Professional Documents
Culture Documents
Financial accounting:
Every business organization wants to know whether it has made profit or loss
at the end of the given period; for this purpose it has to prepare a statement
containing profit or loss. It also wants to know what it owns (assets) and how
much it owes (liabilities) to its suppliers and others. In order to prepare these
statements the business organization has to maintain a set of accounts.
Accounting as an information system is the process of identifying, measuring
and communicating the economic information of an organization to its users
who need the information for decision making. The following are the various
activities for accounting.
3. Recording:
4. Classifying:
5. Summarizing:
It is concerned with the summarization of the classified transactions in a manner
useful to the users. This function involves preparation of financial statements
such as income statement, balance sheet, statement of changes in financial
position, statement of cash flows etc.,
6. Analyzing:
7. Interpreting:
8. Communicating:
Branches of accounting:
1. Financial Accounting
2. Cost Accounting
3. Management Accounting
4. Social responsibility Accounting
Financial accounting:
Cost accounting:
It is the process of Accounting and controlling the cost of a product, operation or
function. The purpose of this branch of Accounting is to ascertain the cost, to
control the cost and to communicate information for decision making.
Management Accounting:
e.g., projected cash flow statement facilitates the management to know the
future receipts and payments and to take decisions regarding anticipated surplus
or shortage of funds.
Written records are always better than oral records since written records can
be used by different persons for decision making purposes and serve as evidence
of transactions. Now-a-days, the volume of transactions is so large; a human
memory cannot absorb each and every transaction. Accounting is done to keep a
systematic record of:
a. financial transactions
b. assets
c. liabilities
e.g., cash budget reports, production reports, idle time reports, feedback reports
whether to retain or replace an equipment decision reports, project appraisal
reports etc.,
Raising finance:
The financial manager is concerned with the efficient allocation of the firm’s
scarce resources to alternate uses. He has to invest money in long-term assets,
inventory, marketable securities, and debtors, paying off dividends, maintaining
sufficient cash to make payments and keep the firm running.
Financial planning:
Treasury operations:
This is another function which the financial manager has to perform; treasury
operations have the potential to generate considerable profit for the organization.
The financial manager has to analyze and understand the trends in business,
industry and competition in order to ascertain the direction in which business
and industry are moving competitors’ objectives and strategies and their
financial and market positions and capital structure.
Management accounting:
The main aim of management accounting is to help the management in its function of
planning, directing and controlling. It provides techniques for the interpretation of the
accounting data. The following facts of management accounting speak for the scope of
this subject.
Financial accounting:
It deals with historical data. The recorded facts are useful for planning the
future course of action. The performance appraisal is based on recorded facts
and figures. Thus management accounting is closely related to financial
accounting.
Cost accounting:
Inventory control:
Management reporting:
Interpretation of data:
Internal audit:
Tax accounting:
A number of tools and techniques are available and are used to supply the information
required by the management. Some of them are discussed below:
Budgetary control:
Budgetary control technique is used as a tool for planning and control. The
budgets of different departments are prepared in advance based on historical data
and future possibilities. The actual performance is recorded and compared with
the predetermined targets. The management is able to assess the performance of
each and every person in the organization.
Standard costing:
Marginal costing:
Decision accounting:
Revaluation accounting:
Comprehensive analysis:
Evolutionary process:
Management is only in the evolutionary stage, the techniques and tools used
by this system give varying results. The conclusions taken from analysis and
interpretations are not the same.
Personal judgment:
Resistance:
Installation of management accounting involves basic change in the
organizational setup. New rules and regulations are also required to be framed
which effect a number of personnel; and hence there is a possibility of resistance
for some quarter or other.
Forecasting
Planning the financial requirements of business
Regulating the cash flows
Managing credit
Raising funds
Maintaining proper relationship with financial
institutions and
Protecting the funds.
The functions of management accountant relate to the management and control of the
firm’s resources. His job involves providing information to design accounting and costing
policies, preparation of financial reports, budgeting and inventory control.
Tax administration:
Management and financial accounting are two sides or branches of accounting. Financial
accounting collects the financial data which is suitably altered for management
accounting purposes. In a broader perspective, the scope of management accounting
includes financial accounting. The major point of distinction is that they differ in their
emphasis and approach. Some of the major areas of distinction between management
accounting and financial accounting are discussed below:
Focus:
Information:
Need:
Timing:
Financial accounting is based on the concept of accounting year in which
annual reports are prepared to be presented to the shareholders and interested
groups. Management accounting reports are prepared for shorter durations,
information is collected for the preparation of long term loans up to five years or
more in case of capital expenditure plans.
Basis of preparation:
Scope:
Financial accounting covers the entire organization and shows revenues and
expenses and equity of the firm as a whole. For the purpose of management
accounting, an organization is divided into centers or units headed by
responsible persons. These centers collect cost and other related data.
Reporting:
Cost accounting:
Cost is the amount of resources given in exchange for some goods or services. The
resources given up are money or money’s equivalent expressed in monetary units.
ICWAI defines cost as, “The amount of expenditure (actual or notional) incurred on or
attributable to a specified thing or activity.”
A cost must always be studied in relation to its purpose and conditions. Different
costs may be ascertained for different purposes and under different conditions. Work in
progress is valued at factory cost while stock of finished goods may be valued at office
cost. Even if the purpose of the study of the cost is the same, different conditions may
lead to variation in cost. The cost per unit of product is sure to vary with an increase in
the volume of output since the amount of fixed expenses to be borne by each unit of
output decreases.
Classification of costs:
Costs can be distinguished as direct and indirect. Costs which can be easily
traceable to a product or some specific activity are called direct costs. Indirect
costs are difficult to trace to a single product or it is uneconomic to do so.
These costs can be classified into fixed, variable, semi variable / mixed
costs.
ii. Variable costs: these are the costs that vary directly and
proportionately with the output- Direct materials and Direct labor.
VI. By function:
VIII. Controllability:
The CIMA defines controllable costs as, “A cost which can be influenced by
the action of a specified member of an undertaking” and uncontrollable cost as,
“ a cost which cannot be influenced by the action of a specified member of an
undertaking.”
X. Others:
2. Helps in Control of Cost: It helps in the control of material costs, labor costs and
overheads by using different techniques of control such as Standard Costing and Budgetary
Control.
3. Helps in Decision making: It helps the management in making various decisions such as
–
(g) How much reduction in the selling price should be made in case of depression?
4. Helps in fixing Selling Prices: It helps the management in fixing selling prices of
products or services by providing detailed cost information.
6. Helps in Cost reduction: It helps in the introduction of cost reduction programme and
finding out new and improved method to reduce costs.
10. Helps in identifying Material Losses: It helps in identifying material losses such as
wastage, scrap, spoilage and defective through report on material losses so that the
necessary corrective action may be taken.
11. Helps in identifying Idle Time and Labour Turnover: It helps in identifying idle time
and labour turnover through the report on idle time and labour turnover so that the necessary
corrective action may be taken.
12. Helps in identifying Idle Capacity: It helps in identifying idle capacity so that the
necessary corrective action may be taken.
(a) Comparison with Standard Figures: Comparison of actual figures with standard of
budgeted figures for the same period and the same firm;
(b) Intra-firm Comparison: Comparison of actual figures of one period with those of another
period for the same firm;
(c) Inter-firm Comparison: Comparison of actual figures of one firm with those of another
standard firm belonging to the same industry; and
(d) Pattern Comparison: Comparison of actual figures of one firm with those of industry to
which the firm belongs.
15. Helps in checking the accuracy of financial accounts: It helps in checking the
accuracy of financial accounts with the help of reconciliation statement prepared to reconcile
the profit as per cost accounts with the profit as per financial accounts.
The Cost Accountant Duties Are Critical To Any Organization And Its Growth
A cost accountant plays a very vital and an informative role in any organization. The
analysis, compare as well as interpretation of facts and figures included in the cost
accountant duties play an important role in the overall operations of the organization. His
sound judgments based on the data collected; his ability to communicate the results of his
work verbally as well as in writing; his interpersonal skills and his ability to work on
various business systems as well as computers along with the most important qualities
like integrity and honesty are some of the qualifications that can separate an excellent
cost accountant from the others. Along with all these the qualification of CPA can really
be the jewel in the crown of a cost accountant.
The cost accountant duties need specialization as it concerns with some of the most
crucial aspects of the entire financial operations that the organization is involved with.
• The cost accountant duties might also include the uncovering of the weaknesses
that might be inherent in the company’s bidding process
• He also has to provide the management with the information regarding the factors
that might have a bearing on the prices as well as profitability of the products and
explain if there are any variances in the same to the senior management
Concerning the seriousness and importance of the cost accountant duties, it is really
imperative that the selection of the cost accountant is done carefully.
Collect operational data and make analyses reports to forecast expenses and budgets.
Manage and coordinate annual physical counts and cycle counts in a plant.
Evaluate production costs, gains & losses and month-end closing data.
Collect and analyze past years data to forecast budget for the ensuing year.
Design, create and implement strategies, best practices and process improvements.
While this was previously a paper-based process, most businesses now use accounting
software. In an electronic financial accounting system, the steps in the accounting cycle
are dependent upon the system itself. For example, some systems allow direct journal
posting to the various ledgers and others do not. Not All AISs are computerized.
Key characteristics of accounting information
There is general agreement that, before it can be regarded as useful in satisfying the needs
of various user groups, accounting information should satisfy the following criteria:
Understandability
This implies the expression, with clarity, of accounting information in such a way that it
will be understandable to users - who are generally assumed to have a reasonable
knowledge of business and economic activities
Relevance
This implies that, to be useful, accounting information must assist a user to form, confirm
or maybe revise a view - usually in the context of making a decision (e.g. should I invest,
should I lend money to this business? Should I work for this business?)
Consistency
This implies consistent treatment of similar items and application of accounting policies
Comparability
This implies the ability for users to be able to compare similar companies in the same
industry group and to make comparisons of performance over time. Much of the work
that goes into setting accounting standards is based around the need for comparability.
Reliability
This implies that the accounting information that is presented is truthful, accurate,
complete (nothing significant missed out) and capable of being verified (e.g. by a
potential investor).
Objectivity
This implies that accounting information is prepared and reported in a "neutral" way. In
other words, it is not biased towards a particular user group or vested interest
- Types of Budgets
- Cash Budgeting
budget, or financial plan, is developed to help you achieve your future goals. In effect,
the budget tells you what must be done if predetermined profit and cost objectives are to
be met. To prepare the budget and stay within it assures your predetermined profit levels.
Without such a plan, you must guess about how much to spend and how much sales you
should anticipate. Effective managers build their budgets, monitor them closely, modify
them when necessary, and achieve their desired results. Budgeting can also cause conflicts.
This is true, for example, when a hotel’s food and beverage department and housekeeping
department both seek dollars budgeted for new equipment. The top needs are for either
a new kitchen range or a new commercial washing machine. Obviously, the food and
beverage manager and the housekeeping manager may hold different points of view on
Hospitality managers working in restaurants and hotels simply must be able to accurately
predict the number of guests they will serve as well as when those guests will arrive. If they
cannot, guest service levels or profits will surely suffer. In this article you will learn how
hospitality managers forecast business revenues so they can carefully plan to maximize
guest satisfaction.
It has been said that average managers know what has happened in their operations
in the past and good managers know what is currently happening in their operations.
However, the very best managers also know what will happen in the future. While it may
not be possible for managerial accountants to predict their future business volume with
100% accuracy, it is possible to create and utilize management tools that will become very
The advantages of maintaining accurate sales forecasts are many but include greater
efficiency in scheduling the employees needed to service anticipated guests, greater accuracy
(because demand for products will be better known), and greater effectiveness in developing
revenue dollars, guest counts, or both, will help you have the right number of workers,
with the right amounts of product available, at the right time. For hoteliers, knowing the
anticipated demand for guest rooms and other hotel services also allows for the proper
scheduling of employees; however, it does even more. Because hotel room rates (unlike
a restaurant’s menu prices) are often adjusted monthly, weekly, or daily to reflect the
immediate demand for rooms, a good understanding of how to forecast room occupancy
rates allows hoteliers the ability tomaximize RevPAR through the effective pricing of rooms
and the elimination of room discounts during periods of high room demand.
In this article, you will learn how managerial accountants can accurately forecast
revenues as well as how they utilize this information to maximize profit and increase
operational efficiency.
- Forecast Methodology
One of the first questions restaurateurs and hoteliers must ask themselves is very simple:
‘‘How many guests will we serve today? This week? This year?’’ The correct answers to
questions such as these are critical, since these guests will provide the revenue from which
basic operating expenses will be paid. Clearly, if too fewguests are served, total revenuemay
be insufficient to cover expenses, even if costs are well managed. In addition, purchasing
decisions regarding the kind and quantity of food or beverage to buy, the number of rooms
to clean, or the supplies to have on hand are dependent on knowing the number of guests
Labor required to serve the guests is also determined based on the manager’s ‘‘best
guess’’ of the projected number of customers to be served and what these guests will buy.
Forecasts of future revenues are normally based on a careful recording of previous sales,
since what has happened in the past in an operation is usually the best predictor of what will
happen in that same operation in the future. Finally, operating, cash, and capital budgets
In the hospitality industry, there are a variety of ways of counting or defining sales. In its
simplest case, sales are the dollar amount of revenue collected during some predetermined
time period. The time period may be an hour, shift, day, week, month, or year. When used
in this manner, sales and revenue are interchangeable terms. It is important, however, to
remember that a distinction ismade in the hospitality industry between sales (revenue) and
sales volume, which is the number of units sold. In many areas of the hospitality industry,
for example, in college and university dormitory food service, it is customary that no cash
actually changes hands during a particular meal period. Of course, the manager of such a
facility still created sales and would be interested in sales volume, that is, how much food
was actually consumed by the students on that day. This is critical information because, as
Planning:
Planning involves selecting a course of action and specifying how the action will be implemented. The first
step in planning is to identify the alternatives and then to select from among the alternatives the one that
does the best job of furthering the organization's objectives. While making choices management must
balance the opportunity against the demands made on the companies resources.
The plans of management are often expressed formally in budgets, and the term budgeting is applied to
generally describe the planning process. Budgets are usually prepared under the direction of controller, who
is the manager in charge of the accounting department. Typically, budgets are prepared annually and
represent management's plans in specific, quantitative terms.
Controlling:
In carrying out the control function, managers seek to ensure that the plan is being followed. Feedback,
which signals operations are on track, is the key to effective control. In sophisticated organizations, this
feedback is provided by detailed reports of various types. One of these reports, which compares budgeted
to actual results, is called a performance report. Performance report suggest where operations are not
proceeding as planned and where some parts of the organization may require additional attention.
Business Planning and Control: Integrating Accounting, Strategy and People starts
with an introduction to core areas of management accounting and business planning. It
then explores relationships between strategy, management accounting information, and
the design of control systems, taking into account the needs of both people and
organizations.
Business Planning and Control is an indispensable text for both undergraduate and
postgraduate students taking modules related to management accounting and business
planning and control.
Management process
The organization's senior management is responsible for carrying out its management
process. However, this is not always the case for all management processes, for example,
it is the responsibility of the project manager to carry out a project management
process[1].
Contributor
By HeidiBW, eHow Contributing Writer
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Applying Accounting
Employment Opportunities
Personal Accounting
Accounting Information Systems (Accounting information systems s) combine the study and practice of
accounting with the design, implementation, and monitoring of information systems. Such systems use modern
information technology resources together with traditional accounting controls and methods to provide users
Input The input devices commonly associated with Accounting information systems include: standard personal
computers or workstations running applications; scanning devices for standardized data entry; electronic
communication devices for electronic data interchange (EDI) and e-commerce. In addition, many financial
systems come ‘‘Web-enabled’’ to allow devices to connect to the World Wide Web.
Process Basic processing is achieved through computer systems ranging from individual personal computers to
large-scale enterprise servers. However, conceptually, the underlying processing model is still the ‘‘double-
Output Output devices used include computer displays, impact and nonimpact printers, and electronic
communication devices for EDI and e-commerce. The output content may encompass almost any type of
financial reports from budgets and tax reports to multinational financial statements.
MISs are interactive human/machine systems that support decision making for users both in and out of
traditional organizational boundaries. These systems are used to support an organization’s daily operational
activities; current and future tactical decisions; and overall strategic direction. MISs are made up of several
major applications including, but not limited to, the financial and human resources systems.
Financial applications make up the heart of an Accounting information systems in practice. Modules commonly
implemented include: general ledger, payables, procurement/ purchasing, receivables, billing, inventory,
assets, projects, and budgeting. Human resource applications make up another major part of modern
information systems. Modules commonly integrated with the Accounting information systems include: human
resources, benefits administration, pension administration, payroll, and time and labor reporting.
Accounting information systems s cover all business functions from backbone accounting transaction processing
systems to sophisticated financial management planning and processing systems. Financial reporting starts at
the operational levels of the organization, where the transaction processing systems capture important business
events such as normal production, purchasing, and selling activities. These events (transactions) are classified
and summarized for internal decision making and for external financial reporting. Cost accounting systems are
used in manufacturing and service environments. These allow organizations to track the costs associated with
the production of goods and/or performance of services. In addition, the Accounting information systems can
provide advanced analyses for improved resource allocation and performance tracking. Management accounting
systems are used to allow organizational planning, monitoring, and control for a variety of activities. This allows
managerial-level employees to have access to advanced reporting and statistical analysis. The systems can be
used to gather information, to develop various scenarios, and to choose an optimal answer among alternative
scenarios.
DEVELOPMENT
The development of an Accounting information systems includes five basic phases: planning, analysis, design,
implementation, and support. The time period associated with each of these phases can be as short as a few
Planning—project management objectives and techniques The first phase of systems development is the
planning of the project. This entails determination of the scope and objectives of the project, the definition of
project responsibilities, control requirements, project phases, project budgets, and project deliverables.
Analysis The analysis phase is used to both determine and document the accounting and business processes used
by the organization. Such processes are redesigned to take advantage of best practices or of the operating
organization. Current data are then compared to the data that the organization should be using for managerial
purposes. This method is used primarily when designing accounting transaction processing systems.
Decision analysis is a thorough review of the decisions a manager is responsible for making. The primary
decisions that managers are responsible for are identified on an individual basis. Then models are created to
support the manager in gathering financial and related information to develop and design alternatives, and to
make actionable choices. This method is valuable when decision support is the system’s primary objective.
Process analysis is a thorough review of the organization’s business processes. Organizational processes are
identified and segmented into a series of events that either add or change data. These processes can then be
modified or reengineered to improve the organization’s operations in terms of lowering cost, improving service,
improving quality, or improving management information. This method is appropriate when automation or
Design The design phase takes the conceptual results of the analysis phase and develops detailed, specific
designs that can be implemented in subsequent phases. It involves the detailed design of all inputs, processing,
storage, and outputs of the proposed accounting system. Inputs may be defined using screen layout tools and
application generators. Processing can be shown through the use of flowcharts or business process maps that
define the system logic, operations, and work flow. Logical data storage designs are identified by modeling the
relationships among the organization’s resources, events, and agents through diagrams. Also, entity relationship
diagram (ERD) modeling is used to document largescale database relationships. Output designs are documented
through the use of a variety of reporting tools such as report writers, data extraction tools, query tools, and on-
line analytical processing tools. In addition, all aspects of the design phase can be performed with software tool
Reporting is the driving force behind an Accounting information systems development. If the system analysis and
design are successful, the reporting process provides the information that helps drive management decision
making. Accounting systems make use of a variety of scheduled and on-demand reports. The reports can be
tabular, showing data in a table or tables; graphic, using images to convey information in a picture format; or
matrices, to show complex relationships in multiple dimensions. There are numerous characteristics to consider
when defining reporting requirements. The reports must be accessible through the system’s interface. They
should convey information in a proactive manner. They must be relevant. Accuracy must be maintained. Lastly,
reports must meet the information processing (cognitive) style of the audience they are to inform.
Reports are of three basic types: A filter report that separates select data from a database, such as a monthly
check register; a responsibility report to meet the needs of a specific user, such as a weekly sales report for a
regional sales manager; a comparative report to show period differences, percentage breakdowns and variances
between actual and budgeted expenditures. An example would be the financial statement analytics showing the
expenses from the current year and prior year as a percentage of sales.
Screen designs and system interfaces are the primary data capture devices of Accounting information systems s
and are developed through a variety of tools. Storage is achieved through the use of normalized databases that
Business process maps and flowcharts are used to document the operations of the systems. Modern Accounting
information systems s use specialized databases and processing designed specifically for accounting operations.
This means that much of the base processing capabilities come delivered with the accounting or enterprise
software.
Implementation The implementation phase consists of two primary parts: construction and delivery.
Construction includes the selection of hardware, software and vendors for the implementation; building and
testing the network communication systems; building and testing the databases; writing and testing the new
program modifications; and installing and testing the total system from a technical standpoint. Delivery is the
process of conducting final system and user acceptance testing; preparing the conversion plan; installing the
production database; training the users; and converting all operations to the new system.
Tool sets are a variety of application development aids that are vendor-specific and used for customization of
delivered systems. They allow the addition of fields and tables to the database, along with ability to create
screen and other interfaces for data capture. In addition, they help set accessibility and security levels for
Security exists in several forms. Physical security of the system must be addressed. In typical Accounting
information systems s the equipment is located in a locked room with access granted only to technicians.
Software access controls are set at several levels, depending on the size of the Accounting information systems .
The first level of security occurs at the network level, which protects the organization’s communication
systems. Next is the operating system level security, which protects the computing environment. Then,
database security is enabled to protect organizational data from theft, corruption, or other forms of damage.
Lastly, application security is used to keep unauthorized persons from performing operations within the
Testing is performed at four levels. Stub or unit testing is used to insure the proper operation of individual
modifications. Program testing involves the interaction between the individual modification and the program it
enhances. System testing is used to determine that the program modifications work within the Accounting
information systems as a whole. Acceptance testing ensures that the modifications meet user expectations and
information systems . There are several methods for achieving this goal. One is to run the new and old systems
in parallel for a specified period. A second method is to directly cut over to the new system at a specified point.
A third is to phase in the system, either by location or system function. A fourth is to pilot the new system at a
Support The support phase has two objectives. The first is to update and maintain the Accounting information
systems . This includes fixing problems and updating the system for business and environmental changes. For
example, changes in generally accepted accounting principles (GAAP) or tax laws might necessitate changes to
conversion or reference tables used for financial reporting. The second objective of support is to continue
development by continuously improving the business through adjustments to the Accounting information systems
caused by business and environmental changes. These changes might result in future problems, new
ATTESTATION
Accounting information systems s change the way internal controls are implemented and the type of audit trails
that exist within a modern organization. The lack of traditional forensic evidence, such as paper, necessitates
the involvement of accounting professionals in the design of such systems. Periodic involvement of public
auditing firms can be used to make sure the Accounting information systems is in compliance with current
internal control and financial reporting standards. After implementation, the focus of attestation is the review
and verification of system operation. This requires adherence to standards such as ISO 9000-3 for software
Periodic functional business reviews should be conducted to be sure the Accounting information systems remains
in compliance with the intended business functions. Quality standards dictate that this review should be done
ERP systems are large-scale information systems that impact an organization’s Accounting information systems .
These systems permeate all aspects of the organization and require technologies such as client/server and
relational databases. Other system types that currently impact Accounting information systems s are supply
Traditional Accounting information systems s recorded financial information and produced financial statements
on a periodic basis according to GAAP pronouncements. Modern ERP systems provide a broader view of
organizational information, enabling the use of advanced accounting techniques, such as activity- based costing
Cost accounting aims at systematic recording of expenses and analysis of the same so as to
ascertain the cost of each product manufactured or service rendered by an organisation.information
regarding cost of each product or service would enable the management to know where to
economize on costs, how to fix prices, how to maximize profits and so on. Thus, the main objects
of cost accounting are the following:
1. To analyze and classify all expenditure with reference to the cost of products and operations.
2. To arrive at the cost of production of every unit, job, operation, process, department or service
and to develop cost standard.
3. To indicate to the management any inefficiencies and the extent of various forms of waste,
whether of materials, time, expenses or in the use of machinery, equipment and tools. Analysis of
the causes of unsatisfactory results may indicate remedial measures.
4. To provide data for periodical profit &loss accounts and balance sheets at such intervals, e.g.,
weekly, monthly or quarterly, as may be desired by the management during the financial year, not
only for the whole business but also by departments or individual products. Also, to explain in
detail the exact reasons for profit or loss revealed in total, in the profit &loss Account.
5. To reveal source of economies in production having regard to methods, types of equipment,
design, output and layout. Daily, weekly, monthly or quarterly information may be necessary to
ensure prompt constructive action.
6. To provide actual figures of cost for comparison with estimates and to serve as a guide for future
estimates or quotations and to assist the management in their price-fixing policy.
7. To show, where standard costs are prepared, what the cost of production ought to be and with
which the actual costs which are eventually recorded may be compared.
8. To present comparative cost data for different periods and various volumes of output and to
provide guidance in the development of business. This is also helpful in budgetary control.
9. To record the relative production results of each unit of plant and machinery in use as a basis for
examining its efficiency. A comparison with the performance of other types of machines may
suggest the necessity for replacement.
10. To provide a perpetual inventory of stores and other materials so that interim profit and loss
account and balance sheet can be prepared without stock taking and checks on stores and
adjustments are made at frequent intervals. Also to provide the basis for production planning and
for avoiding unnecessary wastage or losses of materials and stores.
11. To provide information to enable management to make short term decisions of
various types, such as quotation of price to special customers or during a slump,
make or buy decision, assigning priorities to various products, etc.
Unit-2
1. What to achieve?
2. How to achieve it?
Features of a Budget
(i)One Year Duration-generally, budgets are prepared for one year. however in the
case of seasonal business like fruit canning,ice-cream,apparels etc, here may be
two budgets for each year-a slack season budget and a peak season budget.
(ii)Estimation of Business Units Profit Potential-it shows how much profit or loss
a business unit is expected to make and thereby reveals its profit potential.
A budget is prepared for a defined period of time while a forecast can be for
any time period. A budget is usually expressed in monetary terms whereas a
forecast may not be stated in monetary terms.
3. Clear and realistic nature of goals: Every organization has its own goals
and objectives and budgeting is a tool for achieving them. The goals must be
clear and should preferably be in writing. This would provide proper
direction to the employees and save management’s time.
The goals should also be reasonable, appear realistic and
capable of being attained. Goals should not be set at a very low level as the
same can be easily attained with out providing any motivation. On the other
hand, goals set at an extremely high level appear unrealistic and unattainable
to the employees, creates a sense of demoralization and as a result they do
not make serious efforts to attain them.
ADVANTAGES OF BUDGETING
1. Budgeting helps in solving problems in a disciplined manner.
2. It helps the organization to plan well in advance for mobilizing resources
needed for achieving its goals.
3. The nature of evaluation criteria is more objective. Apart from this, the
performance in each aspect of a manager’s operation can be measured by
using this yardstick.
4. Forward planning gets encouragement where there is a system of
budgeting. Cost consciousness and profit mindedness are created
throughout the organization.
5. As the performance of managers is measured against budgets, they are
motivated to accomplish high performance.
6. One of the advantages of budgeting is that there is an improvement in
communication. More over, it also leads to proper coordination.
7. Another advantage is that if facilitates management by exception. This is
done through variance analysis.
8. Budgeting enables the organization to review and restate its fundamental
goals, policies and procedures.
LIMITATIONS OF BUDGETING:
1. Conflict of goals: The goals of budgeting must match with the objectives of
the enterprise. How ever, it does happen that budget goals are set with out
considering the aims and objectives of the enterprise. This gives rise to
confusion and defeats the purpose of budgeting.
7. High cost of Operating System: The cost of operating the system is quite
high. It is possible that the benefits arising from it may not be commensurate
with the cost. Hence before installing a budgeting system the size of the firm
and its information needs must be studied so that a power system which can
be utilized fully and effectively can be implemented.
Types of budgets
The end results of the budgetary process are a master budget. The master
budget summarizes the objectives of all sub-units of an organization-marketing,
production, finance and distribution. It quantifies the expectations regarding future
income, financial position, cash flows and supporting plans. The master consists of
two parts-operating budgets and financial budgets.
(1)Strategy Analysis:
In the case of companies which do not prepare strategic plans or
multi-business companies having business unit form of organization (i.e. strategic
business unit or division), the budget preparation process starts with strategy
analysis. Strategy analysis essentially consists of the following:
(a)A study of political, social, economic and regulatory environment.
(b)A study of technological environment.
(c)A study of the industry in which the firm or business unit as the case may be
is engaged in.
(d)A study of existing and potential competitors.
The analysis helps in the identification of changes that have taken place after the
last budget was finalized and also the changes expected during the budget period.
(7)Negotiation
The department manager discusses the proposal budget with his
superior .This is said to be the heart of the process. The superior critically analyses
the budget, suggests modifications and discusses the same with the process. The
superior critically analysis the budget, suggest modifications and discusses the
same with the budgetee. He tries to judge how valid each of the adjustments are.
Generally, a consideration relating to budgeting is that performance in the budget
year should be improvement over current year’s performance. At this stage it is
finally decided whether a budget should be accepted without modifications or with
modifications. The superior realizes that at the next level of the budget process he
will become the budge tee and therefore must be prepared to defend the budget
that is finally agreed.
We have already seen that the master budget consists of two parts:
A. Operating budgets
B. Financial budgets.
Initially we would discuss the method of preparation of operating budgets.
A. Operating Budgets:
The sales budget shows the projected sales of various products, their
average sale price and the total sales realization. The revenue budget also
called as the sales budget, is not only the most critical but is also subject to the
greatest uncertainty varies from time to time. Firms having large backlog of
orders or whose volume of sales are subject to production constraints will be
making sales projections with more certainty compared to firms whose sales
volumes are subject to the uncertainties of the market place.
When sales are influenced by factors which are with in the firm, they are
known as internal factors .Internal factors are given below
(A) Pricing policies
(B) Grading sales
(c) Advertisement and publicity
(D) New products
(e) Relative profitability of products
(f) Size, composition of sales force
(g) Capacity of plant
(H) Expansion proposal
When sales are influenced by forces which are outside the firm
and over which it has no control such factors are known as external factors.
External factors are given below:
(A) Population shift
(b) Purchasing power of population
(c) Consumer tastes and habits
(d) Substitutes available in the market and their prices
(e) Nature and extent of competition
(f) General economic conditions
(g) Changes in the exchange rates
(h) Change in direct taxes
(I) changes in indirect taxes namely sales tax, octroi, excise duty
and customs duty
(j) Other government regulations and controls
(k) Seasonal and cyclic fluctuations.
While preparing the sales budget, the following factors should be considered
2. PRODUCTION BUDGET
This budget contains an estimate of the various products that a firm intends
to manufacture during the budget period and their quantity. The volume of
goods to be produced depends upon the sales budget, the closing stock to be
maintained as per the firm’s policy and the opening stock of the goods.
The production budget is geared to the sales budget. In order to
develop an optimum production budget, an optimal balance must be struck
between sales, production and stock levels.
Before preparing this budget, a work flow chart should be prepared
showing the movements of the materials through the factory. It should start
from the point if issue of the material and end with the point of dispatch to
the finished goods store. This chart highlights shortcomings in the plant and
factory layout, bottlenecks in each machine or process and surplus machine
capacity.
Available standard hours form the basis of calculation of plant
capacity which is dependant upon absenteeism, idle time and productivity.
In respect of each product centre i.e., production centre, the available hours
should be calculated. This would enable one to determine the imbalances
between standard hours available at various cost centers and highlight the
shortfall in standard hours which is required to meet the sales budget and
the company’s stock policy.
The direct labor budget is used for the preparation of cash budget and
cost of sales budget. It proves useful to personnel department in drawing up
recruitment, training and allied programs.
6. INVENTORY BUDGET
The direct labor budget and the production budget are used for
calculating indirect labor cost. The number of indirect workers required or first
worked out and then translated in to monitory amount by multiplying by
standard wage rate.
The estimate of expenses for each cost centre is made on the basis
of projected activity level. These are then submitted. The estimates are
reviewed, discussed and changes made if considered necessary, before being
included in the overall budget.
Many factors influence the amount of direct selling expenses and they are
(a) Basis of remuneration to sales personnel e.g., salary vs. commission.
(b) Expansion of regions of areas to be served.
(c) Sales volume.
(d) Incentive scheme for agents and sales personnel.
(e) Withdrawal from existing geographical areas which are being
served.
(f) Appointment of selling agents.
B. FINANCIAL BUDGETS
1. CAPITAL BUDGET
The proposals that have been given approval are totaled into an over
all package at budget time and examined in totality. It is possible that the total
amount is in excess of the amount that the firm is willing to spend. In this case,
some are deleted, others are deferred and the size of others reduced. In respect of
remaining project, an estimate is made of the cash that is expected to be spent in
each month or quarter as the case may be. The capital expenditure which is to be
included in the capital budget should be shown under the following heads:
2. CASH BUDGET
The cash budget shows how much of the cash needs during the year will
be met by retained earnings and how much, if any, must be obtained by borrowing
or other outside sources. It is essentially a statement of planned and receipts and
disbursements.
The cash budget a tool for financial planning. It shows the inflows,
outflows, opening balance and closing balance of cash. This is one of the most
important financial budgets. It enables a firm to plan its cash requirements in such
a manner that an adequate liquidity is always available to meets its needs and to
use cash which is lying idle in the most profitable manner.
The budget is phased into shorter periods/intervals such as weekly,
monthly and quarterly planning lines of credit and short term borrowing and for
control depending on organizational needs it can be prepared by using any one of
the three methods:
The receipts and payments method is usually used. While preparing the cash
budget, the following factors are considered:
1. Sales budget:
Generally, the sales budget is prepared on the basis of the forecast. The reason is
that the levels of production and stock are usually dependent up on the rate of
sales. If it is found that sufficient production capacity is not available in order to
produce the quantity given in the sale forecast, the budget prepared based on the
production capacity (e.g., labor hours, machine hours, skilled labor etc.)
2. PRODUCTION BUDGET
The production budget is the main item which is used for the
preparation of the factory overhead budget. The manner in which the item of
indirect material, indirect labor and indirect expense change with variations with
variations in the production volume determines the amount of factory overhead.
7. INVENTORY BUDGET
1. Definition of goals to be achieved: The goals which are to be defined e.g., flood
control.
2. Definitions of functions-the functions which are necessary for accomplishing
the goals have to be defined at this stage e.g., carry out dredging operations in
rivers.
3. Development of alternate programmes- Now alternate programmes to be
prepared for achieving goals. The costs, benefits and output of programmes have
to be defined. This is necessary for program evaluation. Cost- benefit analysis is
then in order to evaluate each program e.g., building dams, constructing cannels,
etc.
4. Selection of appropriate program: The program which is expected to yield the
highest net benefit is selected. This is done so that the finance available is
allocated to the best program.
1. Basis of budgeting: In the case of traditional budgeting, the exercise starts with
previous year expense as base and additions and deletions are made to it. On the
other hand, proper justification and careful analysis is made of decision packages.
During the process of preparation of budgets, it’s found that there are
some factors which play a limit on the volume of the production or sales. These
are known as principle budget factors. For instance, raw materials, skilled labor,
working capital, space, power, market etc are vital for the smooth running of an
organization and etc. And any storage may restrict the volume of production and
sales.
BUDGET REPORT
PROBLEMS ON BUDGETING
1) Prepare a cash budget of M/S Novan Television &Co. on the basis of the
following information for the first six months of 1989:
A) Cost and price remains unchanged.
B) Cash sales are 25%of the total sales and 75% credit sales.
C) 60% of credit sales are collected in the month after sales, 30% in the second
month and 10% in the third. No bad debts are anticipated.
D) Sales forecasts are as follows:
H) Interest on Rs. 20,00,000 @6% on debentures is due by the end of March and
June.
I) Excise deposit due in April Rs. 2,00,000.
J) Capital expenditure on plant and machinery planned for June Rs. 1,20,000.
K) Company has a cash balance of Rs. 4,00,000 @31.12.1988.
L) Company can borrow on monthly basis.
M) Rent is Rs. 8,000 per month.
2) Following are the balance sheets of metal engineering ltd, one actual as on 31st
December, 1988 and other forecast as on 31st December, 1989:
1988(actual) 1989(forecast)
Cash 18,400 1,36,800
Debtors 49,000 83,200
Stock 61,900 92,500
Investment 1,00,000 90,000
Plant (at cost) 2,20,000 2,40,000
4,49,300 642,500
Accounts payable 67,300 1,00,000
Debentures 73,500 50,000
Accumulated Depreciation 50,000 30,000
Equity share capital 1,25,000 1,75,000
Profit and Loss Account 1,33,5000 2,87,500
4,49300 6,42,500
The forecast profit and loss account in a summarized form for the budget year
ended 31st December, 1989 is as follows:
To accumulated 22,000 By gross profit 2,00,000
Depreciation
To administration 10,000 By profit on sale 2,000
and selling of investment
expenses
To income tax 5,000 By interest 10,000
To interest charged 3,000
To loss on sale of 8,000
plant
To net profit 1,64,000
2,12,000 2,12,000
To dividend 10,000 By net profit 1,64,000
To balance c/d 1,54,000
1,64,000 1,64,000
Additional Information:
i) New plant costing Rs. 80,000 was purchased during the year.
ii) An old plant, costingRs.60,000 and with accumulated depreciation of Rs.
42,000 was sold for Rs. 10,000.
iii) Investments costing Rs. 10,000 were sold for Rs. 12,000.
Prepare cash forecast for the management of the company by adjusted
profit and loss method.
3) Following are available from the records of Jay Ltd, for the year end 31st
December 1988.
Fixed Expenses: Rs. (lakhs)
Wages and salaries 9.5
Rent, Rates and Taxes 6.6
Depreciation 7.4
Sundry administrative expenses 6.5
Semi-variable Expenses50% of capacity)
Maintenance and repairs 3.5
Indirect labour 7.9
Sales department salaries 3.8
Sundry administrative expenses 2.8
Unit -6
Zero base budgeting:
Zero base budgeting is a revolutionary concept of planning the future activities
and there is a sharp contradiction from conventional budgeting. Zero base budgeting, may
be better termed as “DE Nova Budgeting” or budgeting from the beginning without any
reference to any base past budgets and actual happenings. Zero base budgeting may be
defined as “a planning in budgeting process which requires each manager to justify his
entire budget request in detail from scratch (hence Zero base) and shifts the burden of
proof to each manager to justify why he should spend any money at all. The approach
requires that all activities be analyzed in decision packages which are evaluated by
systematic analysis and ranked in order of importance.”
It is a technique which compliments and links the existing planning, budgeting
and review processes. It identifies alternatives and efficient methods of utilizing
resources in effective attainment of selected benefits. It is a flexible management
approach which provides a credible rationale for reallocating resources by focusing one
systematic review and justification of the funding and performance levels of current
programs of activities.
The concept of zero based budgeting was developed in U.S.A. under zero-base
budgeting each programmes and each of its constituent part is challenged for this very
inclusion for each year budget. Programmes objectives are also reexamined with a view
to start things afresh. It requires review analysis and evaluation of each programme in
order to justify its inclusions or exclusions from final budget. The following steps are
usually involved:
a) Describing and analyzing all current or proposed programmes usually called
“decision-packages”. This consists of identification, analysis and formulation
assists an evaluation in terms of purposes, consequence, performance measures,
alternatives and cause and benefits. Decision units are the lowest level
programmes or organizational entity for budget is prepared.
b) Ranking of decision-packages along with documents in support of these packages.
c) The sources are allocated in accordance with the ranking.
Zero based budgeting is based on the premise that every rupee of expenditure requires
justifications. The traditional budgeting approach includes expenditure of previous year
which are automatically incorporated into new budget proposals and only increments are
subjected to debate. Zero based budgeting assumes that a responsibility centre manager
has had no previous expenditure. Important features of Zero based budgeting are:
i) Concentration of efforts is not simply on “how much” a unit will spend but “why”
it needs to spend.
ii) Choices are made on the basis of what each unit can offer for a specific cost.
iv) Quick budget adjustments can be made if, during the operating year costs are
required to maintain expenditure level.
v) Alternative ways are considered.
2) Zero based budgeting has been referred to as very threaten process in which
managers have to justify their budget request in complete detail taking nothing for
granted.
3) Zero based budgeting requires a lot of training for managers. It has to be
impresses upon managers that Zero based budgeting gives them an opportunity to
be heard by top management and therefore, they should use their innovation and
efforts to maximum limits.
Unit II
Cost Analysis and Control
DIRECT EXPENSES
Expense that can be traced directly to (or identified with) a specific cost center or cost
object such as a department, process, or product. Direct costs (such as for labor, material,
fuel or power) vary with the rate of output but are uniform for each unit of production,
and are usually under the control and responsibility of the department manager. As a
general rule, most costs are fixed in the short run and variable in the long run. Also called
direct expense, on cost, operating cost, prime cost, variable cost, or variable expense,
they are grouped under variable costs.
INDIRECT EXPENSES
Indirect expenses are those expenses which are incurred after the manufacturing of
goods. To understand indirect expenses we should first understand direct expenses.
Direct expenses are those which are incurred in relation to the manufacturing of a product
directly.
FOR EX. LABOUR, FACTORY EXPENSES, MACHINERY REPAIRS ETC.
So, indirect expenses will be like, selling and distribution expenses, all the administrative
expenses, carriage outwards,advertisment expenses because they are related indirectly
with the product manufacturing and sales.
Overheads – Meaning:
Overhead may be defined as the cost of indirect material, indirect labour and such other
expenses, including services, as cannot be conveniently charged direct to specific cost
centers or cost units. It should be noted that direct costs (materials, labour, etc,) are
associated with individual jobs or products. Indirect expenses or overheads are not
associated with individual jobs or products. They represent the cost of the facilities
required for carrying on the operations. CIMA London defines overhead as “total cost of
indirect materials, wages and expenses.”
In modern industrial undertakings, overheads are a very large proportion of the total
cost and therefore good deal of attention has to be paid to them. It will be a big mistake to
pay attention to direct cost. The problem in respect of overheads arises from the facts that
the amount of overheads has to be estimated and that too before the concerned period
begins (since it is only continuous costing that is found useful) and that, the amount has
to be distributed over the various cost units, again on an estimated basis.
Classification of Overheads:
The process of classification of overheads involves:
a) The determination of the classes or groups in which the costs are sub-divided: and
b) The actual process of classification of the various items of expenses into one or
another group.
The classification of overheads expenditure depends upon the type and size of a business
and the nature of the product or services rendered.
Generally overheads are classified on the following basis:
a) Function-wise classification
b) Behavior-wise classification
c) Element-wise classification.
a) Function-wise classification
Overheads can be divided into the following categories on functional basis:
i) Manufacturing or Product Overheads:
Manufacturing overheads head includes all indirect costs (indirect material,
indirect labour and indirect expenses) incurred for operations of manufacturing
or production division in a factory. It is also known as factory overheads, work
overheads, factory on cost or work on cost etc.
ii) Administrative Overheads:
It is the sum of those costs of general management, secretarial,
accounting and administrative services, which cannot be directly related to the
production, marketing, research or development functions of the enterprise.
ICMA London defines it as the cost of formulating the policy, directing the
organization and controlling the operations of an undertaking which is not
related directly to production, selling, distribution, research or development
activity or function.
iii) Selling and Distribution:
Selling overheads of the cost of seeking to create and stimulate demand
and of securing orders. It comprises the cost to products of distributors for
soliciting and recurring orders for the articles or commodities dealt in and of
efforts to find and retain customers. Distribution overhead is the expenditure
incurred in the process which begins with making the packed product available
for dispatch and ends with the making the reconditioned returned empty
package, if any available for reuse. It includes expenditure incurred in
transporting articles to central or local storage. It also comprises expenditure
incurred in moving articles to and from prospective customers as in the case of
goods on sale or return basis. In case of gas, electricity and water industries
distribution means pipes, mains and services which may be regarded as
equivalent to packing and transportation.
b) Behavior-wise classification
Based on the behavior patterns, overheads can be classified into the following
categories:
i) Fixed overheads.
ii) Variable overheads.
iii) Semi-variable overheads.
i) Fixed Overheads:
Fixed overheads expenses are those which remains fixed in total amount
with increases or decreases in volume of output or productive activities for a
particular period of time.
E.g. managerial remuneration, rent of building, insurance of building, plant
etc.
Fixed overheads cost remains the same from one period to another except
when incidence of fixed overheads on unit cost decreases as production
increases and vice versa.
Fixed overheads are stated to b uncontrollable in the sense that they are
not influenced by managerial action. However, it should be noted that
expenditure is fixed within specified limit relating to time or activity. In a
hypothetical organization no expenditure remains unchanged for all time.
Therefore, it is true to state that fixed overhead is fixed within specified limit
relating to time and activity.”
ii) Variable Overheads:
Variable overheads costs are those costs which vary in total direct
proportion to the volume of output. For instance, if the output of increased by
5%, the variable expenses are also increased by 5%. Correspondingly, on a
decline of the output it will also decline proportionately. Examples are direct
material and direct labour. Variable overheads changes in total but its
incidences on unit will remains constant.
iii) Semi-Variable Overheads:
These overheads costs are partly fixed and partly variables. they are
known as semi- variable overheads because they contain both fixed and
variable element. Semi variable overheads do not fluctuate in direct
proportion to volume. It may remain fixed within a certain activity level, but
once that level is exceeded, they vary without having direct relationship with
volume changes. Examples are depreciation, telephone charges, repair and
maintenance of buildings, machines and equipments etc.
Semi-variable expenses usually have to parts - one fixed and other
variable. For instance, depreciation usually depends on two factors, - one,
time (fixed) and other wear and tear (variable). The two together make
depreciation (as a whole) semi variable. An analytical study thus can make it
possible for all semi-variable expenses to be split up into two parts.
Fundamentally, therefore, there are only two types of expenses – fixed and
variable.
Advantages of departmentalization:
i) It segregates factory overheads costs and computes the total cost of each service
departments.
ii) It makes possible the establishment of control to keep costs at a minimum.
iii) Ascertainment of cost of different departments helps in computing the cost of
different jobs or products which pass through these departments.
Allocation of Overheads:
After having collected the overheads under proper standing order numbers the
next step is to arrive at the amount for each department or cost center. This may be
through allocation or absorption. According to the institute of cost and management
accountants, London, “cost allocation is the allotment of whole items of cost to cost
centers or cost units.” Thus, the wages paid to maintenance workers as obtained from
wages analysis book can be allocated directly to maintenance services cost center.
Similarly indirect material cost can also be allocated to different cost centres according to
use by pricing stores requisitions.
Apportion of Overheads:
Apportionment refers to the distribution of overheads among departments or cost
centres on an equitable basis. In other words, apportionment involves charging a share of
the overheads to a cost centre; ICMA London has defined it as “the allotment to two or
more cost centres of productions of common items of cost on an estimated basis of
benefit received.” Apportionment is done in case of these overheads items which cannot
be wholly allocated to a particular department. For example, the salary paid to the works
manner of the factory, factory rent, general manger’s salary etc. cannot be charged
wholly to a particular department or cost center, but will have to be charged to all
departments or cost centres on an equitable basis.
Primary Distribution of Overheads:
Primary distribution of overheads involves allocation or apportionment of different
items of overheads to all departments of a factory. This is also known as
departmentalization of overheads. While making primary distribution the distinction
between production departments and service departments disregarded since it is of little
use. The distribution of different items of overheads in different departments is attempted
on some logical and reasonable basis.
Basis of Apportionment of Overhead Expenses:
It is stated that the total overheads expenses of a department comprises direct
overhead expenses incurred in the departments itself as well as the apportioned overhead
expenses of other service departments. Expenses directly incurred in the departments
which are jointly incurred for several departments have also to be apportioned e.g.
expenses on rent, power, lighting, insurance etc. in otherwords, common expenses have
to be apportioned or distributed over the departments on some equitable basis. The
following bases are most commonly used for apportioning items of overhead expenses
among production and service department.
Usually, the computation is made on the basis of the estimated expense or the normal
expense for the coming period. Thus, the machine hour rate usually is a predetermined
rate.. rate for each individual machine may be worked out or, where a machine of similar
machines are working in a group, there may be a single rate for the whole group.
The following steps are required to be taken for the calculation of machine hour rate:
i) Each machine or group of machine should be treated as a cost center.
ii) The estimated overheads expenses for the period should be determined for each
machine or group of machines.
iii) Overheads relating to a machine are divided into two parts i.e., fixed or standing
charges and variable or machine expenses.
iv) Standing charges are estimated for a period for every machine and the amount so
estimated is divided by the total number of normal working hours of the machine
during that period in order to calculate an hourly rate for fixed charges. For
machine expenses, an hourly rate is calculated for each item of expenses
separately by dividing the expenses by the normal working hours.
v) Total of standing charges and machines expenses rate will give the ordinary
machine hour rate.
There is two of computing the machine hour rate. According to the first
method, only indirect expenses directly or immediately connected with the operations of
the machine are taken into account. E.g., power, depreciation, repairs and maintenance,
insurance etc. the rate is calculated by dividing the estimated total of these expenses for a
period by the estimated total of these the machines during the period.
It will be obvious however that in addition to the expenses stated above there
may still be other manufacturing expenses such as supervision charges, shop cleaning and
lighting, consumable stores and shop supplies, shop general labour, rent and rates etc.,
incurred for the departments as a whole and, hence not charged to any particular machine
or group of machines. In order to see that such expenses are not left out of production
costs, one should include a proportionate amount of such expenses, in the expenses of
machines, before proceeding to compute the machine hour rate. Some people even prefer
to add the wages paid to the machine operator in order to get a comprehensive rate for
working a machine for one hour. But it is preferable to include the machine operator’s
wage in direct wages.
Generally, all expenses are not allocated to machines; it will be, therefore,
necessary to calculate another rate for charging the general departmental expenses to
production. This second rate will be calculated on the basis of direct labour hour or
wages. In effect, therefore, both the machine hour rate and the labor rate will be applied,
though separately.
As regards the superiority of one method over the other, it may be considered
hat the recovery of the direct machine expenses without the proportion of the
departmental expenses is likely to be more accurate than when these are made a part
therefore, because the general departmental expenses are not connected with the actual
operation or the machines except remotely. Therefore, when merged with the direct
machine expenses for the purpose of computing the machine hour rate, the resultant rate
may not be as accurate or as it would be otherwise. But the second method has the
advantage of simplifying the routine and procedure of applying manufacturing overheads
in as much as only the machine hour rate has to be applied for charging the general
departmental overhead.
Advantages:
i) Where machinery is the main factor in production, it is usually the best method of
charging machine operating expenses to production.
ii) The under absorption of machine overheads would indicate the extent the
machines have been idle.
iii) It is particularly advantageous where one operator uses several machines (e.g.,
automatic screw manufacturing machines) or where several operations are
engaged in one machine (e.g., the belt press used in making conveyor belts).
iv) It is a logical method and takes into consideration the time factor completely.
Disadvantages:
i) Additional data concerning the operating time of machines, not otherwise
necessary, must be recorded and maintained.
ii) As general data concerning rates for all the machines in a department may be
suitable, the computation of a separate machine hour rate for each machine or
group of machines would mean additional work-rate for each machine or group
of machines would mean additional work.
iii) If gives inaccurate results if hand labour is equally important.