industrial managment

Lecture notes for Industrial Management-Module 1

Industrial Management-S7 EC Page 1

COLLEGE OF ENGINEERING & MANAGEMENT, PUNNAPRA

Industrial Management 08-701

For Seventh Semester Electronics & Communication Engineering

Lecture Notes

Ramnath.P, Asst Professor ,Dept of Mech Engg,CEMP

Syllabus VII Semester

08.701 Industrial Management (TA)

L-T-P : 2-1-0 Credits: 3

Module I

• Evolution of Scientific Management and industrial Engineering.

• Functions of Management- Brief description of each function.

• System concept.

• Types of organization structures - Types of companies and their formation.

• Personal Management – Objectives and functions – Recruitment, Selection, Training and

Induction concepts and Techniques.

• Cost concept - Break even analysis (simple problems).

• Depreciation - Methods of calculating depreciation.

• Introduction to reliability. Reliability of electronic components

Notes

Definition of Management:

Management is the art, or science, of achieving goals through people. MANAGERS also supervise i.e.

make sure people do what they are supposed to do. Managers are, therefore, expected to ensure

greater productivity.

More broadly, management is the process of designing and maintaining an environment in which

individuals, working together in groups, efficiently accomplish selected aims.

Functions of Management –

Planning, Organizing, Staffing, Direction, Co-ordination, Co-operation, Control,

Planning:

Planning involves selecting missions and objectives and the actions to achieve them. It requires

decision-making – i.e., choosing future courses of action from among alternatives. Before a decision

is made, all that exists is planning study, analysis, or a proposal; there is no real plan.

Organizing:



People working together in groups to achieve some goal must have roles to play. Generally, these

roles have to be defined and structured by someone who wants to make sure that people

contribute in a specific way to group effort. Organizing, therefore, is that part of management that

involves establishing an intentional structure of roles for people to fill in an organization. Goals are

assigned and assigned to people who can do those best. Indeed, the purpose of an organizational

structure is to help in creating an environment for human performance.

Staffing:

Staffing involves filling, and keeping filled, the positions in the organization structure. This is done by

identifying work-force requirements; inventorying the people available; and recruiting, selecting,

placing, promoting, appraising, planning the careers of, compensating, and training or otherwise

developing both candidates and current jobholders to accomplish their tasks effectively and

efficiently.

Leading/Directing:

Leading is the influencing of people so that they will contribute to organization and group goals; it

has to do predominantly with the interpersonal aspect of managing. Most important problems to

managers arise from people – their desires and attitudes, their behavior as individuals and in groups.

Hence, effective managers need to be effective leaders. Leading involves motivation, leadership

styles and approaches and communication.

Controlling:

Controlling, for example, budget for expense, is the measuring and correcting of activities of

subordinates to ensure that events conform to plans. It measures performance against goals and

plans, shows where negative deviations exist, and by putting in motion actions to correct deviations,

helps ensure accomplishment of plans.

Coordination:

Finally, coordination is the essence of manager-ship for achieving harmony among individual efforts

toward the accomplishment of group goals. A manager who achieves such an aim is said to be a

strategic manager. The second goal or aim of all managers is that they must be productive.

Productivity improvement is about effectively performing the basic managerial and non-managerial

activities. Simply defined, Productivity is about the output-input ratio within a time period with due

consideration for equality.

Main areas for management:

1) Problem solving:

Management is about solving problems that keep emerging all the time in the course of an

organization struggling to achieve its goals and objectives. Problem solving should be accompanied

by problem identification, analysis and the implementation of remedies to managerial problems.

2) Administration:

Administration involves following laid down procedures for the execution, control, communication,

delegation and crisis management.

3) Human resource management:



Human resource management should be based on strategic integration of human resource,

assessment of workers, and exchange of ideas between shareholders and workers.

4) Organizational leadership:

Organizational leadership should be developed along lines of interpersonal relationship, teamwork,

self-motivation to perform, emotional strength and maturity to handle situations, personal integrity,

and general management skills.

System concept – types of systems, Definition of MIS, Characteristics of MIS,

Components of IS, Decision making,

Systems approach to problem solving

Definition

A system is commonly defined as a group of interacting units or elements that have a common

purpose.

The units or elements of a system can be cogs, wires, people, computers, and so on.

Systems are generally classified as open systems and closed systems and they can take the form of

mechanical, biological, or social systems.

Open and Closed Systems

Open systems refer to systems that interact with other systems or the outside environment,

whereas closed systems refer to systems having relatively little interaction with other systems or the

outside environment.

For example, living organisms are considered open systems because they take in substances from

their environment such as food and air and return other substances to their environment. Humans,

for example, inhale oxygen out of the environment and exhale carbon dioxide into the environment.

Similarly, some organizations consume raw materials in the production of products and emit finished

goods and pollution as a result. In contrast, a watch is an example of a closed system in that it is a

relatively self-contained, self-maintaining unit that has little interacts or exchange with its

environment.

All systems have boundaries, a fact that is immediately apparent in mechanical systems such as the

watch, but much less apparent in social systems such as organizations. The boundaries of open

systems, because they interact with other systems or environments, are more flexible than those of

closed systems, which are rigid and largely impenetrable. A closed-system perspective views

organizations as relatively independent of environmental influences. The closed-system approach

conceives of the organization as a system of management, technology, personnel, equipment, and

materials, but tends to exclude competitors, suppliers, distributors, and governmental regulators.

This approach allows managers and organizational theorists to analyse problems by examining the

internal structure of a business with little consideration of the external environment.

Subsytems

The open-system approach serves as a model of business activity; that is, business as a process of

transforming inputs to outputs while realizing that inputs are taken from the external environment

and outputs are placed into this same environment. Companies use inputs such as labour, funds,

equipment, and materials to produce goods or to provide services and they design their subsystems



to attain these goals. These subsystems are thus analogous to cells in the body, the organization

itself is analogous to the body, and external market and regulatory conditions are analogous to

environmental factors such as the quality of housing, drinking water, air and availability of

nourishment.

The production subsystem, for example, focuses on converting inputs into marketable outputs and

often constitutes a primary purpose of a company. The boundary subsystem's goal is to obtain

inputs or resources, such as employees, materials, equipment, and so forth, from the environment

outside of the company, which are necessary for the production subsystem. This subsystem also is

responsible for providing an organization with information about the environment. This adaptive

subsystem collects and processes information about a company's operations with the goal of aiding

the company's adaptation to external conditions in its environment. Another subsystem,

management, supervises and coordinates the other subsystems to ensure that each subsystem

functions efficiently. The management subsystem must resolve conflicts, solve problems, allocate

resources, and so on.

System and its environment

To simplify the process of evaluating environmental influences, some organizational theorists use

the term "task environment" to refer to aspects of the environment that are immediately relevant to

management decisions related to goal setting and goal realization. The task environment includes

customers, suppliers, competitors, employees, and regulatory bodies.

Furthermore, in contrast to closed-systems, the open-system perspective does not assume that the

environment is static. Instead, change is the rule rather than the exception. Consequently,

investigation of environmental stability and propensity to change is a key task of a company, making

the activities of an organization contingent on various environmental forces.

As an open system, an organization maintains its stability through feedback, which refers to

information about outputs that a system obtains as an input from its task environment. The

feedback can be positive or negative and can lead to changes in the way an organization transforms

inputs to outputs. The difference between closed-systems and open-systems, then, is in the

complexity of environmental interactions. Closed-systems assume relatively little complexity; a

thermostat is a simple device dependent mainly on temperature fluctuations.

Different Types of Management Information Systems

Management information systems are those systems that allow managers to make decisions for the

successful operation of businesses. Management information systems consist of computer

resources, people, and procedures used in the modern business enterprise. The term MIS stands for

management information systems. MIS also refers to the organization that develops and maintains

most or all of the computer systems in the enterprise so that managers can make decisions. The goal

of the MIS organization is to deliver information systems to the various levels of corporate

managers. MIS professionals create and support the computer system throughout the company.

Trained and educated to work with corporate computer systems, these professionals are responsible

in some way for nearly all of the computers, from the largest mainframe to the desktop and portable

PCs.

Management information systems can be used as a support to managers to provide a competitive

advantage. The system must support the goals of the organization.

Most organizations are structured along functional lines, and the typical systems are identified as

follows:



Accounting management information systems:

All accounting reports are shared by all levels of accounting managers.

Financial management information systems:

The financial management information system provides financial information to all financial

managers within an organization including the chief financial officer. The chief financial officer

analyses historical and current financial activity, projects future financial needs, and monitors and

controls the use of funds over time using the information developed by the MIS department.

Manufacturing management information systems:

More than any functional area, operations have been impacted by great advances in technology. As

a result, manufacturing operations have changed. For instance, inventories are provided just in time

so that great amounts of money are not spent for warehousing huge inventories. In some instances,

raw materials are even processed on railroad cars waiting to be sent directly to the factory. Thus

there is no need for warehousing.

Marketing management information systems:

A marketing management information system supports managerial activity in the area of product

development, distribution, pricing decisions, promotional effectiveness, and sales forecasting. More

than any other functional area, marketing systems rely on external sources of data. These sources

include competition and customers, for example.

Human resources management information systems:

Human resources management information systems are concerned with activities related to

workers, managers, and other individuals employed by the organization. Because the personnel

function relates to all other areas in business, the human resources management information

system plays a valuable role in ensuring organizational success. Activities performed by the human

resources management information systems include, work-force analysis and planning, hiring,

training, and job assignments.

Relationship of MIS with other discipline

Definition: Management Information Systems (MIS) is the term given to the discipline focused on

the integration of computer systems with the aims and objectives on an organisation. The

development and management of information technology tools assists executives and the general

workforce in performing any tasks related to the processing of information. MIS and business

systems are especially useful in the collation of business data and the production of reports to be

used as tools for decision making.

Applications of MIS

With computers being as ubiquitous as they are today, there's hardly any large business that does

not rely extensively on their IT systems.

However, there are several specific fields in which MIS has become invaluable.

* Strategy Support

While computers cannot create business strategies by themselves they can assist management in

understanding the effects of their strategies, and help enable effective decision-making. MIS systems



can be used to transform data into information useful for decision making. Computers can provide

financial statements and performance reports to assist in the planning, monitoring and

implementation of strategy. MIS systems provide a valuable function in that they can collate into

coherent reports unmanageable volumes of data that would otherwise be broadly useless to

decision makers. By studying these reports decision-makers can identify patterns and trends that

would have remained unseen if the raw data were consulted manually.

MIS systems can also use these raw data to run simulations – hypothetical scenarios that answer a

range of ‘what if’ questions regarding alterations in strategy. For instance, MIS systems can provide

predictions about the effect on sales that an alteration in price would have on a product. These

Decision Support Systems (DSS) enable more informed decision making within an enterprise than

would be possible without MIS systems.

* Data Processing

Not only do MIS systems allow for the collation of vast amounts of business data, but they also

provide a valuable time saving benefit to the workforce. Where in the past business information had

to be manually processed for filing and analysis it can now be entered quickly and easily onto a

computer by a data processor, allowing for faster decision making and quicker reflexes for the

enterprise as a whole.

Management by Objectives

While MIS systems are extremely useful in generating statistical reports and data analysis they can

also be of use as a Management by Objectives (MBO) tool.

MBO is a management process by which managers and subordinates agree upon a series of

objectives for the subordinate to attempt to achieve within a set time frame. Objectives are set

using the SMART ratio: that is, objectives should be Specific, Measurable, Agreed, Realistic and Time-

Specific.

The aim of these objectives is to provide a set of key performance indicators by which an enterprise

can judge the performance of an employee or project. The success of any MBO objective depends

upon the continuous tracking of progress.

In tracking this performance it can be extremely useful to make use of an MIS system. Since all

SMART objectives are by definition measurable they can be tracked through the generation of

management reports to be analysed by decision-makers.

Benefits of MIS

The field of MIS can deliver a great many benefits to enterprises in every industry. Expert

organisations such as the Institute of MIS along with peer reviewed journals such as MIS Quarterly

continue to find and report new ways to use MIS to achieve business objectives.

Core Competencies

Every market leading enterprise will have at least one core competency – that is, a function they

perform better than their competition. By building an exceptional management information system

into the enterprise it is possible to push out ahead of the competition. MIS systems provide the tools

necessary to gain a better understanding of the market as well as a better understanding of the

enterprise itself.

Enhance Supply Chain Management



Improved reporting of business processes leads inevitably to a more streamlined production

process. With better information on the production process comes the ability to improve the

management of the supply chain, including everything from the sourcing of materials to the

manufacturing and distribution of the finished product.

Quick Reflexes

As a corollary to improved supply chain management comes an improved ability to react to changes

in the market. Better MIS systems enable an enterprise to react more quickly to their environment,

enabling them to push out ahead of the competition and produce a better service and a larger piece

of the pie.

Types of Companies in India

Indian company law classifies companies but as laypersons, many of us are not aware of this.

Typically, a company is a group of individuals who come together for a common purpose, mainly

profit making and revenue sharing. The working of a business entity in India is governed by the

Companies Act, 1956. There are various types of business entities defined by the Indian legal system,

such as corporations, sole traders, cooperatives and partnerships.

A company can be classified as:

1. Incorporated company

2. Unincorporated company

The Companies Act: Incorporated Companies

All the companies registered under the Companies Act, 1956, carry out their business activities as

incorporated companies.

These can be further classified as:

1. Public companies limited by shares.

2. Public companies limited by guarantee.

3. Public unlimited companies.

4. Private companies limited by shares.

5. Private companies limited by guarantee.

6. Private unlimited companies.

7. Foreign companies.

8. Government companies.

The Companies Act: Unincorporated Companies

Unincorporated companies are formed with intention of establishing large partnerships. The liability

of the members is unlimited. This type of company persists even after the death or insolvency of any

member. The number of members is restricted up to 10 for the banking sector and up to 20 for

other industries.

The Companies Act: Basis of Classification

Companies can be classified based on the following:

On the basis of Incorporation:



1. Statutory Companies: These companies are formed by particular act of government.

Example: Reserved bank of India.

2. Registered Companies: These are companies which are registered under the Companies Act,

1956.

On the basis of liability:

1. Companies with limited liability: These can be subdivided as companies limited by shares

and companies limited by guarantee.

2. Companies with unlimited liability: In such companies, every member is accountable for

debt of the company.

On the basis of number of members:

1. A private company

2. A public company

Private Limited Company

A private company is a company which has the following characteristics:

1. Shareholders’ right to transfer shares is restricted;

2. The number of shareholders is limited to fifty; and

3. An invitation to the public to subscribe to any shares or debentures is prohibited.

A Private Limited Company is the most popular form of business entity used for Foreign Investors in

India, including USA investors in India. It takes some time to incorporate in India as there are various

steps required in forming a private limited company in India. There are various steps required to

establish a business in India, before and after incorporation, as mentioned hereinafter.

Public Limited Company

Limited Liability Partnership

A law to allow "Limited Liability Partnership" (LLP) in India has been enacted by the Parliament of

India recently. (Limited Liability Partnership (LLP) Act of 2008)

LLP is an alternative corporate business entity that provides the benefits of limited liability of a

company but allows its members the flexibility of organizing their internal management on the basis

of a mutually-arrived agreement, as is the case in a partnership firm.

This format would be quite useful for small and medium enterprises in general and for the

enterprises in services sector in particular, including professionals and knowledge based enterprises.

A public company is defined as a company which is not a private company. The following conditions

apply only to a public company:

1. It must have at least seven shareholders.

2. A public company is not authorized to start business upon the grant of the certificate of

incorporation. In order to be eligible to commence business as a corporation, it must obtain

another document called "trading certificate".

3. It must publish a prospectus or file a statement in lieu of a prospectus before it can start

transacting business.



4. A public company is required to have at least three directors.

5. It must hold statutory meetings and obtain government approval for the appointment of the

management.

There are several other provisions contained in the Companies Act 1956 which are applicable only to

public companies and should be consulted.

Procedures for Incorporation and Registration of Companies

A company is a voluntary association of persons formed for the purpose of business activities. A

company has distinct name and limited liability, it is a juristic person having a separate legal entity

different from its members who constitute it, capable of rights and duties of its own and endowed

with a potential or perpetual succession. The Companies Act, 1956 prescribes specific procedures for

incorporation and registration of companies. A company can be formed either by:—

(i) incorporation of a new company; or

(ii) conversion of existing business (sole proprietorship concern or partnership firm or co-operative

societies) into company under the provisions of Chapter IX and Chapter IXA of the Companies Act,

1956; or

(iii) companies incorporated under section 25 of the Companies Act, 1956.

The incorporation (birth) and winding up and dissolution (death) of a company are governed by the

provisions of the Companies Act, 1956. Therefore each company is subject to the provisions of the

Companies Act, 1956, as may be amended from time to time. The following procedure involves for

incorporation of a company.

STEP WISE FORMALITIES FOR FORMATION OF A NEW COMPANY

Persons desirous of forming a company must adhere to the step by step procedure as discussed

below:—

I. Selection of type of the company.

II. Selection of name for the proposed company.

III. Apply for Directors Identification Number and Digital Signatures, if does not have

IV. Drafting of Memorandum and Articles of Association.

V. Stamping, digitally signing and e-filing of various documents with the Registrar.

VI. Payment of Fees.

VII. Obtaining Certificate of Incorporation.

VIII. Preparation and filing of Prospectus/Statement in lieu of Prospectus and e-Form 19/20 (in case

of public companies) for obtaining the certificate of commencement of business.

IX. Obtaining Certificate of Commencement of business (in case of public limited companies).

Selection of the type of company



The promoters of a company may be individuals or bodies corporate engaged in efforts to

incorporate a company. They have the power of defining the object of the company and deciding

various connected matters regarding incorporation. Proposed scale of operations, capital involved,

etc. depend upon the purposes for which the company is to be incorporated. The promoters are at

liberty to select type of the company viz. private company, public company, nonprofit making

company, etc. (See my previous Article “BASIC UNDERSTANDING ABOUT COMPANIES”)

Requirement for having DIN

As per proviso to section 253 of the Companies Act, 1956, inserted by the Companies (Amendment)

Act, 2006, w.e.f. 1-11-2006, no company shall appoint or re-appoint any individual as director of the

company unless he has been allotted a Director Identification Number under section 266B.

New section 266A has been inserted by the Companies (Amendment) Act, 2006 which provides that

every individual, intending to be appointed as director of a company shall make an application for

allotment of Director Identification Number (DIN) to the Central Government in the prescribed DIN

Form. Therefore, before submission of e-Form 1A all the directors of the proposed company must

ensure that they are having DIN and if they are not having DIN, it should be first obtained, however

on the basis of the provisional DIN allotted online will serve the purpose.

Specific care should be taken that a person cannot have more than one DIN, therefore, a DIN once

obtained shall serve the requirement for all the companies in which he is director or intended to be

a director.

Requirement for having digital signatures

After 16th

Sept., 2006, every documents prescribed under the Companies Act, 1956 is required to be

filed with the digital signature of the managing director or director or manager or secretary of the

Company, therefore, it is compulsorily required to obtain digital signatures of at least one director to

sign the e-Form 1A and other documents.

Selection of name

Six names are required to be selected in order of preference after taking notes of numerous

clarifications, circulars and rules made by the Ministry of Company Affairs (DCA), etc. In case key

word is required, significance of each key word should be given in the e-Form 1A.

APPLYING FOR ASCERTAINING THE AVAILABILITY OF THE SELECTED NAME

The promoters are required to make an application to the concerned Registrar of Companies be

submitted electronically to the Ministry of Company Affairs on the portal of MCA. An application

shall be in e-Form 1A as prescribed by Notification No. GSR 56(E) dated 10th Feb., 2006 duly digitally

signed by any one promoter or managing director or director or manager or secretary of the

company alongwith the required fee of Rs. 500 only for ascertaining whether the selected name is

available for adoption by the promoters of the proposed company.

APPROVAL OF THE NAME

After receipt of completed application in e-Form 1A, the Registrar shall intimate whether the

proposed name is available for adoption or not. The confirmation of the name made available by the

Registrar shall be valid for a period of six months from the date of letter issued in these regards. In

case, if the promoters fails to submit all the required documents for incorporation within that



period, then they are required to submit another application for revalidation of name with fresh

filing fee of Rs. 500 only.

Preparation of the Memorandum of Association (MOA) and Articles of Association (AOA)

Drafting of the MOA and AOA is generally a step subsequent to the availability of name made by the

Registrar. It should be noted that the main objects should match with the objects shown in e-Form

1A. These two documents are basically the charter and internal rules and regulations of the

company. Therefore, it must be drafted with utmost care and with the advise of the experts and the

other object clause should be drafted in a very broader sense.

Estimate of registration fees for a new company

The fees payable to the Registrar at the time of registration of a new company varies according to

the authorised capital of a company proposed to be registered as per Schedule X to the Act. Fees can

be calculated at the MCA portal using fees calculator.

Filing of documents with the Registrar

Next step for the promoters is to file the following documents with the Registrar for incorporation of

the company. The following documents shall be submitted to the Registrar alongwith the adequate

filing fees as applicable for registration of the company electronically on line basis within a period of

six months from the date of intimation of availability of name:—

(i) Memorandum of Association, duly signed by the subscribers and witnessed, showing the number

of shares against their names electronically attached in PDF file. It should also be properly stamped

as per the stamp duty applicable in the State, where the registered office of the company is to be

situated. Photographs of the subscribers shall also be attached. Simultaneously original stamped

copy of the Memorandum of Association shall be submitted (physical submissoin) with the Registrar

of Companies concerned.

(ii) Articles of Association should also be duly signed by the subscribers and witnessed, showing the

number of shares against their names electronically. It should also be properly stamped according to

the authorised share capital. Photographs of the subscribers shall also be attached. Simultaneously

original stamped copy of the Article of Association shall be submitted with the Registrar of

Companies concerned.

(iii) Copy of the agreement, if any, which the company proposes to enter into with any individual for

appointment as its managing or whole-time director or manager shall be attached in the PDF file.

(iv) Declaration in e-Form 1 by an advocate or company secretary or chartered accountant engaged

in whole time practice in India or by a person named in the Articles as a director, manager or

secretary of the company, that all the requirements of the Companies Act, 1956 and the rules made

thereunder have been complied with in respect of registration. [Refe Section 33(2)]

(v) Power of Attorney for should be furnished by all the subscribers in favour of any one subscriber

or any other person authorising him to file these documents and to with the Registrar and to obtain

certificate of incorporation. The power of attorney should be given on Non-Judicial stamp paper of

appropriate value and shall be submitted to the Registrar.



(vi) Other agreement if any, which has been stated in the Memorandum or Articles of Association

shall also be filed in the PDF file with the Registrar because in such cases the agreement will form

part of this basic document.

(vii) E-Form 18 is to be filed with the Registrar electronically with the digital signatures in regard to

location of the registered office. E-Form 18 shall also be certified by the company secretary or

chartered accountant or cost accountant in whole-time practice. [Section 146(2)]

(viii) E-Form 32 is required to be filed with the Registrar electronically for filing particulars of

directors. The personal details should match with the information provided in the DIN. Following

additional details are also required to given in e-Form 32:

E-Form 32 is required to be digitally signed by the director or managing director or manager or

secretary of the company. E-Form 32 shall be filed along with the adequate filing fee as prescribed

under Schedule XIII of the Companies Act, 1956.

SUBMISSION OF E-FORM 1

E-Form 1 has to be submitted with following enclosures:

(1) Memorandum of Association (MoA) and Article of Association (AoA) of the company [Not

required for a company licensed under section 25];

(2) Annexure containing details of subscribers (Optional);

(3) Power of Attorney/Authority letter given by the subscribers/promoters/directors to the

professional i.e. advocate or attorney or pleader or CS or CA (in whole-time practice) for formation

of a company.

(4) Copy of Memorandum of Association (MoA) and Article of Association (AoA) after stamping and

physically signed by all the subscribers should be delivered at the RoC office where company is to be

registered.

Further that an Affidavit on the stamp paper of adequate value that he had been explained the

contents of the Memorandum and Articles of Association and all other relevant documents for

incorporation of the company and he/she had put his/her signature after proper understanding of

the same and this affidavit should also be furnished with the Registrar along with all the documents

as described above.

Certificate of Incorporation (Sections 33 and 34)

On the satisfaction of the Registrar that the requirements specified in sections 33(1) and 33(2) have

been complied with by the company, he shall retain the documents and register the MOA, AOA and

other documents. Section 34(1) cast an obligation on the Registrar to issue a Certificate of

Incorporation, normally within 7 days of the receipt of documents. It is advisable to authorise some

person to collect the certificate personally from the ROC Office.

Commencement of Business

A Private limited company and a company not having share capital may commence its business

activities from the date of its incorporation. However, a Public Limited Company having share capital

is also required to obtain a separate certificate of commencement of business according to section

149(2A) of the Companies Act, 1956.



Personal Management – Objectives and functions – Recruitment,

Selection, Training and Induction

Personnel management can be defined as obtaining, using and maintaining a satisfied workforce. It

is a significant part of management concerned with employees at work and with their relationship

within the organization.

According to Flippo, “Personnel management is the planning, organizing, compensation, integration

and maintenance of people for the purpose of contributing to organizational, individual and societal

goals.”

According to Brech, “Personnel Management is that part which is primarily concerned with human

resource of organization.”

Following are the elements of Personnel Management:

• Organization- Organization is said to be the framework of many activities taking place in

view of goals available in a concern. An organization can be called as a physical framework of

various interrelated activities. Right from manpower planning to employees’ maintainance,

all activities take place within this framework. The nature of the organization is dependent

upon it’s goal. The business concern goal being profit- making. Clubs, hospitals, schools,etc.

their goal being service. The objective of consultancy being providing sound advice.

Therefore, it is organizational structure on which the achievement of goals of an enterprise

depends upon. In personnel management, a manager has therefore to understand the

importance of organizational structure.

• Job- The second element, i.e., jobs tell us the activities to be performed in the organization.

It is said that the goals of an enterprise can be achieved only through the functional

department in it. Therefore, seeing the size of organization today, the nature of activities are

changing. In addition to the three primary departments, personnel and research department

are new additions. Various types of jobs available are :

• Physical jobs

• Creative jobs

• Proficiency jobs

• Intellectual jobs

• Consultancy jobs

• Technical jobs

• People- The last and foremost element in personnel management is people. In a

organizational structure, where the main aim is to achieve the goals, the presence of

manpower becomes vital. Therefore, in order to achieve departmental goals, different kinds

of people with different skills are appointed. People form the most important element

because :

The organizational structure is meaningless without it.

• It helps to achieve the goals of the enterprise.

• It helps in manning the functional areas.

• It helps in achieving the functional departmental goals.

• They make a concern operational.



• They give life to a physical organization.

The different types of people which are generally required in a concern are :

• Physically fit people

• Creative people

• Intellectuals

• Technical people

• Proficient and skilled people

In personnel management, a personnel manager has to understand the relationship of the three

elements and their importance in organization. He has to understand basically three relationships:-

• Relationship between organization and job

• Relationship between job and people

• Relationship between people and organization.

Relationship between organization and job helps making a job effective and significant. Relationship

between job and people makes the job itself important. Relationship between people and

organization gives due importance to organizational structure and the role of people in it.

Nature of Personnel Management

1. Personnel management includes the function of employment, development and

compensation- These functions are performed primarily by the personnel management in

consultation with other departments.

2. Personnel management is an extension to general management. It is concerned with

promoting and stimulating competent work force to make their fullest contribution to the

concern.

3. Personnel management exist to advice and assist the line managers in personnel matters.

Therefore, personnel department is a staff department of an organization.

4. Personnel management lays emphasize on action rather than making lengthy schedules,

plans, work methods. The problems and grievances of people at work can be solved more

effectively through rationale personnel policies.

5. It is based on human orientation. It tries to help the workers to develop their potential fully

to the concern.

6. It also motivates the employees through it’s effective incentive plans so that the employees

provide fullest co-operation.

7. Personnel management deals with human resources of a concern. In context to human

resources, it manages both individual as well as blue- collar workers.

Role of Personnel Manager

1. Personnel manager is the head of personnel department. He performs both managerial and

operative functions of management. His role can be summarized as :

2. Personnel manager provides assistance to top management- The top management are the

people who decide and frame the primary policies of the concern. All kinds of policies

related to personnel or workforce can be framed out effectively by the personnel manager.

3. He advices the line manager as a staff specialist- Personnel manager acts like a staff advisor

and assists the line managers in dealing with various personnel matters.

4. As a counsellor,- As a counsellor, personnel manager attends problems and grievances of

employees and guides them. He tries to solve them in best of his capacity.



5. Personnel manager acts as a mediator- He is a linking pin between management and

workers.

6. He acts as a spokesman- Since he is in direct contact with the employees, he is required to

act as representative of organization in committees appointed by government. He

represents company in training programmes.

Functions of Personnel Management

Following are the four functions of Personnel Management

1. Manpower Planning

2. Recruitment

3. Selection

4. Training and Development

Manpower Planning which is also called as Human Resource Planning consists of putting right

number of people, right kind of people at the right place, right time, doing the right things for which

they are suited for the achievement of goals of the organization. Human Resource Planning has got

an important place in the arena of industrialization. Human Resource Planning has to be a systems

approach and is carried out in a set procedure. The procedure is as follows:

1. Analysing the current manpower inventory

2. Making future manpower forecasts

3. Developing employment programmes

4. Design training programmes

5. Steps in Manpower Planning

Analysing the current manpower inventory- Before a manager makes forecast of future manpower,

the current manpower status has to be analysed. For this the following things have to be noted-

Type of organization

• Number of departments

• Number and quantity of such departments

• Employees in these work units

Once these factors are registered by a manager, he goes for the future forecasting.

Making future manpower forecasts- Once the factors affecting the future manpower forecasts are

known, planning can be done for the future manpower requirements in several work units.

The Manpower forecasting techniques commonly employed by the organizations are as follows:

• Expert Forecasts: This includes informal decisions, formal expert surveys and Delphi

technique.

• Trend Analysis: Manpower needs can be projected through extrapolation (projecting past

trends), indexation (using base year as basis), and statistical analysis (central tendency

measure).

• Work Load Analysis: It is dependent upon the nature of work load in a department, in a

branch or in a division.

• Work Force Analysis: Whenever production and time period has to be analysed, due

allowances have to be made for getting net manpower requirements.



• Other methods: Several Mathematical models, with the aid of computers are used to

forecast manpower needs, like budget and planning analysis, regression, new venture

analysis.

Developing employment programmes- Once the current inventory is compared with future

forecasts, the employment programmes can be framed and developed accordingly, which will

include recruitment, selection procedures and placement plans.

Design training programmes- These will be based upon extent of diversification, expansion plans,

development programmes,etc. Training programmes depend upon the extent of improvement in

technology and advancement to take place. It is also done to improve upon the skills, capabilities,

knowledge of the workers.

Importance of Manpower Planning

• Key to managerial functions- The four managerial functions, i.e., planning, organizing,

directing and controlling are based upon the manpower. Human resources help in the

implementation of all these managerial activities. Therefore, staffing becomes a key to all

managerial functions.

• Efficient utilization- Efficient management of personnels becomes an important function in

the industrialization world of today. Seting of large scale enterprises require management of

large scale manpower. It can be effectively done through staffing function.

• Motivation- Staffing function not only includes putting right men on right job, but it also

comprises of motivational programmes, i.e., incentive plans to be framed for further

participation and employment of employees in a concern. Therefore, all types of incentive

plans becomes an integral part of staffing function.

• Better human relations- A concern can stabilize itself if human relations develop and are

strong. Human relations become strong trough effective control, clear communication,

effective supervision and leadership in a concern. Staffing function also looks after training

and development of the work force which leads to co-operation and better human relations.

• Higher productivity- Productivity level increases when resources are utilized in best possible

manner. higher productivity is a result of minimum wastage of time, money, efforts and

energies. This is possible through the staffing and it's related activities ( Performance

appraisal, training and development, remuneration)

Need of Manpower Planning

Manpower Planning is a two-phased process because manpower planning not only analyses the

current human resources but also makes manpower forecasts and thereby draw employment

programmes. Manpower Planning is advantageous to firm in following manner:

• Shortages and surpluses can be identified so that quick action can be taken wherever

required.

• All the recruitment and selection programmes are based on manpower planning.

• It also helps to reduce the labour cost as excess staff can be identified and thereby

overstaffing can be avoided.

• It also helps to identify the available talents in a concern and accordingly training

programmes can be chalked out to develop those talents.

• It helps in growth and diversification of business. Through manpower planning, human

resources can be readily available and they can be utilized in best manner.

• It helps the organization to realize the importance of manpower management which

ultimately helps in the stability of a concern.



Types of Recruitment

Recruitment is of 2 types:

• Internal Recruitment - is a recruitment which takes place within the concern or organization.

Internal sources of recruitment are readily available to an organization. Internal sources are

primarily three - Transfers, promotions and Re-employment of ex-employees. Re-

employment of ex-employees is one of the internal sources of recruitment in which

employees can be invited and appointed to fill vacancies in the concern. There are situations

when ex-employees provide unsolicited applications also.

• Internal recruitment may lead to increase in employee’s productivity as their motivation

level increases. It also saves time, money and efforts. But a drawback of internal recruitment

is that it refrains the organization from new blood. Also, not all the manpower requirements

can be met through internal recruitment. Hiring from outside has to be done.

Internal sources are primarily 3

• Transfers

• Promotions (through Internal Job Postings) and

• Re-employment of ex-employees –

Re-employment of ex-employees is one of the internal sources of recruitment in which employees

can be invited and appointed to fill vacancies in the concern. There are situations when ex-

employees provide unsolicited applications also.

External Recruitment –

External sources of recruitment have to be solicited from outside the organization. External sources

are external to a concern. But it involves lot of time and money. The external sources of recruitment

include - Employment at factory gate, advertisements, employment exchanges, employment

agencies, educational institutes, labour contractors, recommendations etc.

• Employment at Factory Level - This a source of external recruitment in which the

applications for vacancies are presented on bulletin boards outside the Factory or at the

Gate. This kind of recruitment is applicable generally where factory workers are to be

appointed. There are people who keep on soliciting jobs from one place to another. These

applicants are called as unsolicited applicants. These types of workers apply on their own for

their job. For this kind of recruitment workers have a tendency to shift from one factory to

another and therefore they are called as “badli” workers.

• Advertisement - It is an external source which has got an important place in recruitment

procedure. The biggest advantage of advertisement is that it covers a wide area of market

and scattered applicants can get information from advertisements. Medium used is

Newspapers and Television.

• Employment Exchanges - There are certain Employment exchanges which are run by

government. Most of the government undertakings and concerns employ people through

such exchanges. Now-a-days recruitment in government agencies has become compulsory

through employment exchange.

• Employment Agencies - There are certain professional organizations which look towards

recruitment and employment of people, i.e. these private agencies run by private individuals

supply required manpower to needy concerns.



• Educational Institutions - There are certain professional Institutions which serves as an

external source for recruiting fresh graduates from these institutes. This kind of recruitment

done through such educational institutions is called as Campus Recruitment. They have

special recruitment cells which help in providing jobs to fresh candidates.

• Recommendations - There are certain people who have experience in a particular area. They

enjoy goodwill and a stand in the company. There are certain vacancies which are filled by

recommendations of such people. The biggest drawback of this source is that the company

has to rely totally on such people which can later on prove to be inefficient.

• Labour Contractors - These are the specialist people who supply manpower to the Factory or

Manufacturing plants. Through these contractors, workers are appointed on contract basis,

i.e. for a particular time period. Under conditions when these contractors leave the

organization, such people who are appointed have to also leave the concern.

The Employee selection Process

Employee Selection is the process of putting right men on right job. It is a procedure of matching

organizational requirements with the skills and qualifications of people. Effective selection can be

done only when there is effective matching. By selecting best candidate for the required job, the

organization will get quality performance of employees. Moreover, organization will face less of

absenteeism and employee turnover problems. By selecting right candidate for the required job,

organization will also save time and money. Proper screening of candidates takes place during

selection procedure. All the potential candidates who apply for the given job are tested.

But selection must be differentiated from recruitment, though these are two phases of employment

process. Recruitment is considered to be a positive process as it motivates more of candidates to

apply for the job. It creates a pool of applicants. It is just sourcing of data. While selection is a

negative process as the inappropriate candidates are rejected here. Recruitment precedes selection

in staffing process. Selection involves choosing the best candidate with best abilities, skills and

knowledge for the required job.

The Employee selection Process takes place in following order-

1. Preliminary Interviews- It is used to eliminate those candidates who do not meet the

minimum eligibility criteria laid down by the organization. The skills, academic and family

background, competencies and interests of the candidate are examined during preliminary

interview. Preliminary interviews are less formalized and planned than the final interviews.

The candidates are given a brief up about the company and the job profile; and it is also

examined how much the candidate knows about the company. Preliminary interviews are

also called screening interviews.

2. Application blanks- The candidates who clear the preliminary interview are required to fill

application blank. It contains data record of the candidates such as details about age,

qualifications, reason for leaving previous job, experience, etc.

3. Written Tests- Various written tests conducted during selection procedure are aptitude test,

intelligence test, reasoning test, personality test, etc. These tests are used to objectively

assess the potential candidate. They should not be biased.

4. Employment Interviews- It is a one to one interaction between the interviewer and the

potential candidate. It is used to find whether the candidate is best suited for the required

job or not. But such interviews consume time and money both. Moreover the competencies

of the candidate cannot be judged. Such interviews may be biased at times. Such interviews

should be conducted properly. No distractions should be there in room. There should be an

honest communication between candidate and interviewer.

5. Medical examination- Medical tests are conducted to ensure physical fitness of the potential

employee. It will decrease chances of employee absenteeism.



6. Appointment Letter- A reference check is made about the candidate selected and then

finally he is appointed by giving a formal appointment letter.

Training of Employees - Need and Importance of Training

Training of employees takes place after orientation takes place. Training is the process of enhancing

the skills, capabilities and knowledge of employees for doing a particular job. Training process

moulds the thinking of employees and leads to quality performance of employees. It is continuous

and never ending in nature.

Importance of Training

Training is crucial for organizational development and success. It is fruitful to both employers and

employees of an organization. An employee will become more efficient and productive if he is

trained well.

Training is given on four basic grounds:

New candidates who join an organization are given training. This training familiarize them with the

organizational mission, vision, rules and regulations and the working conditions.

The existing employees are trained to refresh and enhance their knowledge.

If any updations and amendments take place in technology, training is given to cope up with those

changes. For instance, purchasing a new equipment, changes in technique of production, computer

implantment. The employees are trained about use of new equipments and work methods.

When promotion and career growth becomes important. Training is given so that employees are

prepared to share the responsibilities of the higher level job.

The benefits of training can be summed up as:

1. Improves morale of employees- Training helps the employee to get job security and job

satisfaction. The more satisfied the employee is and the greater is his morale, the more he

will contribute to organizational success and the lesser will be employee absenteeism and

turnover.

2. Less supervision- A well trained employee will be well acquainted with the job and will need

less of supervision. Thus, there will be less wastage of time and efforts.

3. Fewer accidents- Errors are likely to occur if the employees lack knowledge and skills

required for doing a particular job. The more trained an employee is, the less are the

chances of committing accidents in job and the more proficient the employee becomes.

4. Chances of promotion- Employees acquire skills and efficiency during training. They become

more eligible for promotion. They become an asset for the organization.

5. Increased productivity- Training improves efficiency and productivity of employees. Well

trained employees show both quantity and quality performance. There is less wastage of

time, money and resources if employees are properly trained.

Ways/Methods of Training

Training is generally imparted in two ways:

• On the job training- On the job training methods are those which are given to the employees

within the everyday working of a concern. It is a simple and cost-effective training method.



The inproficient as well as semi- proficient employees can be well trained by using such

training method. The employees are trained in actual working scenario. The motto of such

training is “learning by doing.” Instances of such on-job training methods are job-rotation,

coaching, temporary promotions, etc.

• Off the job training- Off the job training methods are those in which training is provided

away from the actual working condition. It is generally used in case of new employees.

Instances of off the job training methods are workshops, seminars, conferences, etc. Such

method is costly and is effective if and only if large number of employees have to be trained

within a short time period. Off the job training is also called as vestibule training,i.e., the

employees are trained in a separate area( may be a hall, entrance, reception area,etc.

known as a vestibule) where the actual working conditions are duplicated.

Training and Development - Meaning, its Need and Importance

Training and development is vital part of the human resource development. It is assuming ever

important role in wake of the advancement of technology which has resulted in ever increasing

competition, rise in customer’s expectation of quality and service and a subsequent need to lower

costs. It is also become more important globally in order to prepare workers for new jobs. In the

current write up, we will focus more on the emerging need of training and development, its

implications upon individuals and the employers.

Noted management author Peter Drucker said that the fastest growing industry would be training

and development as a result of replacement of industrial workers with knowledge workers. In United

States, for example, according to one estimate technology is de-skilling 75 % of the population. This

is true for the developing nations and for those who are on the threshold of development. In Japan

for example, with increasing number of women joining traditionally male jobs, training is required

not only to impart necessary job skills but also for preparing them for the physically demanding jobs.

They are trained in everything from sexual harassment policies to the necessary job skills.

The need for Training and Development

Before we say that technology is responsible for increased need of training inputs to employees, it is

important to understand that there are other factors too that contribute to the latter. Training is

also necessary for the individual development and progress of the employee, which motivates him

to work for a certain organisation apart from just money. We also require training update employees

of the market trends, the change in the employment policies and other things.

The following are the two biggest factors that contribute to the increased need to training and

development in organisations:

• Change: The word change encapsulates almost everything. It is one of the biggest factors

that contribute to the need of training and development. There is in fact a direct relationship

between the two. Change leads to the need for training and development and training and

development leads to individual and organisational change, and the cycle goes on and on.

More specifically it is the technology that is driving the need; changing the way how

businesses function, compete and deliver.

• Development: It is again one the strong reasons for training and development becoming all

the more important. Money is not the sole motivator at work and this is especially very true

for the 21st century. People who work with organisations seek more than just employment

out of their work; they look at holistic development of self. Spirituality and self awareness

for example are gaining momentum world over. People seek happiness at jobs which may

not be possible unless an individual is aware of the self. At ford, for example, an individual

can enrol himself / herself in a course on ‘self awareness’, which apparently seems



inconsequential to ones performance at work but contributes to the spiritual well being of

an individual which is all the more important.

Training and development is one of the key HR functions. Most organisations look at training and

development as an integral part of the human resource development activity. The turn of the

century has seen increased focus on the same in organisations globally. Many organisations have

mandated training hours per year for employees keeping in consideration the fact that technology is

deskilling the employees at a very fast rate.

So what is training and development then? Is it really that important to organisational survival or

they can survive without the former? Are training and development one and the same thing or are

they different? Training may be described as an endeavour aimed to improve or develop additional

competency or skills in an employee on the job one currently holds in order to increase the

performance or productivity.

Technically training involves change in attitude, skills or knowledge of a person with the resultant

improvement in the behaviour. For training to be effective it has to be a planned activity conducted

after a thorough need analysis and target at certain competencies, most important it is to be

conducted in a learning atmosphere.

While designing the training program it has to be kept in mind that both the individual goals and

organisational goals are kept in mind. Although it may not be entirely possible to ensure a sync, but

competencies are chosen in a way that a win-win is created for the employee and the organisation.

Typically organisations prepare their training calendars at the beginning of the financial year where

training needs are identified for the employees. This need identification called as ‘training need

analysis’ is a part of the performance appraisal process. After need analysis the number of training

hours, along with the training intervention are decided and the same is spread strategically over the

next year.

Development

Lots of time training is confused with development, both are different in certain respects yet

components of the same system. Development implies opportunities created to help employees

grow. It is more of long term or futuristic in nature as opposed to training, which focus on the

current job. It also is not limited to the job avenues in the current organisation but may focus on

other development aspects also.

At Goodyear, for example, employees are expected to mandatorily attend training program on

presentation skills however they are also free to choose a course on ‘perspectives in leadership

through literature’. Whereas the presentation skills program helps them on job, the literature based

program may or may not help them directly.

Similarly many organisations choose certain employees preferentially for programs to develop them

for future positions. This is done on the basis of existing attitude, skills and abilities, knowledge and

performance of the employee. Most of the leadership programs tend to be of this nature with a

vision of creating and nurturing leaders for tomorrow.

The major difference between training and development therefore is that while training focuses

often on the current employee needs or competency gaps, development concerns itself with

preparing people for future assignments and responsibilities.

With technology creating more deskilled workers and with industrial workers being replaced by

knowledge workers, training and development is at the forefront of HRD. The onus is now on the



human development department to take a proactive leadership role in responding to training and

business needs.

Depreciation

The value of assets gradually reduces on account of use. Such reduction in value is known as

depreciation. Different authors have given different definitions of depreciation, such as:

"Depreciation may be defined as the permanent continuous diminution in the quality, quantity or

value on an asset." (By Pickles)

Depreciation is the diminution in intrinsic value of an asset due to use and/or the lapse of time." (By

Institute of Cost and Management Accountants, England)

From the above definitions, it follows that an asset gradually declines on account of use and passage

of time and this causes permanent reduction in the value and utility of asset. Such reduction in the

value or utility of asset is called depreciation. In other words, expired cost or utility of asset is

depreciation.

Characteristics of Depreciation:

Depreciation has the following characteristics:

• Depreciation is charged in case of fixed assets only. e.g., building, plant and machinery,

furniture etc. There is no question of depreciation in case of current assets - such as stock,

debtors, bills receivable etc.

• Depreciation causes perpetual, gradual and continual fall in the value of assets.

• Depreciation occurs till the last day of the estimated working life of the asset.

• Depreciation occurs on account of use of asset. In certain cases, however, depreciation may

occur even if the assets are not used, e.g., leasehold, property, patent, copyright etc.

• Depreciation is a charge against revenue of an accounting period.

• Depreciation does not depend on fluctuations in market value of assets (see difference

between depreciation and fluctuation page)

• The amount of depreciation of an accounting year cannot be determined precisely - it has to

be estimated. In certain cases, however, it may be ascertained exactly, e.g., leasehold

property, patent right, copyright etc.

• Total depreciation of an asset cannot exceed its depreciable value (cost less scrap value).

Causes of Depreciation:

The main causes of depreciation may be divided into two categories, namely:

1. Internal Cause and

2. External Causes

Internal Causes:

Depreciation which occurs for certain inherent normal causes, is known as internal depreciation. The

main causes of internal depreciation are:

1. Wear and Tear:

Some assets physically deteriorate due to wear and tear in use. More and more use of an

asset, the greater would be the wear and tear. Physical deterioration of an asset is caused

from movement, strain, friction, erasion etc. An obvious example of this is motor car which



rapidly wears out. Other assets like this are building, plant, machinery, furniture, etc. The

wear and tear is general but primary cause of depreciation.

2. Depletion:

Some assets declines in value proportionate to the quantum of production, e.g. mine, quarry

etc. With the raising of coal from coal mine the total deposit reduces gradually and after

sometime it will be fully exhausted. Then its value will be reduced to nil.

External Causes:

Depreciation caused by some external reasons is called external depreciation. The main external

causes are as follows:

1. Obsolescence:

Some assets, although in proper working order, may become obsolete. For example, old

machine becomes obsolete with the invention of more economical and sophisticated machine

whose productive capacity is generally larger and cost of production is therefore less. In order to

survive in the competitive market the manufacturers must must install new machines replacing

the old ones. Again, it may happen that the articles produced by old machine are no longer

saleable in the market on account of change of habit and taste of the people. In such a case the

old machine, although in good working condition, must be discarded and the new one

purchased.

2. Efflux of Time:

Some assets diminish in value on account of sheer passage of time, even though they are not

used e.g., leasehold property, patent right, copyright etc. Suppose we take a lease of a house for

10 years for $10,000. Its annual depreciation will be $1,000 (10,000/10), irrespective of the the

whether the house has been used or not. Because with the end of lease after 10 years, the

house will go out of possession.

3. Accident:

Assets may be destroyed by abnormal reasons such as fire, earthquake, flood etc. In such a case

the destroyed asset must be written off as loss and a new one purchased.

Need for Depreciation:

The Need for depreciation arises for the following reasons:

Ascertainment of True Profit or Loss:

Depreciation is a loss. So Unless it is considered like all other expenses and losses, true profit or

loss cannot be ascertained. In other words, depreciation must be considered in order to into out

true profit or loss of a business.

Ascertainment of True Cost of Production:

Goods are produced with the help of plant and machinery which incurs depreciation in the

process of production. This depreciation must be considered as a part of the cost of production

of goods. Otherwise, the cost f production would be shown less than the true cost. Sales price is

fixed normally on the basis of cost of production. So, if the cost of production is shown less by

ignoring depreciation, the sale price will also be fixed at low level resulting in a loss to the

business.



True Valuation of Assets:

Value of assets gradually decreases on account of depreciation, if depreciation is not taken into

account, the value of asset will be shown in the books at a figure higher than its true value and

hence the true financial position of the business will not be disclosed through balance sheet.

Replacement of Assets:

After sometime an asset will be completely exhausted on account of use. A new asset must then

be purchased requiring a large sum of money. If the whole amount of profit is withdrawal from

business each year without considering the loss on account of depreciation, necessary sum may

not be available for buying the new asset. In such a case the required money is to be collected

by introducing fresh capital or by obtaining loan or by selling some other assets. This is contrary

to sound commerce policy.

Keeping Capital Intact:

Capital invested in buying an asset, gradually diminishes on account of depreciation. If loss on

account of depreciation is not considered in determining profit or loss at the year end, profit will

be shown more. If the excess profit is withdrawal, the working capital will gradually reduce, the

business will become weak and its profit earning capacity will also fall.

Basic Factors of Determination of Depreciation:

For calculation depreciation the basic factors are:

1. The original cost of the asset.

2. The estimated working life of the asset or the number of years the asset is expected to last.

3. The estimated residual or scrap value at the end of its life. It is the value which the asset will

fetch when discarded as useless.

4. The amount to be spent periodically for repairs and renewals. If the repairs necessary to

keep the asset in a proper state of efficiency are regularly carried out, the life of the asset is

prolonged and the amount of annual depreciation is proportionately lowered.

5. The possibility of the asset becoming obsolete. If there are great chances of improvements

being made in a particular asset on account of inventions, higher depreciation should be

written off such an asset.

Depreciation Methods:

Fixed assets differ from each other in their nature so widely that the same depreciation methods

cannot be applied to each. The following methods have therefore been evolved for depreciating

various assets:

1. Fixed installment or Straight line or Original cost method.

2. Diminishing Balance Method or Written down value method or Reducing Installment

method.

3. Annuity Method.

4. Depreciation fund method or Sinking fund amortization fund method.

5. Insurance policy method.



6. Revaluation method.

7. Sum of the year's digits method (SYD).

8. Double declining balance method.

9. Depletion method.

10. The basis of use system.

Fixed Installment Method or Straight Line Method or Original Cost Method of Depreciation:

Fixed installment method is also know as straight line method or original cost method. Under this

method the expected life of the asset or the period during which a particular asset will render

service is the calculated. The cost of the asset less scrap value, if any, at the end f its expected life is

divided by the number of years of its expected life and each year a fixed amount is charged in

accounts as depreciation. The amount chargeable in respect of depreciation under this method

remains constant from year to year. This method is also know as straight line method because if a

graph of the amounts of annual depreciation is drawn, it would be a straight line.

Formula:

The following formula or equation is used to calculate depreciation under this method:

Annual Depreciation = [(Cost of Assets - Scrap Value)/Estimated Life of Machinery]

Journal Entries:

The journal entries that will have to be made under this method are very simple. The journal entries

will be as under:

1. Depreciation account To Asset account (Being the depreciation of the asset)

2. Profit and loss account To Depreciation account (Being the amount of depreciation charged to

Profit and Loss account)

These entries will be passed at the end of each year so long as the asset lasts. In the last year, the

scrap will be sold and with the amount that realised by the sale the following entry will be passed:

3. Cash account

To Asset account

(Being the sale price of scrap realised.)

Advantages:

1. Fixed installment method of depreciation is simple and easy to work out

2. The book value of the asset can be reduced to zero.

Disadvantages:

1. This method, in spite of its being simplest is not very popular because of the fact that

whereas each year's depreciation charge is equal, the charge for repairs and renewals goes

on increasing as the asset becomes older. The result is that the profit and loss account has to

bear a light burden in the initial years of the asset but later on this burden becomes heavier.



2. Interest on money is locked up in the asset is not taken into account as is done in some

other methods.

3. No provision for the replacement of the asset is made.

4. Difficulty is faced in calculation of depreciation on additions made during the year.

Scope of Application:

On account of the above mentioned advantages and disadvantages of fixed installment method, it is

generally applied in case of those assets which have small value or which do not require many

repairs and renewals for example copyright, patents, short leases etc.

Diminishing Balance Method of Depreciation:

Learning Objectives:

1. Define, explain and give example of the diminishing balance method/written down value

method/reducing installment method?

2. What are advantages and disadvantages of diminishing balance method?

Definition and Explanation:

Diminishing balance methodis also known as written down value method or reducing installment

method. Under this method the asset is depreciated at fixed percentage calculated on the debit

balance of the asset which is diminished year after year on account of depreciation.

Journal Entries:

The entries in this case will be identical to those discussed in the case of the fixed instalment

method. Only the amount will be differently calculated.

Advantages of Diminishing Balance Method:

1. The strongest point in favor of this method is that under it the total burden imposed on

profit an loss account due to depreciation and repairs remains more or less equal year after

year since the amount after depreciation goes on diminishing with the passage of time

whereas the amount of repairs goes on increasing an asset grow older.

2. Separate calculations are unnecessary for additions and extensions, though in the first year

some complications usually arise on account of the fact that additions are generally made in

the middle of the year.

Disadvantages of Diminishing Balance method:

1. This method ignores the question of interest on capital invested in the asset and the

replacement of the asset.

2. This method cannot reduce the book value of an asset to zero if it is desired.

3. Very high rate of depreciation would have to be adopted other wise it will take a very long

time to write an asset down to its residual value


Diminishing balance method of depreciation is most suited to plant and machinery where additions

and extensions take place so often and where the question of repairs is also very important. Written



down value method or reducing instalment method does not suit the case of lease, whose value has

to be reduced to zero.

Example:

On 1st January, 1994, a merchant purchased plant and machinery costing $25,000. It has been

decided to depreciate it at the rate if 20 percent p.a. on the diminishingbalancemethod (written

down value method). Show the plant and machinery account in the first three years.

Plant and Machinery Account

Debit Side Credit Side

Date Rs Date Rs

2009 Jan.

1 To Cash 25,000

2009 Dec.

31 By Depreciation 5,000*

" By Balancec/d 20,000

25,000 25,000

2010 Jan.

1 To Balanceb/d 20,000

2010 Dec.

31 By Depreciation 4,000**

" By Balancec/d 16,000

20,000 20,000

2011 Jan.

1 To Balanceb/d 16,000

2011 Dec.

31 By Depreciation 3,200***

By Balancec/d 12,800

16,000 16,000

Formula or equation for the depreciation calculation may be written as follows:

*First year: 25,000 × 20% = 5000

**SecondYear: (25000 - 5000) × 20% = 4,000

***Third Year: [25000 - (5,000 + 4,000)] × 20% = 3,200

Annuity Method of Depreciation:

According to this method, the purchase of the asset concerned is considered aninvestment of

capital, earning interest at certain rate. The cost of the asset and also interest thereon are written

down annually by equal installments until the book value of the asset is reduced to nil or its bread up

value at the end of its effective life. The annual charge to be made by way of depreciation is found

out from annuity tables. The annual charge for depreciation will be credited to asset account and



debited to depreciation account, while the interest will be debited to asset account and credited

tointerest account.

Journal Entries:

Under annuity method,journal entries have to be made in respect of interest and depreciation. As

regards interest, it has to be calculated on the debit balance of the asset account at the

commencement of the period, at the given rate. The entry that is passed:

1. Asset account

To Interest account

(Being interest on capital sunk in asset)

With regard to depreciation the amount found out from the depreciation annuity table, the

following entry is passed:

2. Depreciation account

To Asset account

(Being the depreciation of asset)

It should be remembered that the interest is charged on the diminishing balance of the asset

account, the amount of interest goes on declining year after year. But the amount of depreciation

remains the same during the life time of the asset.

Example:

A firm purchased a 5 years' lease for Rs 40,000 on first January. It decides to write off depreciation

on the annuity method. Presuming the rate of interest to be 5% per annum.

Show the lease account for the first 3 years. Calculations are to be made to the nearest dollar.

Annuity Table

Amount required to write off Rs 1 by the annuity method.

Years 3% 3.5% 4% 4.5% 5%

3 0.353530 0.359634 0.360349 0.363773 0.367209

4 0.269027 0.272251 0.275490 0.278744 0.282012

5 0.218355 0.221418 0.224627 0.227792 0.230975

6 0.184598 0.187668 0.190762 0.193878 0.197017

7 0.160506 0.163544 0.166610 0.169701 0.172820

8 0.142456 0.145477 0.148528 0.151610 0.154722

Solution:

According to the annuity table given above, the annual charge for depreciation reckoning interest at

5 percent p.a. would be:

230975×40,000 = $9,239



Lease Account

Debit Side Credit Side

Date Rs Date Rs

1st Year 1st Year

Jan. 1 To Cash 40,000 Dec. 31 By Depreciation 9,239

Dec. 31 To Interest 2,000 By Balance c/d 32,761

42,000 42,000

2nd

Year 2nd Year

Jan. 1 To Balance b/d 32,761 Dec. 31 By Depreciation 9,239


34,399 34,399

3rd Year

Jan. 1 To Balance b/d 25,160 Dec. 31 By Depreciation 9,239


26,418 26,418

3rd Year

Jan. 1 To Balance b/d 17,170

Advantages:

1. This method takes interest on capitalinvestedin the asset into account.

2. It is regarded as most exact and precise from the point of view of calculations; and is

therefore most scientific.

Disadvantages:

1. The system is complicated.

2. The burden on profit and loss account goes on increasing with the passage of time whereas

the amount of depreciation charged each year remains constant. The amount of interest

credited goes on diminishing as years pass by, the ultimate consequence being that the net

burden on profit and loss account grows heavier each year.

3. When the asset requires frequent additions and extensions, the calculation have to be

changed frequently, which is very inconvenient.


This method is best suited to those assets which require considerable investment and which do not

call for frequent additions e.g., long lease.

Depreciation Fund Method or Sinking Fund Method of Depreciation:




Depreciation fund method is also known as sinking fund method or amortization fund method.

Under this method, a fund known as depreciation fund or sinking fund is created. Each year the

profit and loss account is debited and the fund account credited with a sum, which is so calculated

that the annual sum credited to the fund account and accumulating throughout the life of the asset

may be equal to the amount which would be required to replace the old asset. In order that ready

funds may be available at the time of replacement of the asset an amount equal to that credited to

the fund account is invested outside the business, generally in gilt-edged securities. The asset

appears in the balance sheet year after year at its original cost while depreciation fund account

appears on the liability side.

Journal Entries:

The following entries are necessary to record the depreciation and replacement of an asset by this

method.

(a). First year (at the end)

(1). Debit profit and loss account and credit depreciation fund account with the amount of

the annual depreciation charge.

(2). Also debit depreciation fund investment account and credit cash account with an

equal amount.

(b). In subsequent years.

(1). Debit depreciation fund investment account and credit depreciation fund account

with the amount of interest earned and reinvested.

(2). Debit profit and loss account and credit depreciation fund account with the annual

depreciation installment.

(3). Debit depreciation fund investment account and credit cash account with an equal

amount.

(c). On replacement of asset.

(1). Debit cash account and credit depreciation fund investment account with the amount

realized by the sale of investment.

(2). Transfer any profit or loss on sale of investment to profit and loss account.

(3). Debit the new asset purchased and credit cash account.

(4). Debit depreciation fund account and credit the account of the old asset which has

become useless.

The amount of annual depreciation to be provided for by the depreciation fund method will be

ascertained from sinking fund table.

Advantages of Depreciation Fund Method Or Sinking Fund Method:

The most important advantages of this method is that it makes available a sum of money for the

replacement of the asset, which has become useless. If separate provision was not made, the sum

required to purchase the new asset will have to be drawn from the business which might effect the

financial position of the concern adversely.

Disadvantages of the Depreciation Fund Method or Sinking Fund Method:



1. The burden on profit and loss account goes on increasing as years pass by since the amount

of depreciation every year remains same but the amount spent on repairs goes on increasing

as the asset becomes old.

2. It can also be said that the work of investing money is complicated.

3. Prices of securities may fall at the time when they are to be realized as a result of which loss

may have to be suffered.


This method is found suitable wherever it is desired not only to charge depreciation but also to

replace the asset as happens in the case of plant and machinery and other wasting assets.

Insurance Policy Method of Depreciation:


Insurance policy method is a slight modification of the depreciation fund method or sinking fund

method. Under this method the amount represented by the depreciation fund, instead of being used

to buy securities, is paid to an insurance company as premium. The insurance company issues a

policy promising to pay a lump sum at the end of the working life of the asset for its replacement.

The advantage of insurance policy method is that risk of loss on the sale of investment and the

trouble and expense of buying investment are avoided, while disadvantage lies that the interest

received on the premiums paid is comparatively very low.

When insurance policy method is employed the policy account will take the place of the

depreciation fund investment account and no interest will be received at the end of each year, but

the total interest on the premiums will be received when the policy matures.

Revaluation Method of Depreciation:

As the name implies under revaluation method, the assets are valued at the end of each period so

that the difference between the old value and the new value, which represents the actual

depreciation can be charged against the profit and loss account. This method is mostly used in case

of assets like bottles, horses, packages, loose tools, casks etc. On rare occasions when on revaluation

the value of an asset is found to have increased, it being of temporary nature not taken into account.

Revaluation method is open to various objections.

Firstly, the method do not specify as to which is the value that the experts are to estimate at the end

of each year. It however appears that this is the market value. If so, to assess depreciation with

reference to market value is against the basic principles and theory of depreciation. A fixed asset has

nothing to do with market value.

Secondly, the charge against profit and loss account on account of depreciation will vary year to year

through the asset renders the same service throughout of its life time.

Thirdly, this method is unscientific, because there are great chances of manipulations.

Sum of the Years' Digits Method of Depreciation:




Sum of the Years' Digits Method an accelerated method of depreciation which is also based on the

assumption that the loss in the value of the fixed asset will be greater during the earlier years and

will go on decreasing gradually with the decrease in the life of such asset. The SYD is found by

estimating an asset's useful life in years, then assessing consecutive numbers to each year, and

totaling these numbers. For n years:

SYD = 1 + 2 + 3 + 4 + ...... + n

For example if the useful life of an asset is 5 years, the SYD would be 1 + 2 + 3 + 4 + 5 = 15.

Determining the SYD factor by simple addition can be somewhat laborious for long-lived assets. For

these assets the formula n (n + 1) / 2 where n = the number of periods in the asset's useful life can

be applied to derive the SYD. In our example, we have:

5(5 + 1) =30

= 15

2 2

The yearly depreciation is then calculated by multiplying the total depreciable amount for the life of

the asset by a fraction whose numerator is the remaining useful life and whose denominator is the

SYD. Thus in our example the calculation would:

First year depreciation = 5/15 × Depreciation cost

Second year depreciation = 4/15 × Depreciation cost

Third year depreciation = 3/15 × Depreciation cost

Fourth year depreciation = 2/15 × Depreciation cost

Fifth year depreciation = 1/15 × Depreciation cost

The formula for depreciation for this method is:

Depreciation = Depreciation cost × (Remaining useful life/SYD)

Double Declining Balance Method of Depreciation:

Double declining balance method is another type of accelerated depreciation method followed

generally in USA. The depreciation expense is computed by multiplying the asset cost less

accumulated depreciation by twice the straight line rate expressed in percentage. No provision is

made for salvage value of the asset.

Double declining balance rate is found by using the following formula:

Double Declining Balance Rate = (100%/Years of Useful Life) × 2



Example:

A printing machine is purchased for $20,000 on January 1991. The scrap value is estimated at $2,000

at the end of 5 years useful life of the asset.

Required: Calculate the annual depreciation charge by applying double declining balance method

Solution:

Depreciation rate (100%/5) × 2 = 40%

Depletion Method of Depreciation:

Depletion method of depreciation is especially suited to mines, quarries, sand pits, etc. According to

it the cost of the asset is divided by the total workable deposits. In this way, rate of depreciation per

unit of output is ascertained. Depreciation in any particular year is charged on the basis of the

output during that year.

Example:

A mine was acquired at a cost of Rs 20,00,000 the quantity of minerals expected to be mined is

5,00,000 tons, the rate of depreciation per unit will be Rs 4 i.e., (20,00,000 / 5,00,000). If during the

year 25,000 tons minerals is extracted, the amount of depreciation will be 25,000 × 4 = Rs 1,00,000.

Concept of Cost

Cost accounting is concerned with cost and therefore is necessary to understand the meaning of

term cost in a proper perspective.

In general, cost means the amount of expenditure (actual or notional) incurred on, or attributable to

a given thing.

However, the term cost cannot be exactly defined. Its interpretation depends upon the following

factors:

• The nature of business or industry

• The context in which it is used

In a business where selling and distribution expenses are quite nominal the cost of an article may be

calculated without considering the selling and distribution overheads. At the same time, in a

business where the nature of a product requires heavy selling and distribution expenses, the

calculation of cost without taking into account the selling and distribution expenses may prove very

costly to a business. The cost may be factory cost, office cost, cost of sales and even an item of

expense. For example, prime cost includes expenditure on direct materials, direct labor and direct

expenses. Money spent on materials is termed as cost of materials just like money spent on labor is

called cost of labor and so on. Thus, the use of term cost without understanding the circumstances

can be misleading.

Different costs are found for different purposes. The work-in-progress is valued at factory cost while

stock of finished goods is valued at office cost. Numerous other examples can be given to show that



the term “cost” does not mean the same thing under all circumstances and for all purposes. Many

items of cost of production are handled in an optional manner which may give different costs for the

same product or job without going against the accepted principles of cost accounting. Depreciation

is one of such items. Its amount varies in accordance with the method of depreciation being used.

However, endeavor should be, as far as possible, to obtain an accurate cost of a product or service.

Elements of Cost

Following are the three broad elements of cost:

1. Material

The substance from which a product is made is known as material. It may be in a raw or a

manufactured state. It can be direct as well as indirect.

a. Direct Material

The material which becomes an integral part of a finished product and which can be

conveniently assigned to specific physical unit is termed as direct material. Following

are some of the examples of direct material:

� All material or components specifically purchased, produced or

requisitioned from stores

� Primary packing material (e.g., carton, wrapping, cardboard, boxes etc.)

� Purchased or partly produced components

Direct material is also described as process material, prime cost material, production

material, stores material, constructional material etc.

b. Indirect Material

The material which is used for purposes ancillary to the business and which cannot

be conveniently assigned to specific physical units is termed as indirect material.

Consumable stores, oil and waste, printing and stationery material etc. are some of

the examples of indirect material.

Indirect material may be used in the factory, office or the selling and distribution

divisions.

2. Labor

For conversion of materials into finished goods, human effort is needed and such human

effort is called labor. Labor can be direct as well as indirect.

a. Direct Labor

The labor which actively and directly takes part in the production of a particular

commodity is called direct labor. Direct labor costs are, therefore, specifically and

conveniently traceable to specific products.



Direct labor can also be described as process labor, productive labor, operating

labor, etc.

b. Indirect Labor

The labor employed for the purpose of carrying out tasks incidental to goods

produced or services provided, is indirect labor. Such labor does not alter the

construction, composition or condition of the product. It cannot be practically traced

to specific units of output. Wages of storekeepers, foremen, timekeepers, directors’

fees, salaries of salesmen etc, are examples of indirect labor costs.

Indirect labor may relate to the factory, the office or the selling and distribution

divisions.

3. Expenses

Expenses may be direct or indirect.

a. Direct Expenses

These are the expenses that can be directly, conveniently and wholly allocated to

specific cost centers or cost units. Examples of such expenses are as follows:

� Hire of some special machinery required for a particular contract

� Cost of defective work incurred in connection with a particular job or

contract etc.

Direct expenses are sometimes also described as chargeable expenses.

b. Indirect Expenses

These are the expenses that cannot be directly, conveniently and wholly allocated to

cost centers or cost units. Examples of such expenses are rent, lighting, insurance

charges etc.

4. Overhead

The term overhead includes indirect material, indirect labor and indirect expenses. Thus, all

indirect costs are overheads.

A manufacturing organization can broadly be divided into the following three divisions:

o Factory or works, where production is done

o Office and administration, where routine as well as policy matters are decided

o Selling and distribution, where products are sold and finally dispatched to customers

Overheads may be incurred in a factory or office or selling and distribution divisions. Thus,

overheads may be of three types:

d. Factory Overheads



They include the following things:

� Indirect material used in a factory such as lubricants, oil, consumable stores

etc.

� Indirect labor such as gatekeeper, timekeeper, works manager’s salary etc.

� Indirect expenses such as factory rent, factory insurance, factory lighting etc.

e. Office and Administration Overheads


� Indirect materials used in an office such as printing and stationery material,

brooms and dusters etc.

� Indirect labor such as salaries payable to office manager, office accountant,

clerks, etc.

� Indirect expenses such as rent, insurance, lighting of the office

f. Selling and Distribution Overheads


� Indirect materials used such as packing material, printing and stationery

material etc.

� Indirect labor such as salaries of salesmen and sales manager etc.

� Indirect expenses such as rent, insurance, advertising expenses etc.

Elements of Cost

• Direct material

• Direct labor

• Direct expenses

• Overheads

• Factory overheads

• Selling and distribution overheads

• Office and administration overheads

• Indirect material

• Indirect labor

• Indirect expenses


• Indirect labor



• Indirect labor


Components of Total Cost

1. Prime Cost

Prime cost consists of costs of direct materials, direct labors and direct expenses. It is also

known as basic, first or flat cost.



2. Factory Cost

Factory cost comprises prime cost and, in addition, works or factory overheads that include

costs of indirect materials, indirect labors and indirect expenses incurred in a factory. It is

also known as works cost, production or manufacturing cost.

3. Office Cost

Office cost is the sum of office and administration overheads and factory cost. This is also

termed as administration cost or the total cost of production.

4. Total Cost

Selling and distribution overheads are added to the total cost of production to get total cost

or the cost of sales.

Various components of total cost can be depicted with the help of the table below:

Components of total cost

Direct material

Direct labor

Direct expenses

Prime cost or direct cost or first cost

Prime cost plus works overheads Works or factory cost or production cost or

manufacturing cost

Works cost plus office and administration

overheads Office cost or total cost of production

Office cost plus selling and distribution

overheads Cost of sales or total cost

Classification of Cost

Cost may be classified into different categories depending upon the purpose of classification. Some

of the important categories in which the costs are classified are as follows:

1. Fixed, Variable and Semi-Variable Costs

The cost which varies directly in proportion with every increase or decrease in the volume of output

or production is known as variable cost. Some of its examples are as follows:

• Wages of laborers

• Cost of direct material

• Power

The cost which does not vary but remains constant within a given period of time and a range of

activity inspite of the fluctuations in production is known as fixed cost. Some of its examples are as

follows:

• Rent or rates



• Insurance charges

• Management salary

The cost which does not vary proportionately but simultaneously does not remain stationary at all

times is known as semi-variable cost. It can also be named as semi-fixed cost. Some of its examples

are as follows:

• Depreciation

• Repairs

Fixed costs are sometimes referred to as “period costs” and variable costs as “direct costs” in system

of direct costing. Fixed costs can be further classified into:

• Committed fixed costs

• Discretionary fixed costs

Committed fixed costs consist largely of those fixed costs that arise from the possession of plant,

equipment and a basic organization structure. For example, once a building is erected and a plant is

installed, nothing much can be done to reduce the costs such as depreciation, property taxes,

insurance and salaries of the key personnel etc. without impairing an organization’s competence to

meet the long-term goals.

Discretionary fixed costs are those which are set at fixed amount for specific time periods by the

management in budgeting process. These costs directly reflect the top management policies and

have no particular relationship with volume of output. These costs can, therefore, be reduced or

entirely eliminated as demanded by the circumstances. Examples of such costs are research and

development costs, advertising and sales promotion costs, donations, management consulting fees

etc. These costs are also termed as managed or programmed costs.

In some circumstances, variable costs are classified into the following:

• Discretionary cost

• Engineered cost

The term discretionary costs is generally linked with the class of fixed cost. However, in the

circumstances where management has predetermined that the organization would spend a certain

percentage of its sales for the items like research, donations, sales promotion etc., discretionary

costs will be of a variable character.

Engineered variable costs are those variable costs which are directly related to the production or

sales level. These costs exist in those circumstances where specific relationship exists between input

and output. For example, in an automobile

industry there may be exact specifications as one radiator, two fan belts, one battery etc. would be

required for one car. In a case where more than one car is to be produced, various inputs will have

to be increased in the direct proportion of the output.

Thus, an increase in discretionary variable costs is due to the authorization of management whereas

an increase in engineered variable costs is due to the volume of output or sales.

2. Product Costs and Period Costs



The costs which are a part of the cost of a product rather than an expense of the period in which

they are incurred are called as “product costs.” They are included in inventory values. In financial

statements, such costs are treated as assets until the goods they are assigned to are sold. They

become an expense at that time. These costs may be fixed as well as variable, e.g., cost of raw

materials and direct wages, depreciation on plant and equipment etc.

The costs which are not associated with production are called period costs. They are treated as an

expense of the period in which they are incurred. They may also be fixed as well as variable. Such

costs include general administration costs, salaries salesmen and commission, depreciation on office

facilities etc. They are charged against the revenue of the relevant period. Differences between

opinions exist regarding whether certain costs should be considered as product or period costs.

Some accountants feel that fixed manufacturing costs are more closely related to the passage of

time than to the manufacturing of a product. Thus, according to them variable manufacturing costs

are product costs whereas fixed manufacturing and other costs are period costs. However, their

view does not seem to have been yet widely accepted.

3. Direct and Indirect Costs

The expenses incurred on material and labor which are economically and easily traceable for a

product, service or job are considered as direct costs. In the process of manufacturing of production

of articles, materials are purchased, laborers are employed and the wages are paid to them. Certain

other expenses are also incurred directly. All of these take an active and direct part in the

manufacture of a particular commodity and hence are called direct costs.

The expenses incurred on those items which are not directly chargeable to production are known as

indirect costs. For example, salaries of timekeepers, storekeepers and foremen. Also certain

expenses incurred for running the administration are the indirect costs. All of these cannot be

conveniently allocated to production and hence are called indirect costs.

4. Decision-Making Costs and Accounting Costs

Decision-making costs are special purpose costs that are applicable only in the situation in which

they are compiled. They have no universal application. They need not tie into routine-financial

accounts. They do not and should not conform the accounting rules. Accounting costs are compiled

primarily from financial statements. They have to be altered before they can be used for decision-

making. Moreover, they are historical costs

and show what has happened under an existing set of circumstances. Decision-making costs are

future costs. They represent what is expected to happen under an assumed set of conditions. For

example, accounting costs may show the cost of a product when the operations are manual whereas

decision-making cost might be calculated to show the costs when the operations are mechanized.

5. Relevant and Irrelevant Costs

Relevant costs are those which change by managerial decision. Irrelevant costs are those which do

not get affected by the decision. For example, if a manufacturer is planning to close down an

unprofitable retail sales shop, this will affect the wages payable to the workers of a shop. This is

relevant in this connection since they will disappear on closing down of a shop. But prepaid rent of a

shop or unrecovered costs of any equipment which will have to be scrapped are irrelevant costs

which should be ignored.



6. Shutdown and Sunk Costs

A manufacturer or an organization may have to suspend its operations for a period on account of

some temporary difficulties, e.g., shortage of raw material, non-availability of requisite labor etc.

During this period, though no work is done yet certain fixed costs, such as rent and insurance of

buildings, depreciation, maintenance etc., for the entire plant will have to be incurred. Such costs of

the idle plant are known as shutdown costs.

Sunk costs are historical or past costs. These are the costs which have been created by a decision

that was made in the past and cannot be changed by any decision that will be made in the future.

Investments in plant and machinery, buildings etc. are prime examples of such costs. Since sunk

costs cannot be altered by decisions made at the later stage, they are irrelevant for decision-making.

An individual may regret for purchasing or constructing an asset but this action could not be avoided

by taking any subsequent action. Of course, an asset can be sold and the cost of the asset will be

matched against the proceeds from sale of the asset for the purpose of determining gain or loss. The

person may decide to continue to own the asset. In this case, the cost of asset will be matched

against the revenue realized over its effective life. However, he/she cannot avoid the cost which has

already been incurred by him/her for the acquisition of the asset. It is, as a matter of fact, sunk cost

for all present and future decisions.

11. Out-of-Pocket Costs

Out-of-pocket cost means the present or future cash expenditure regarding a certain decision that

will vary depending upon the nature of the decision made. For example, a company has its own

trucks for transporting raw materials and finished products from one place to another. It seeks to

replace these trucks by keeping public carriers. In making this decision, of course, the depreciation of

the trucks is not to be considered but the management should take into account the present

expenditure on fuel, salary to drive$ and maintenance. Such costs are termed as out-of-pocket costs.

12. Opportunity Cost

Opportunity cost refers to an advantage in measurable terms that have foregone on account of not

using the facilities in the manner originally planned. For example, if a building is proposed to be

utilized for housing a new project plant, the likely revenue which the building could fetch, if rented

out, is the opportunity cost which should be taken into account while evaluating the profitability of

the project. Suppose, a manufacturer is confronted with the problem of selecting anyone of the

following alternatives:

Selling a semi-finished product at Rs. 20 per unit

Introducing it into a further process to make it more refined and valuable

Alternative (b) will prove to be remunerative only when after paying the cost of further processing,

the amount realized by the sale of the product is more than Rs. 20 per unit. Also, the revenue of Rs.

20 per unit is foregone in case alternative (b) is adopted. The term “opportunity cost” refers to this

alternative revenue foregone.

13. Traceable, Untraceable or Common Costs

The costs that can be easily identified with a department, process or product are termed as

traceable costs. For example, the cost of direct material, direct labor etc. The costs that cannot be



identified so are termed as untraceable or common costs. In other words, common costs are the

costs incurred collectively for a number of cost centers and are to be suitably apportioned for

determining the cost of individual cost centers. For example, overheads incurred for a factory as a

whole, combined purchase cost for purchasing several materials in one consignment etc.

Joint cost is a kind of common cost. When two or more products are produced out of one material

or process, the cost of such material or process is called joint cost. For example, when cottonseeds

and cotton fibers are produced from the same material, the cost incurred till the split-off or

separation point will be joint costs.

14. Production, Administration and Selling and Distribution Costs

A business organization performs a number of functions, e.g., production, illustration, selling and

distribution, research and development. Costs are to be curtained for each of these functions. The

Chartered Institute of Management accountants, London, has defined each of the above costs as

follows:

Production Cost

The cost of sequence of operations which begins with supplying materials, labor and services and

ends with the primary packing of the product. Thus, it includes the cost of direct material, direct

labor, direct expenses and factory overheads.

Administration Cost

The cost of formulating the policy, directing the organization and controlling the operations of an

undertaking which is not related directly to a production, selling, distribution, research or

development activity or function.

Selling Cost

It is the cost of selling to create and stimulate demand (sometimes termed as marketing) and of

securing orders.

Distribution Cost

It is the cost of sequence of operations beginning with making the packed product available for

dispatch and ending with making the reconditioned returned empty package, if any, available for

reuse.

Research Cost

It is the cost of searching for new or improved products, new application of materials, or new or

improved methods.

Development Cost

The cost of process which begins with the implementation of the decision to produce a new or

improved product or employ a new or improved method and ends with the commencement of

formal production of that product or by the method.

Pre-Production Cost

The part of development cost incurred in making a trial production as preliminary to formal

production is called pre-production cost.



15. Conversion Cost

The cost of transforming direct materials into finished products excluding direct material cost is

known as conversion cost. It is usually taken as an aggregate of total cost of direct labor, direct

expenses and factory overheads.

Reliability of electronic components

■ What is reliability engineering?

Reliability engineering is also called failure engineering. It is a branch of engineering that involves

increasing reliability of products by assessing and analyzing how failure is caused in the product. In

other words, it can be considered engineering that creates broken products.

*The difference between failure and defect

・Defective products are defective from the moment they are produced.

・Broken products were conforming products when they were produced, but became defective

products over time.

Reliability engineering deals with the process during which a conforming product turns into a

defective product.

There are three factors that cause failure:

(1) Latent internal causes that existed in the product from the start (predispositions)

(2) External stressors such as heat and humidity applied from the usage environment (external

causes)

(3) Degradation with time

■ What is failure?

In the preceding part, I said that, "Reliability engineering is also called failure engineering." There are

actually different types of patterns of failure. The bathtub curve below is a graph that shows the

correlation between failure rate and time.



During a product's lifetime, it goes through three successive periods (initial failure, chance failure,

wear-out failure) that each has different causes of failure.

<Initial failure>

Failure occurs soon after starting to use the product, and the failure rate drops gradually over time.

The main cause is thought to be latent defects. Improvement of the design and filtering process and

screening of products are essential for preventing such products from being leaked to the market.

<Chance failure>

After the initial failure period eases, a period starts during which failure can occur by chance. These

failures are usually caused by unpredictable events such as lightening and dropping the product. This

means that such failure occurs at a nearly constant failure rate that is unrelated to how much time

has passed. The goal is to reduce accidental defects in the production process and fluctuations in

environmental stressors during use to approach a zero failure rate.

<Wear-out failure>

After the chance failure period has passed, the failure rate begins to rise gradually with the passage

of time. This is mainly thought to be due to wear-and-tear of the product as the product reaches the

end of its lifetime.

You can therefore see that there are different types of failures and that each has its own causes. For

quality assurance, it is necessary to examine the factors in detail and select the best test method

(reliability test).

What is a reliability test?

Reliability tests are tests for predicting quality during the time a product will be used, from factory

shipment to the end of mechanical lifetime in the market. The aim is to select stress factors that

correlate strongly with the market environment, set the size of the stress and duration of application

and accurately assess product reliability in as little time as possible.

Tests have various test items. Some tests go beyond looking at simple stressors and test the impact

of multiple stressors acting simultaneously, and yet other tests have been developed to examine

failure mechanisms.

The following chart shows some of the most common reliability tests used on electronic

components.



How to estimate the lifetime of components?

We will discuss accelerated tests performed to estimate the service life of electronic components,

using the example of monolithic ceramic capacitors.

Electronic components are built into many different kinds of electronic devices. When actually used

in the market, they are exposed to all types of external stress. For example, there is the physical

stress of the electronic device being dropped, the thermal stress of temperature differences and the

electrical stress applied when the device is powered up. These types of external stress become

factors that may cause failure of electronic components during use of the product in which they are

embedded. To address this, we investigate the mechanisms of external stress and failure occurrence

in each type of electronic component from the design stage and use the results as feedback for

reliability design of electronic components. Moreover, by assessing the relationship between the

degree of external stress and the onset and probability of failure occurrence, we can build an

"external stress and failure occurrence acceleration model" that lets us assess service life of



electronic components more quickly.

To give a specific example of an acceleration model, I will talk about temperature and voltage

acceleration aspects of service life in monolithic ceramic capacitors. In general, monolithic ceramic

capacitors are made of an electrical insulator (dielectric) and are known to be extremely highly

reliable even when continuously energized.

For example, the ambient temperature around the control module installed near the automobile

engine room becomes very hot during use.

Figure 1 shows what happens inside ceramic material used in capacitors when energized under a

high-temperature environment.

The atomic level electrical defects contained in minute quantities in ceramic material are thought to

move from the anode (+) to the cathode (-).

In barium titanate and other electric ceramics, a minute number of atomic level defects (called

oxygen defects) are encapsulated in the crystal structure during the firing process. They gradually

shift when voltage is applied externally and eventually accumulate in the vicinity of the cathode, at

some point leading to breakdown of the ceramics.

The service life (lifetime) of monolithic ceramic capacitors is thus determined by how fast oxygen

defects move through the ceramic material and the number of defects present.

The service life (lifetime) of monolithic ceramic capacitors is thus thought to be determined by how

fast oxygen defects move through the ceramic material and the number of defects present, and a

model has been created with ambient temperature and applied voltage during product use as

parameters. The most common acceleration model uses the Arrhenius theory, but the following

empirical formula can also be used as a simple method for estimation.



From this relational expression, you can conduct accelerated tests under relatively harsh conditions

(higher temperature and higher voltage) to estimate service life under the actual conditions in which

the product will be used.

Let us consider a comparison between accelerated tests on monolithic ceramic capacitors and the

estimated conditions of practical product usage. To do so, we will use the above formula with the

endurance test time of the accelerated test on the capacitor as LA and lifetime in standard condition

under the actual usage conditions as LN.

A 1000-hour-long endurance test conducted at 85ºC with an applied voltage of 20V is estimated to

be equivalent to 1,448,155 hours at 65ºC with an applied voltage of 5V. This is about 165 years! The

voltage acceleration constant and temperature acceleration constant used in the formula vary with

the type and structure of the ceramic material. However, we can use the acceleration model to

verify the service life under certain usage conditions over the long term from the results of a

relatively short test.

This is an example using monolithic ceramic capacitors, but the types of commonly used electronic

components and estimated usage conditions vary widely. It is therefore important to establish an

acceleration model related to the stress that affects each type of electronic component.

Date post:	20-Jul-2016
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