour rate Variance ( Standard rate / Hr - Actual Rate / Hr) x Actual Hrs

(6-6.40)*65000

26000 ( A )

7 Variable Overhead Efficiency Variance

(Standard Hours for Actual Output- Actual Hrs ) x Standard Overhead

Rate / Hr

(64000- 65000) x10

10000 (A)

Variable Overhead Expense Variance Budgeted Overhead - Actual Overhead

650000-648000

Rs 2000 F

Favourable Adverse Rs

Budgeted Contribution 300000

Gross Margin Sales Volume Variance 20000 (F)

gross Margin Sales Price Variance 96000 (F) 116000

416000

Cost Variance

Material Usage 32000

Material Price 18000

Labour Efficiency 6000

Labour Rate 26000

Variable Overhead Efficiency 10000

variable Overhead Expense 2000

Total 20000 740000 54000

Actual Contribution 362000



Exercis

e

5 Working Note

Standard Data for Actual Output Actual Data for Actual Output

1 Material Qty Price Amount Qty Price Amount

32000 8 256000 36000 7.5 270000

2 Labour 64000 6 384000 65000 6.4 416000

Standard/ Budgeted Data Actual Data

3 Budgeted Variable O/H for Actual Hrs 650000 650000

Actual

Variable

O/H 648000

Standard Variable Overhead Rate/hr 10

Actual

Units 6400

Standard Variable Overhead Rate/Unit 100 Actual Hrs 65000

4 Sales Data Budgeted Data Actual Data

Units Margin Amount Units Margin Amount

6000 50 300000 6400 65 416000

116000

F

250-200 265-200



Budgetary Control

• Objectives

• Activities

• Plan

• Performance Evaluation

• Control Action

Objectives

• Definition of Goals

• Defining Responsibility

• Basis for Performance Evaluation.

• Optimum use of Resource

• Co-ordination

• Planned Action

• Basis of Policy

Merits & Demerits

• Merits :

• Cost Control

• Policy Formulation

• Performance Evaluation

• Standard Costing & Variance

Analysis

• Efficiency Monitoring

• Demerits :

• Estimates

• Rigidity

• False Sense of Security

• Lack of Coordination

• Time & Cost

Budgetary Control

1. What is it : Financial / Quantitative. Statement prepared & approved prior to a defined period of time of the policy to be

pursued during that period for the purpose of attaining a given objective.


Steps in preparation of Budget

• Definition of Objectives

• Identification of key

factors

• Budget Committee &

Controller

• Budget Manual

• Budget Period

• Standard of activity of

output

Role of CMA

• Functional Budget

Preparation

• Communication to

responsibility center

• Coordination

• Follow-up

• Budget Committee

Review

• Board Review

Classification of

Budgets Based on

• Time Period -

• Long Term Budget

• Short Term Budget

• Condition -

• Basic Budget

• Current Budget

• Capacity -

• Fixed Budget

• Flexible Budget

• Coverage -

• Functional

• Master Budget

Functional Budgets

• Physical Budgets

• Cost Budgets

• Profit Budgets

• Financial Budgets

Budgetary Control


Budgetary Control

Budget Process/Calculations

Sales Budget

In Quantity & in Value

Production Budget (in

Qty)

Sales Qty + Closing FG –Opening FG

Raw Material Consumption /usage Budget

a) Raw Material Usage Qty= Budget Production of FG xRM Usage / ut of FG

b) Cost of RM Consumed = RM Usage Qty x RM Purchase Cost / unit

Raw Material Purchase Budget

a) Raw Material

Purchase Qty=

RM Usage Qty + Closing stock of raw materail –Opening stock of raw material.

b) Cost of Raw Material Purchase = RM purchased quantity x price of raw material per unit

Labor Cost Budget

a) DLH requirement= Budgeted production of FG x DLH required pu of FG.

b) Direct Labor Cost= DLH required x Labor rate per hour

c) Manpower Required = Total DLH required/ Effective hrs per worker

Overhead Budget

a) Fixed Budget lists fixed OH, Variable OH & semi-variable OH at one level of activity.

b) Flexible Budget lists fixed OH, Variable OH & Semi Variable OH at variable levels of activity.


Budgetary Control

Ratio

1. Budgeted Capacity Usage Ratio

2. Actual Capacity UsuageRatio

3. Efficiency Ratio

4. Calendar Ratio

5. Volume/ Activity Ratio

Tim

e B

ased F

orm

ula

1.Budgeted Hrs/Prcaticalplant capacity in hrs.

2. Actual Hrs/Budgeted Hrs

3. Standard hrs/Actual hrs

4. Actual Days/ Budgeted Days

5. Standard hrs/ Budgeted hrs

Ou

tpu

t B

ase

d F

orm

ula

1.Budgeted Output/PraticalPlant capacity (in output)

2. Actual output/Standard output

3. Actual output/ Standard Output

4. Possible output/Budgeted Output

5. Actual Output/ Budgeted Output

Budget Ratios


Zero Based Budgeting – Starting from Scratch

Meaning

• Expenditure Control

Device where each

divisional head has to

justify the requirement of

funds for each head of

expenditure and prepare

the budget accordingly

without reference to the

past budget or

achievement

Features

• 1. Wholistic

2. Analytical

3. Priority

Based

4. Review

Based

5. Rational

Steps

• 1. Objectives

2. Coverage

3. Decision

Areas

4. Ranking

5. Budgeting

Merits

1. Priority Allocation

2. Maximum Efficiency

3. Cost Benefit Analysis

4. Goal Congruence

5. Management By Objective

Demerits

1. Lack of coordination

2. Old is gold attitude

3. Time Consuming


Pareto Analysis Tool

Helps to focus on most important aspects of decision making- To simplify the process of decision

making.

First observed by Mr. Vilfredo Pareto, an Italian Economist.

Can use 80-20 relationship to direct its attention to key control mechanism aspects.

Helps to establish priorities & to identify both profitable & unprofitable target.

Application :

Product Pricing : 80% of total sales; Revenue earned from 20% of firm’s profit.

Customer Profitability Analysis : 20% of customers generate 80% of profit.

ABC Analysis- Inventory Control : 80% of material value ; constitute 20% of quantity.

Activity Base Costing : 20% of firm's cost drivers responsible for 80% of total cost.

Quality Control : 80% of reported quality problems are traceable to 20% of underlying causes.


Target Costing

Focus on further possibilities of cost reduction & maintaining the quality of product i.e. Continuous Improvement Program

Achieve Cost Reduction & Target Profit by Effective Implementation of cost reduction decisions.

Analyze Cost Reduction Target into various components & identify cost reduction opportunities using VE & VA ( for direct costs) & ABC ( for indirect costs).

Set Cost Reduction Target in order to reduce Current Cost to Target Cost.

Determine Current cost of producing the new product.

Set target cost per unit for each product= target selling price < target profit margin.

Establish target profit margin for each product.

Set target production & sales volume.

Set target selling price = customer’s willingness to pay.

Identify Market requirements & product qualities/attributes.

Steps in Target Costing :


Target Costing

Value Engineering(VE) : Searching for opportunities to modify design of each component or part of the

product to reduce cost but without reducing the functionality or quality of the product.

Value Analysis(VA) : Studying the activities involved in producing the product to detect NVA activities that

may be eliminated or minimized to save costs, but without reducing functionality or quality of the product.

Issues analyzed in VA & VE :

1. Elimination of unnecessary functions from the production process.

2. Elimination of unnecessary product qualities.

3. Design Minimizations.

4. Better product design to suit manufacturing process

5. Substitution of parts (component part analysis)

6. Combination of steps (process centering)

7. Search for better way of doing things

Cost Reduction Aspects

1. Production Planning 6. Quality Control

2. Accident Prevention 7. Better Product Design

3. Material Handling &

movement

8. Job Evaluation & Merit

Rating

4. Plant Layout 9. Operations Research

Techniques

5. Plant Automation 10. SIMO Charts

VA Costing:

o If eliminated, this would reduce the

value or utility customers obtain from

using the product or service.

NVA Costing :

o If eliminated, this would not reduce

the value or utility customers obtain

from using the product or service.


Target Costing

Merits Demerits

Merits & Demerits of Target Costing : Merits:

o Real Cost Reduction- Uses management control

system to support and reinforce manufacturing

strategies and to identify market opportunities to

convert it into real savings for better value rather than

lowest cost principles.

o Market Driven Management- For designing and

manufacturing products that meet the price required

for market success.

o Innovation – Top to bottom commitment to process

and product innovation for resolving issues.

o Competitive Advantage – Long run advantage due to

realistic cost reduction targets.

Demerits:

o Time Factor – Development process takes up long

time. Due to designing factor for reduction in cost.

o Responsibility for Cost Reduction - Strong

interpersonal and negotiation skills are required on the

part of project manager for ensuring proper sharing of

benefits of department.

o Coordination – Lot of coordination required.


Target Costing

Kaizen Costing :

o Ongoing continuous improvement program.

o Focuses on waste reduction in production.

o Lowers costs below initial targets in design phase.

o Small but cost reductions during implementation stage on account of worker’s involvement.

Cost Reduction in works services:

o Keeping records of consumption & fuel.

o Study of influence of power factor & maximum demand on electricity charges.

o Boiler House Instrumentation.

o Preventive Maintenance plans to avoid breakdown.

o Maintenance cost bill vis a vis plant replacement cost.

o Quality control techniques

o Study & review of clerical procedures & systems.

Phase I II III IV

Sales

Volume

Low Rise at increasing

rates.

Rise at

decreasing rates.

Constant & then

start decreasing.

Prices of

Products

High Levels Retention of high

level prices

Prices fall closer

to cost

Gap between

price and cost is

reduced.

% of Sales

overhead to

sales

Highest Total expenses

remain same,

while ratio of S&D

OH to sales is

reduced.

Ratio reaches a

normal % of

sales, which

becomes industry

standard.

Reduced sales

promotional

efforts.

Competition Negligible &

insignificant

Entry of large no.

of competitors.

Fierce

Competition

Starts

disappearing

Profits Nil- heavy initial

costs

Increase at a rapid

pace.

Normal rate of

profits

Declining Profits


Life Cycle Costing

Introduction Growth Maturity Decline


Product Life Cycle- Features

• Finite Lives

• Follow predictable courses

• Profit p.u varies for each product

• Different opportunities and threats

• Functional emphasis in each

phase

• Extend life of the product

Product Life Cycle- Stages

• Market Research

• Specification

• Design

• Prototype Manufacture

• Development

• Tooling

• Manufacture

• Selling

• Distribution

• Product Support

• Decommissioning or replacement

Product Life Importance

• Time based Analysis

• Overall Cost Analysis –

Production as well as Non –

Production Costs

• Pre-production Cost Analysis

• Effective Pricing Decisions

• Better Decision Making –

Accurate & Realistic Estimates of

Costs & Revenue

• Long Run Wholistic View

• Life Cycle Budgeting- cost

reduction at Design Stage ittself.

• Review of all Phases

Life Cycle Costing


How Activities are classified?

• Line Activities –

• a) Material Handling

b) Conversion

• c) Order Processing & Distribution

• d) Installation, Repair & Service

• e) Communication Pricing &

Channel Management

• Support Activities -

• a) Procurement

b) Technology Department

• c) HR & Administration.

Differential Advantage

• Occurs when customers perceive

a Firm’s product is of a higher

quality

• Involves less risk , and / or

outperforms competing products.

• How – Timely delivery / bettter

quality /after sales support/ wide

range of items.

• Exploited by Firm –

• By increasing prices till it offsets

improvement in customer

benefits

• Pricing below the full premium

level to build market share.

Low Cost Advantage

• Firms enjoys a relative low cost

advantage if its total costs are

lower than mkt.

• How- Access to low cost raw

material / Innovative Process

Technology/ Low cost access to

distribution channel / economies

of scale.

• Exploited by Firm

• Pricing the Product lower than

Competitor to gain market share./

maintain

• current profit

• Matching the Competitors price

and increasing profitability .

Value Chain Analysis (VCA)

What is it : Value Chain for any firm is the value – creating activities all the way from Basic Raw Material sources ,from

component suppliers through to the ultimate end – use product delivered into the final consumers hand .



Steps in VCA

• Internal Cost Analysis

• Differential Cost Analysis

• Vertical Linkage Analysis

Internal Cost Analysis

• Identify Firms Value – Creating

Process { VCP)

• Evaluate portion of Total Cost of

Product / Service to above each

process.

• Identify their Cost Drivers .i,e. of

each Process.

• Identify the Links between

processes.

• Evaluate the Opportunities for

achieving Relative Cost

Advantage

Vertical Linkage Analysis

• Identify the Industry’s Value Chain

& Assign Costs ,revenues asset to

VCP

• Diagnose the Cost Drivers for

each VCP.

• Evaluate the Opportunities for

achieving Relative Cost

Advantage.



Core Competencies Analysis

• Created by Superior Integration of

Technology , Material & HR

resource.

• Represent Special Skills ,

Intellectual Assets

• Cultural Capabilities – Ability to

manage Change..

• Organization is looked upon as a

Bundle of Few Core

Competencies

• supported by several Individual

skills.

• Core Competencies based

diversification reduces Risks

&Investments and helps in

transferring Learning and Best

Practices across Business Units.

How Core Competencies Identified.

3 Tests

• Leverage Test –Does it provide

potential access to wide variety of

markets.

• Value Enhancement Test – Does

it make significant contribution to

perceived customer the benefits

of the end product.

• Imitability Test – Can it be imitated

. Does it reduce the threat of

Imitation.

Role of CMA

• Need for Awareness , Education &

Training.

• Creativity .

• Cooperation.

• Exploring for Information

• System Design.


Just In Time

JIT-

Time Management Philosophy to utilize key factor time in an effective

and efficient manner.

Classify significant activities of firm in VA & NVA

Simplify VA to improve productivity.

Eliminate NVA

Cost reduction by eliminating time related & NVA related activity-cost

JIT in FG

• Standardization of FG

• Identification of sales & production capacities.

• Finalization of despatchschedule

• Simplification of process cycle.

• Finalization of production schedule.

• JIT stores Requisition

JIT in Raw Material

•Standardization of RM & Components.

•Make or Buy decisions.

•Standardization of supplier list

•Streamlining of purchase process

•Firm Contracts

•Supplier Assistance

•Supplier Information System.

•Reviewing Logistics

•JIT Ordering

•Direct Delivery

JIT in WIP

•Affects Cost

•a) Piling up WIP

•b) Delayed tracking of defectives

•Solution:

•Kanban Card: Notification card from downstream to upstream machine authorizing of just enough components to fullfill the production requirements.

•Working Cells : Small cluster of machines which can be run by single machine operator.


Just In Time

Objectives

1. Waste Reduction 4. Zero Inventory 7. Economical Batch Sizes

2. Time Reduction 5. Zero Defects 8. Product Quality

3. Elimination of NVA 6. Zero Break-downs 9. Timely deliver to customer

Back flushing : Sequential Tracking Method for accounting cost omits recording of some or all of the

journal entries relating to the cycle from purchase of Direct Materials to the sale of Finished Goods.

Requires no data entry on any kind until a finished product is completed.

At that time the total amount of finished product is entered into the computer system which is multiplied by

all components as per the bill of materials (BOM) for each item produced.

This yields the lengthy list of components that should have been used in production process which is

subtracted from the opening stock to arrive at the closing stock inventory.

Issues :

1. Accurate Production reporting : Quantity reported should be very correct.

2. Proper Scrap Reporting : All abnormal scraps must be diligently tracked and recorded.

3. Lot Tracing : Not Possible.

4. Inventory Accuracy : Inventory cannot be maintained on day-to-day basis.


Material Requirements Planning (MRP)

MRP Planning

• Computerized

Production Scheduling

System providing a

basis for production

decisions.

• Involves input (RM)

Planning based on

Output (FG) Budget.

Pre Requisites

• Production Schedule

• Standard Material Input

• Workers Cooperation

• Accuracy of Data

Benefits of MRP

• Determine quantity & timing of FG production.

• Ascertain quantity of raw materials, sub-assemblies & components required.

• Compute inventories, WIP, batch sizes & manufacturing & packaging lead times.

• Control Inventory by ordering bought in-components & raw materials.

• Forecast Inventory position period-by-period.

• Serve as inventory information systems.

• Generate purchase requisition notes & purchase orders.

Requirements of MRP Operation

• Master Production

Schedule.

• Bill of Materials

• Inventory File/ Store

Ledger

• Routing File

• Master Parts File


Enterprise Resource Planning (ERP)

Need for ERP

• Complete automation &

faster services

• Standardized Processes

• Integrated Financial

Data

• Standardized HR

Information

• Tailor made

• Information

Management

ERP Components

• Sales & Marketing

• Master Production

Scheduling

• Material Requirement

Planning

• Bill of Materials

• Capacity Requirement

Planning

• Purchasing

• Shop Floor Control

• Logistics

• Accounts Payable/

Receivable

• Asset Management

• Financial Accounting

Features of ERP

• Integrated

• Customer Service

• Information Sharing

• Project Management

• E-Com Facilities

• Futuristic

• Business Decision

Making Solutions

Benefits of ERP

• Product Costing

• Cost Monitoring &

Control

• Planning & Managing

• Information Flow

• Efficient Database

Management

• Inventory Management

• Customer Satisfaction

• Competitive Edge


Good cost management practice is goes wrong because of crucial mismatch in how information was presented Vs how it should have been presented.

Managing the Management

Five (5) types of Senior Management Peoples

Followers ( 36 % )

who make decisions based on the how other highly successful

people have made decisions in

the past.

Charismatics(25%)

who get enthusiastic about new ideas but rely on others to think

through all details.

Skeptics ( 19%) who automatically distrust anything

they hear, especially if it

confilcts with their view of the world.

Thinkers ( 11%) who need to

methodically work through all the

advantages and disadvantages

before making a decision.

Controllers ( 9%) who have to be hands-on and

involved in every aspect of the

decision making process.


“Followers” : who make decisions based on the how other highly successful people have made decisions in the past

Dealing with Followers

Lay proper foundation

Supply enough proof that proposal has worked in comparable situation in past and prove it is a good deal.


“Charismatic” : who get enthusiastic about new ideas but reply on others to think through all details.

Dealing with Charismatic

Provide them balance detailed information

Influence the delegated person on the matter

Be in touch with the delegated person.


“Skeptics” :who automatically distrust anything they hear, especially if it conflicts with their view of the world.

Dealing with skeptics

Provide a good proposal .

Build your confidence in them as source of good ideas.


“Thinkers” : who need to methodically work through all the advantages and disadvantages before making a decision

Dealing with Thinkers

Provide them with full details

Discuss the pros and cons of your proposal with other conceivable alternatives


“Controllers” : who have to be hands-on and involved in every aspect of the decision making process.

Dealing with Controllers

Beware as they make lead to frustration

You should make them in-charge

Bring the controller’s allies on your side.


If all of them are together then how do you handle it

1. Start with road map of your ideas – appeals to “Thinkers”

2. Establish your creditability – appeals to “Skeptics” and “Followers”.

3. Launch into ideas quickly – to get to “Charismatic”.

4. Be logical and methodical- appealing to “Thinkers”

5. There’s not much you can do to get to “Controllers”.

Dealing with “ All of them”


Need of the Hour is a

“VUCA” Professional Who will be the

“PUCCA” Professional

To handle

Volatility of Data

Uncertainty of Data

Complexity of Data

Ambiguity of Data

Current Complex Corporate World


A Big Thank You

Date post:	10-Jun-2018
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