Cost Assgn

Table of Contents

1.0 Uniform costing..........................................................................................................2

1.1 Pre-requisites for Uniform Costing.......................................................................2

1.2 Advantages of Uniform Costing...........................................................................3

1.3 Disadvantages of Uniform Costing.......................................................................4

1.4 Example of Uniform Costing................................................................................5

2.0 Value-added Statement..............................................................................................6

2.1 Problems in preparation of VAS...........................................................................6

2.2 Advantages of Value-added Statement.................................................................7

2.3 Disadvantages of Value-added Statement.............................................................8

3.0 Presentation of Information to Management.........................................................10

Implication of Cost Management Information...........................................................10

3.1 Competitive pricing............................................................................................11

3.2 Monitoring and Controlling Costs......................................................................11

3.3 Strategic Planning...............................................................................................12

Reference...........................................................................................................................13

BM054-3.5-2 COST AND MANAGEMENT ACCOUNTING

1.0 Uniform costing

Uniform costing defined as “the use by several undertakings of the same costing

systems, i.e. the same basic costing methods, principles and techniques.” (LCCI, 1986,

p.302) Uniform costing cannot be considered as a distinct method of costing formally.

The basic idea behind uniform costing is that the different concerns in an industry should

adopt a common method of costing and apply uniformly the same principles and

techniques for better cost comparison and common good (ICAI, n.d.).

1.1 Pre-requisites for Uniform Costing

To implement a successful uniform costing in an industry, there must be a spirit

of co-operation and mutual trust prevailing among the participating firms. No

competition and hatred should exist among participant members. All the firms in the

industry must be willing to share and furnish relevant information with no concealment.

There should be a frequently mutual exchange of ideas. Moreover, the superior firms

should take the lead towards sharing their experience and expertise with the minor firms

to enable the latter to improve their performance.

Besides that, uniformity must be established with regard to three matters. The first

is size of the various units covered by uniform costing (ICAI, n.d.). The size of units

should be more or less the same which are to be brought under uniform costing. Units

differing in size should be classified in a number of categories according to their size.

Since the cost structure in an organization is influenced by its size, the classification of

units based on their size would make the cost statements of these units more comparable.

Next is the uniformity in production methods (ICAI, n.d.). All units in an industry

should use uniform methods of production. The third point would be accounting methods,

principles and procedures used. In fact, the uniformity should be achieved in respect of

methods of valuing inventory, cost unit, classification of costs and its components, basis

of allocation and apportionment of overheads and joint cost, methods of depreciation,

treatment of notional expenses, preparation of cost statements, reports and their

submission schedule and etc.

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1.2 Advantages of Uniform Costing

One of the greatest advantages of a uniform costing system for an industry is the

ability to make cost comparisons. Comparison made under such circumstance provide

objective basis, thus management can use it as guideline to self-examine their operation

and control costs effectively and efficiently. Moreover, the benefits derived are not only

those of price fixing, but also of the competition in efficiency of operation that develops

from such a comparison. Ordinarily, rumours and hearsay drift through the various

organizations in regard to costs of manufacture, and no doubt the comparisons would be

able to dispel these unfounded rumours (Halligan, 1928). In fact, uniform costing is also

very helpful in comparing the production efficiency of two units at the time of an

amalgamation and merger (Jawahar-Lal 2008, p.968).

The trend toward uniform cost accounting in all industries generally, has

improved competition and has promoted more intelligent competition based upon a more

intimate knowledge of the cost of manufacture and marketing (Halligan, 1928). It

managed to restrict unfair price competition and hence for restoring discipline and order

in applied industries (Walker and Mitchell, 1996). This improvement occurred during the

period of investigation and development of the uniform system of accounting. The

industry key companies will undoubtedly assume the leadership. In the process

comparing methods used, the companies will find that the "other fellow" has some good

ideas. They would discover that each of them has some distinctive feature of value, but at

the same time some cost elements have been ignored. This development period will

stimulate interest among the accountants of companies actively engaged in the work that

have some good influence in promoting more intelligent competition, providing other

economic forces do not befog the field too greatly, such as violent fluctuations in the

prices of raw material, or decided overproduction beyond the consuming power of the

buying public .

The management will be saved of botheration of developing and introducing a

costing system of theirs. The time and cost incurred on designing and establishing a

costing system is likely to be saved. A uniform costing system for the firms in the same

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industry is provided for the adoption of similar undertakings. Since the system is devised

by manual consultation and after considering the difficulties and circumstances prevailing

in the various undertakings, therefore it is readily adopted and successfully implemented.

1.3 Disadvantages of Uniform Costing

However, it is not easy to implement uniform costing in an industry due to the

differing circumstances in which firms operate (Dutta, 2009, pg.18-7). Individual firms in

the industry may differ in nature of work, conditions and organizational characteristics. In

case the differences are significant and there are no way to eliminating them, the adoption

of uniform costing would be unworkable.

Besides that, this system of costing tends to suggest a single price within the

industry which may lead to monopolistic tendencies (Solomons, 1950). On account of a

single market entity controlling supply, degree of price and supply control

exerted by the industry is greater. All the firms in the industry may act in a

concerted manner by curtailing supplies and thereby resulting in artificially raising price

of products.

In fact, uniform costing requires utmost cooperation, openness and confidence

among members of the industry group. But there would be some of the firms are hesitant

towards the use of this costing system. They may not be willing to reveal data or

information to the trade association for the fear of confidential information being passed

on to competitors. Even all firms are willing to share the information, it is possible that

the data provided may not be accurate. The firms may accidentally or intentionally reveal

the wrong information. As the result, the utility of the system lost.

The expenses needed for hundreds firms, big or small, public or private, in an

industry, to implement similar undertakings in their costing system definitely would be a

very big figure. Large and medium size firms may have the ability to pay for it, however

small or new established firms cannot afford it. The high installation cost would increase

the burden of the weaker firms. Some of the small size firms would rather adopt their

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own costing system which best suited their environment. Therefore, the workability of

uniform costing would be a big problem.

1.4 Example of Uniform Costing

The News Print Service Bureau, an association of newsprint paper manufacturers,

is one of the outstanding examples of an industry which adopting uniform costing

(Halligan, 1928). This association conducts a monthly comparison of the cost of

converting pulp wood into paper, excluding the material and marketing costs so that by

no stretch of imagination could its activities be construed as an attempt at fixing prices.

This monthly exchange of costs, supplemented by numerous operating efficiency data, is

based upon a uniform classification of accounts contained in the association's manual,

which has been universally adopted by all companies in the industry, so that all figures

are comparable and every member is talking the same language. These comparisons are

now, after so many years' operation, a fixture in the newsprint paper industry and are

veritable score cards registering monthly the results of the competition in efficiency

going on among the association members.

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2.0 Value-added Statement

The Institute of Cost and Management Accountants define added value as “the

increase in realizable value resulting from an alternative in form, location or availability

of a product or service, excluding the cost of purchased materials or service.” In short,

value added equal to sales revenue less materials and service purchased. It represents the

wealth the firm has been able to create by the efforts of its employees. (LCCI, 1986, p.

303)

The implementation of value added statement (VAS), in addition to an income

statement, a balance sheet and a cash flow statement, developed since 1970s in Britain. In

fact, the value added statement involves a recasting of the data contained in income

statement. Besides than showing the firm’s added value, the statement also illustrates

how the value added is shared between employees, the providers of capital and

government.

The publication of value-added statement is apparently adopts a broader

stakeholder-oriented viewpoint in compared with the income statement which is focus on

shareholders’ perspective only. It is recognize the fact that other members of a society

have a stake in corporate performance. Therefore, various professional reports in Britain

such as The Corporate Report and Green Paper support the inclusion of value added

statement in company financial reports.

2.1 Problems in preparation of Value-added Statement

However, the firms would be complied with two major problems in preparation of

value added statement. The first problem would be treatment of depreciation. Firms

would have to choose between gross value added approach and net value added approach.

In gross value added approach, depreciation is excluded from the calculation of value

added and is reported with retained earnings in the statement of changes in equity as a

‘distribution’ of value added. In contrast, depreciation is treated as a deduction from sales

in the calculation of value added in net value added approach.

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Some firms favour the former one because the sum of depreciation and retained

earning shows the amount of the value added that is available for reinvestment. It would

be difficult to be determined if depreciation is included with bought-in materials and

services. Nevertheless, the net value added approach is preferred because the use of gross

value added involves double-counting, as the supplier of a depreciable asset will include

its sale as part of value added, while the purchaser will not deduct depreciation from sales

revenue in calculating its value added. The arguments above are illustrating the fact that

both approaches should also be included in the value added statement.

The next problem is to identify which taxes should be reported in the value added

statement as a distribution to government. Most British companies choose to report only

corporate income tax because it can help in avoiding subjective decisions about which

payments to governments and their instrumentalities should be shown as the

government’s share of value added. Sales and excise taxes are excluded from value added

based on idea that the government sector has played no role in the wealth created by the

firm. The taxes are not shown as distribution to government as the view of ‘government

as public sector’ is not supported by most company (Meek & Gray, 1988).

2.2 Advantages of Value-added Statement

Annual report is an important medium by which a corporation communicates

information to a diverse set of users. In fact, value-added statement is always packaged as

social responsibility reporting. It is believed that through the supplemental disclosures in

the VAS, the company can reach out to new or expanded audience and thereby enlarge

the scope of interest in the company (Meek & Gray, 1988). Beside of maintaining the

primary orientation of its traditional financial statements towards shareholders, VAS also

provides information to other groups that may be meaningful to them. The good name of

company would be dispersed to society and thus establish a superior corporate image.

The VAS has been indirectly become one of the effective marketing tools.

In addition, the VAS can also be a motivation tool for employees. Income

statement just shows profit which is the reward of shareholders but not employees. Few

workers are said to be enthusiastic about maximizing somebody else's reward, and,

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therefore, a profit statement has little interest or motivational value for employees. In

contrast, the VAS reflects the wealth created by the firm to which employees contribute

and the distribution to them of a portion of wealth. When fully informed about VA, they

should be better motivated to work, be more cooperative and more identified with their

company. The illustration of reward to employees will enhance their attitudes to work

and thus reduce industrial disputation. In short, the value added reporting produces a

good organizational climate for labor by high lighting its contribution to the final results

of the firm (Riahi-Belkaoui, 1999, p.9).

The Corporate Report (ASSC) regards value added as a more preferable way of

describing performance. Product-based approach in VAS is more objective than profit-

based approach in income statement. Profits measure only shareholder’s share of a

company’s result of activities, while value assessed statements focus attention on the

success of a company in creating wealth and generating national income (Porwal, 2001,

p.233).

Besides than the focus of VAS, the net value added is a better index of

performance than net profit, especially in cases where arbitrary and in corrigible

accounting techniques result in recognition of an accounting loss rather than an

accounting profit (Sinha, 1983).

Also, the value added-based ratio analysis may provide a better index for the

measurement of managerial efficiency (Ball, 1968) and vertical integration (Morley, 1979). The

VA/payroll ratio makes it easier for the company to introduce a productivity bonus scheme

for employees. Imperial Chemical Industries Ltd. is the best known, have introduced such

schemes to enhance productivity. The employees receive bonus payments according to a

formula based on demonstrated improvements over time in the ratio (Morley, 1979).

2.3 Disadvantages of Value-added Statement

However, inclusion of VAS in an annual report can cause confusion with the

income statement, especially in cases when the trend of VA and earnings are different (Morley,

1979). What would those who are financial illiterate reading the annual report infer if he

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saw that VA was rising while earnings were falling? Suppose a company's sales for the

year were $500, bought-in costs of $300 and it paid $250 in wages. In these

circumstances VA for the year would be $500- $300 = $200, for that would be the value

placed on the company's efforts by its customers. However, a loss of $50 has been made.

What has happened here is that the team has earned $200 of VA but has over-distributed

to employees. In effect, shareholders have lost $50 of the company's reserves, as this is

the excess of wages over VA. The shareholders can rightly say they have lost value to the

extent of $50, but the VAS is not a report on shareholders' welfare. It is a report on the

welfare of a more broadly defined team, and that team taken as a whole has benefited by

value added of $200.

The next disadvantage of the VAS is that it raises a new danger of inefficient

management, since managers may wrongly seek to maximize their company's VA rather

than profit. This unsound advice could lead to grossly wasteful decisions in which

shareholders' capital would be dissipated in subsidizing uneconomic output and eventual

liquidation of company (Morley, 1979). For example, a company have choices between

self-manufacture or external supply of a component. The misled manager might choose

manufacturing when he discovers that the cost of direct material is lower than supplier’s

price, as the bought-in cost would be decrease and the VA would be increase. Yet, he

might have ignored about the cost of direct labour which is higher than the difference

between direct material and supplier’s price. In this case, the shareholders' earnings

would be fallen. The VA-maximizer would, therefore, be dissipating shareholders' capital

by manufacturing instead of buying in.

Last but not least, the objection of VAS is related to the preparation of VAS. Its

inclusion in the annual report would involve extra work, therefore extra costs and delay

and also a slight loss of confidentiality in view of the additional disclosure involved. In

practice the extra work, cost, and delay have proved to be negligible. Also, VA

Statements are flagrantly improperly regulated. No framework and standards have been

designed especially for VA Statement. Accountants have no guidelines to refer when

preparing VA Statement. Indeed, an unscrupulous accountant could manipulate the

choice of methods of VA calculation to produce almost any VA figure desired.

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3.0 Presentation of Information to Management

Degree of detail in information presented to management varies in accordance

with the recipient (LCCI, 1986). The data presented to higher management should be

fewer details. Comprehensive production cost data is presented to lower management

whereas only the summary figures are presented to higher management.

Next, the scope of information would also be different. The information to lower

management only covers the relevant section of the organization (LCCI, 1986).

Production manager only presented to production statistics and sales information to sales

manager. While, to correspond with wide scope of responsibilities, top management

needs all ranges of data to assist them in decision making.

In fact, the lower level management needs to have access to on-the-spot

information (LCCI, 1986). They are the one who leading the daily operation, thus any

incident happened which effect the process should be informed to lower level manager.

But, the top management would just have to view information presented on a regular

basis. They just want to check on the statistic to ensure the progression of the project is

under control.

The presentation of information is also following concept of ‘management by

exception’ (LCCI, 1986). Only variances or exceptions from budgets are highlighted to

management. This is to help managers to better utilize their time by concentrating only

on essential areas.

Implication of Cost Management Information

Cost management information would be able to help management improves

financial performance. A cost management approach recognizes that all strategic,

operational, and financial issues are interrelated. Cost management information can help

companies improve their financial and operational performance and better address an

array of management issues. Improved cost information enables companies to price

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product and services more competitively, reduce and control operation costs, and upgrade

strategic planning efforts (George, 1989).

3.1 Competitive pricing

For many organizations, securing or maintaining market position depends on

effectively pricing the services offered. Determining competitive yet profitable prices for

services requires a comprehensive knowledge of the cost, overhead, and potential sales

volume. While supply and demand issues, market considerations, and environmental

factors still form the foundation of a sound pricing policy, it is also important to properly

apply cost information.

Using the product margin reports the cost, margin, and profitability at current

gross charges for both individual products and for the entire product line can be easily

evaluated (George, 1989). And through various discount and product volume levels,

management can more effectively evaluate the potential effects of a variety of

assumptions on pricing and profitability (George, 1989). All these evaluation would

improve the basis for competitive pricing decisions.

By including accurate cost information in pricing decisions, management is able

to achieve profitability and understand the implications of various price and risk levels.

While each competitive opportunity should be evaluated based on its relative importance,

the proper interpretation and use of cost management information provides a means to

achieve sound, profitable pricing guidelines (George, 1989).

3.2 Monitoring and Controlling Costs

The performance reporting capabilities of a cost management system give

management information to better monitor and assess the financial results of day-to-day

decisions. Starting with summary performance information, "management by exception"

can be used to determine which cost centers are performing significantly above or below

expectations. More importantly, this report pinpoints the primary reasons, such as an

efficiency variance, for unexpected performance.

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Cost management information enhances the ability to measure financial

performance by providing the necessary framework to better monitor, control, and reduce

costs. Cost management information can use to compares budgeted and earned amounts

with actual results on a regular basis. With this information, the performance of each

manager or department can be accurately measured. A cost management system can also

provide information that is critical to pinpointing management's strengths and

weaknesses and is a key to implementing performance-related incentive compensation

programs.

3.3 Strategic Planning

The key objectives for strategic planning are to provide a clear direction for an

organization and to minimize the effects of future uncertainties. Before expanding an

existing service or introducing a product line, an analysis should be performed to

determine the resources required to produce an increased volume of products.

Product cost information can augment a company's strategic and operational

planning efforts. Bringing this information into the strategic planning process enables

executives to analyze the return on investment in conjunction with competition and

demand, maximizing the application of resources (George, 1989). With accurate cost

information, management can position the company to increase market share and

profitability by selectively expanding products that are most attractive to investors.

A cost management system provides information to help managers determine

where to invest limited capital and human resources. Product cost determination

information can provide the cost and revenue component necessary for strategic planning.

The cost and operational data generated by a cost management system help management

optimize strategic planning directives.

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Reference

Printed resources

1. Dutta, M. 2009, Cost Accounting: Principles and Practice, Pearson Education,

India

2. Jawahar-Lal 2008, Cost Accounting, 4th ed., McGraw-Hill, India

3. LCCI 1986, LCCI Study Pack: Cost Accounting, Professional Publications, Kuala Lumpur

4. Porwal, L. S. 2001, Accounting Theory-3E, McGraw-Hill, India

5. Riahi-Belkaoui, A. 1999, Value Added Reporting and Research: State Of The Art,

Greenwood Publishing Group.

6. Sinha, G. 1983, Value Added Income, Book World, Calcutta

Electronic resources

7. Ball, R.J. 1968, ‘The Use of Value Added in Measuring Efficiency’, Business

Ratios, pp.5-11.

8. George, M. J. K. 1989, ‘Cost Management Information Improves Financial

Performance’, Healthcare Financial Management. Retrieved 12 July, 2010, from

http://findarticles.com/p/articles/mi_m3257/is_n5_v43/ai_7589597/

9. Halligan, C. W. 1928, ‘The Relation of Uniform Cost Accounting to Competition’, Annals of the American Academy of Political and Social Science, vol. 139, Stabilization of Commodity Prices, pp. 74-79. Retrieved 12 July, 2010, from JStor: http://www.jstor.org/stable/1017508

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10. ICAI n.d. Uniform Costing and Inter Firm Comparison. Retrieved 10 July, 2010, from www.icai.org/resource_file/18861sm_finalnew_cp9.pdf

11. Morley, M. F. 1979, ‘The Value Added Statement in Britain’, The Accounting

Review, vol. 54, no. 3, pp. 618-629. Retrieved 10 July, 2010, from JStor:

http://www.jstor.org/stable/245988

12. Solomons, D. 1950 ‘Uniform Cost Accounting-A Survey’, Economica, New Series, vol. 17, no. 67, pp. 237-253. Retrieved 9 July, 2010, from JStor: http://www.jstor.org/stable/2549718

13. Walker, S. P. & Mitchell, F. 1996, ‘Propaganda, attitude change and uniform costing in the British printing industry: 1913-1939’, Accounting, Auditing &Accountability Journal, vol.9 no. 3, 1996, pp. 98-126. Retrieved from Emerald Insight: http://www.emeraldinsight.com/journals.htm?issn=0951-3574&volume=9&issue=3&articleid=869673&show=pdf&PHPSESSID=kvs46bgsfi7nou0hbueq6gpgo5

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Cost Assgn