INTRODUCTORY STUDY MATERIAL

FOR
DIPLOMA IN COST & MANAGEMENT ACCOUNTANCY
FOR ENGINEERS

Institute of Cost Accountants of India

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 CONTENTS

Sl No. Section Page Diagrams

1 INTRODUCTION
2 FACETS IN DEVELOPMENT OF COST & MANAGEMENT
ACCOUNTACY
3 INTER-RELATIONSHIPS OF COST & 1, 2,3
MANAGEMENTACCOUNTING AND OTHER DISCIPLINES
INFLUENCING IT
4 QUALITY-VALUE-COST : THE THREE PRIME FACTS 1, 2,3
UNDERPINNING BUSINESS STRATEGIES & THEIR
IMPLICATIONS IN COST & MANAGEMENT
ACCOUNTANCY
5 BASIC TOOLS & TECHINIQUES OF COST &
MANAGEMENT ACCOUNTING
6 EMERGING TRENDS IN COST & MANAGEMENT 1,2,3.1, 3.2,
ACCOUNTING : INTEGRATION OF ENGINEERING, 3.3, 4
FINANCE & OTHER SYSTEMS FOR MANAGERIAL
ANALYSIS
7 NEED FOR THIS CURRICULUM & ITS OBJECTIVES
(WHY SHOULD ENGINEERS PURSUE THIS
CURRICULUM?)

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 INTRODUCTION

"The stock market clearly does not value a company for excellently prepared financial statements
if operational excellence is lacking" (Philip Lawton).

Business excellence presupposes information-based management as one of its core principles.In

today’s context, integrated information system with global and local networks, cuts across all
activities of an enterprise and it attunes the enterprise to its internal and external realities. It is the
principal tool to the management for analysing facts, taking decisions, communicatinginstructions
and reviewing performance. Information system indispensably includes ‘accounting’ for the
money measureof transactions for an entity (enterprise). However, traditional or financial
accounting records transactions between an entity and its contractual persons (suppliers,
customers, employees, etc). It is also used for discharging statutory liabilities. There is no reason
as to why should financial acounting record internal transactions like processing, handling &
testing of materials, idleness of machineries, abnormal wastages and so on.Therefore, traditional
or financial accounting is historical in its approach enshrined in its own principles. It does not
throw much light on risks that confront future and opportunities that are lost.

The need for a complementary system combining all other systems for strengthening financial
information was felt for long. Initially, ‘cost accounting’ was developed with the advent of factories
after industrial revolution (1760-1820). Cost accounting was then practiced as a confidential
discipline for matching revenue-cost, controlling expenditure and pricing products. It was
institutionalized much laterin comparison to accounting and management professions.Decades
after institutionalization, industries started viewing cost accounting as a useful tool for
management which should outgrow the limitations of traditional or financial accounting and
become a comprehensive discipline by itself. This led to evolution of ‘cost & management
accounting’ specially during the great depression following the great wars ending in 1945.Thus,
cost & management accounting has its initial roots in cost accounting. Many authors prefer to
name it as ‘cost & management accounting’. [Note : Britain is known to be the first to
institutionalize Cost & Works Accountancy in 1919. Later, the institute was renamed for Cost &
Management Accountancy in 1972 and for Management Accountancy in 1986].

Today & management accounting is the mostimportant information-link between accounting and
management. Ongoing researches on the subject across the globe consider significant issues
fect of enterprise’s processes (including employee development), e-transactions and integrated
between cost & management accounting and financial accounting :

Sl Aspects Cost & management Financial Accounting

accounting
1 Purpose  Voluntarily adopted for internal  Mandatory in corporate
use of management. and many other
 Information processed are businesses.
usually confidential.  Disclosures to external
stakeholders (investors,
lenders, tax authorities,
etc).
2 Processes Use of tools like the following :  Book-keeping and ledger
 Marginal & differential cost posting
analysis,throughput accounting.  Extraction of trial balance
 Opportunity cost analysis.  Preparation of financial
 Risk accounting, inflation statements (Balance
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 accounting, replacement cost & Sheet, Profit & Loss A/c,
other valuations. Cash-Flow, Consolidation
 Human resource accounting of group accounts)
 Cash-flow and funds-flow
 Financial ratios
 Budgeting, variance analysis
with standard costing,
responsibility accounting.
 Quantitative techniques and
quality management tools.
3 Interdependency  Governed by management’s  Governed by Generally
information needs. Accepted Accounting
 Requires co-ordination with Practices (GAAP) and
other systems for balanced Accounting Standards.
information.  Independent system.
 Not subject to audit unless  Accountsare subject to
management’s self-audit statutory (external) audit
(internal audit) is reinforced. depending on the nature
and size of enterprises.

Note : ‘Cost & management accounting’ and ‘financial accounting’ are not watertight compartments. Former
draws basic information from the latter (e.g. receipts and payments, income and expenditure, etc) and generates
several information utilizing other systems for use by finance and non-finance executive.

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 FACETS IN DEVELOPMENT OF COST & MANAGEMENT
ACCOUNTING

There are five important facets in development of cost & management accounting as narrated
below:

1. Evolution of modern management:

a) Scientific approach -

Works of Taylor and his followers, Gilbreth andGnatthad laid the foundation of scientific
management. Such approach explores ‘best’ way of doing work for improving productivity.
It includes logical work division, employee training and result-based incentives.Taylor’s
‘Time Study’ and Gilbreth’s ‘Motion Study’combined as ‘Time & Motion Study’ breaks
human motion into one or more of 18 basic elements (called THERBLIG after Gilbreth). It
also establishes motion-time as influenced by working conditions and various human
strains. These subsequently got enlarged in ‘Work Study’ for improving methods and for
measuring work. It is supported by ‘Ergonomics’, another science emerged for
determining convenient work conditions for minimizing human fatigue. Gnatt’stime-
scheduling of activities is a widely recognized technique for project management.

Notes :
(i) Fayol’s 14 Principles of Management, from work division (with authority-responsibility, unity of
command, etc) to fair remuneration, stability of tenure and team spirit, were considered to be pioneering
work. According to Urwick, works of both Fayol and Taylor were complementary.
(ii) During primitive days of industrialization, difficulties in maintaining uniformity in product was an issue
which was quite significant in regard to interchangeability of assembled parts. Later, it triggered quality
drive including standardization of processes, inspection &testing at every stage from input receipt to
output recognition, preventive maintenance of machineries, employee training, etc. Such drive gave rise
to modern quality management systems.
(iii) Modern scientific approach takes support of rationalistic approach and ‘human factor’ elaboratedlater. It
combines Work Study, Ergonomics, Operations Research& Statistical techniques, Information &
Communication Technology, etc into a discipline called “Industrial Engineering” which deals in designing
& implementation of man-machine integrated systems. Management discipline has further progressed as
we will see later integrating all approaches toholistic or integrated management. Modern quality
management systems uphold such integration as pronounced in Total Quality Management (TQM).

b) Humanistic or behavioural approach -

Man “thinks” and behaves unlike materials and machines. Works of Follet, Mayo, Maslow,
McGregor, Herzberg, Weber, etc stressed on human motivation & learning for continuous
inventions of better ways. Homan, Newcomb, Tuckman, Thiabant, Keley, Senge, etc
worked on group behavior of man as a “social animal”. Their findings suggest goal-role
clarities, inter-personal relationships and reward system as the focal points for
performance of the group or team as a whole.It is said “Organization learns through
people, people learn through organization”. Organization is viewed in this approach as a
system (group or team) with leader complementing and harmonizing the skills of others. A
leader designs learning process and enables personal masteries.

In today’s context of fast changing technologies, it is all the more important to develop
Human Resource as the ultimate controller of physical resources. As technology reduces
hands (and even brains), it may be necessary to make an enterprise as lean as possible
with thrust on multi-skilling and clustered tasks. But human intelligence cannot be
substituted and hence, “No system is better than the persons who design and operate it”.
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 It is also said “Human resource is the most valuable asset which appreciates with time but
not recorded in the balance sheet”. There had been various attempts for measuring
effects of Human Resource Development (HRD) on enterprise’s business results.
Though such attempts are still in research, these opened up another aspect of man-
management viz. Human Resource Accounting.

c) Rationalistic approach -

Business decisions should be fact-based and logical. It is difficult for human brains to solve
complicated problems with large number of factors. It requires computers and mathematical
tools.

Charles Babbage (1933, known as the ‘father of computing’) showed the way for
quantitative solution of business problems. Several scientists have since worked on it
during and after the great wars and formulated the subject called ‘Operations Research’
(O.R.). It comprises mathematical & statistical techniques for solving constrained
objectives, both in deterministic and probabilistic forms. O.R. models can be simulated
according to situations, using definite steps called ‘algorithm’.

A technique similar to ‘algorithm’ for logical planning of information-flow in computers is

called ‘systems analysis’. It standardizes documentation process for an enterprise.
Science concerning communication known as ‘cybernetics’ has also been developed,
understandably after the works of Claude Shannone (1948).

In 90’s, online and integrated information systems emerged with widespread uses as a
result of advancements in computer technology and communication networks. Two major
application areas are Enterprise Resource Planning(ERP) systems and e-Commerce.
By this time, interfacial electronic appliances like audio-visual devices, sensing-actuating
devices, etc were well established. All these revolutionized Information and
Communication Technology (ICT). Thus, 21st century is rightly called an ‘information-
age’.

d) Contingency approach -

Despite scientific techniques and rationalistic outlooks, it is difficult to co-relate enterprise’s

results (effect) to its processes (cause). This is because of large number of factors many of
which are uncontrollable within an enterprise. Hence, enterprises grope in the risks of
uncertainties as ever and rather more in today’s fast changing situations. Therefore, an
enterprise needs to learn continuously its weaknesses from results. It needs to assess its
internal and external threats and adopt appropriate strategies for risk-bearing. Similar
views are expressed by Drucker, who while advocating Management By Objectives
(MBO), suggested early mitigation of adverse exceptions. Contingency approach points to
the need for Risk Management. It is true that profit is the reward for risk-bearing. Such
risk-bearing is not a blind speculation. Risk of losses due any threat, internal or external, is
borne through careful assessment supported by information-analysis. Such assessment
takes into account pains in mitigating the threat and possible gains arising out of such
mitigation.

Notes :
(i) There are views rejecting the notion of ‘uncontrollability’ as it denies managerial responsibilities for
innovations as major part of strategies.
(ii) Some models suggest experimentation as a basis of learning. Some others suggest long-run view
instead of quick profits and use of non-financial indicators for driving financial results.

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 Thus, management thoughts progressed from scientific approach to humanistic & rationalistic
approaches and finally to contingency approach. As every approach has its own merits,
modern trend is to take a holistic or an integrated view. Oliver’s ‘Supply Chain Management’
(1982) and Porter’s ‘Value Chain’ (1985) are examples of internal integration with meaningful
segmentations. Such integrated views gave rise to Total Quality Management (TQM). TQM is
also being increasingly practiced through various award systems of different accrediting
bodies e.g. Malcom-Baldridge, ISO, Demings, 6 Sigma, etc. These made significant
influences on cost & management accounting as well.We will consider these later in a
separate section in more details.

2. Fast changing technologies and ongoing globalization :

Fast changing technologies and gradual globalization of markets are increasingly

making competition keener and have dimensionally changed management’s
information needs.Today, almost all enterprises are forced to adapt to changing
business realities. In doing so, an enterprise has to interface between its changing
environment and adaptive organization, foresee opportunities & threats (risks) and
adopt appropriate strategies. An enterprise which does not do so is destined to perish
sooner or later. It is worth noting that even patented products are competed away in
the long run. More sosince with barriers of place & time in business are disappearing
fast.

Some of the important strategies which an enterprise undertakesto cope up with the
changing realities or scenarios are as follows :

a) Continuous innovations& improvementsthrough human motivation and

learning.
b) ‘Supply Chain Management’ (SCM)(covered later in details).
c) Multi-skilling of employees, clustering of tasks and lean enterprise for agility
and economy.

Cost & management accounting has an important role in financial evaluation of various options
that are considered for strategy-making. Feasible options often require implementation
through capital projects assessed techno-commercially for assured returns.

3. Global financial scams over last two decades and economic slow-downs of 2007-2010:

Global financial scams prompted several nations to review standards for financial reporting &
auditing, develop parallel audits (like forensic audit, systems audit, etc), initiate modern
practices and reinforce regulatory bodies. Repeated economic slow-downs further roused
several questions on finance discipline. These have also widened the scope of cost &
management accounting.

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 DISCIPLINES INFLUEINCING COST &
MANAGEMENTACCOUNTING& THEIR INTER-
RELATIONSHIPS

We have seen in the foregoing sections that cost & management accounting draws upon various
disciplines for meaningful analysis of financial information for use by the management. Such
disciplines are as follows :

1. Economics as the foundation of cost & management accounting

Economics provides rationales for allocating limited resources to unlimited and competing
human ends with ‘money’, the medium of exchange, providing the common measure. Though
money has no intrinsic value, yet it is a distinct property for storing and lending savings without
wear and obsolescence. Therefore, demand-supply of money (currency and credit in
circulation) affect prices and income besides their determinate influence on interest rate.

Important points are summarized below :

a. An enterprise earns profit as residual revenue over cost by managing demand-supply of its
products through appropriate organization deploying necessary capital.
b. In short-run, an enterprise may earn super profits or incur losses. There are fewer options
for avoiding losses like price-cuts or break-even. Labour may also be laid-off for minimizing
fund-erosion (subject to compliance of labour regulations). But in the short-run, an
enterprise can neither divest of its existing business not invest in new business. In long-run,
labour-capital can be re-organized innovatively if reasonable profits are expected over life
of capital. in long-run, profits must justify capital invested in the business. Else, an
enterprise may have to divest, rehabilitate itself or even exit.
c. Though profit over capital is used for measuring ‘return on capital’ (ROC), it is a reward for
risk bearing. Risk attaches to capital for uncertainties in demand-supply.
d. National income as aggregate expenditure is also related to demand-supply of money and
consequent interest rate. Lower interest rate (below ROC) induces investment in an
enterprise.
e. ‘Utility’ creation and its costare the principles underlying demand-supply [Note : ‘utility’
refers to need satisfying power of a product (article or service)].

The above facts of economics are the foundations of cost & management accounting in as
much as cost & management accounting explains business economics of an enterprise in
accounting language.

2. Operations Research (O.R.) and Statistical techniques

Quantitative techniques developed during the war, are now applied to solve numerical
business problems involving constrained objectives. Many of the O.R. models aresimulated
according to situations using definite steps (algorithms). A number of problems can be solved
like the following :

a) Games of competitive strategies

b) Product-mix yielding optimum profits
c) Resource allocation with minimum costs (e.g. allocation of transport vehicles amongst
various warehouses)
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 d) Que and idle time rationalization for cost minimization
e) Inventory replenishment for least cost of replenishment, storage & stock-out
f) Equipment replacement for minimising average discounted operating & maintenance cost
over equipment (This often requires Discounted Cash Flow technique, a well known
technique in cost & management accounting tool).
g) Project time-cost trade off (Projects may include product development or modification
including simplification & upgradation, plant modernization, market expansion, etc).

A generalized format for defining a problem in O.R. is as follows :

Parts of problem Functions Conditions

Objective Y = F(x1, x2,….,xn) Maximize Y (as for sales and profit) or
Minimize Y (as for cost and time)
Constraints G(x1, x2,….,xn) ≤ c1
H(x1, x2,….,xn) ≤ c2
: x1, x2,….,xn≥ 0
:
M(x1, x2,….,xn) ≤ cm

Where x1, x2,….,xn represent decision variable (e.g. quantities of two or more products), ‘c’
represents restrictions or limits on resources e.g. restrictions on capacity, time, funds,
etc.There are ‘m’ number of restrictive functions (G, H,…..M).

The problems can be solved through Linear Programming, Non-Linear Programming, Integer
Programming or Dynamic Programming as appropriate.

Also, statistical forecasting, estimation and testing have profound applications in business
research and quality control much as these are used in probabilistic models of O.R.
Regression analysis, which is one of the key techniques of forecasting, is also used for
understanding cost behaviour, sales projection and the like.

Cost & management accounting makes use of above quantitative techniques often through
computer programs for helping management in planning and control.

3. Information & Communication Technology (ICT)

Modern computers are used in solving complicated business problems involving large number
of variables. Many enterprises use O.R. & Statistical techniques tailored into computer
programs after careful systems analysis. This apart, increasing use of e-Commerce(like net
banking, e-tendering, e-invoicing, etc) with global networking since 90’s and of LAN-connected
digital applications (like bar coding/ decoding, Auto-CAD, CAM, PLC, GPS, Digital-Survey,
Biometric Scanner, Face & Voice Recognizersetc) took information system to a new height.
Today, integrated software (like ‘Enterprise Resource Planning’ or ERP) captures data not
only from online vouchers but also from digital applications aforesaid and external sources.
Further, ICT today offers a number of communication channels from e-mails to web
conferencing (audio & video) such that dependence on public assembly and board-room
meetings are much reduced. Therefore, this era is rightly called ‘information-age’.

It goes without saying that cost & management accountinghas now at its disposal, a wide
range of tools for extracting and analysing information and for making right information
available to the management at right time.

4. Value-Chain Concept

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Michael Porter introduced ‘Value-Chain’ concept in 1985. It stresses on value accumulation
through the chain of supplies into and within the enterprise and stretching to customers. It
identifies primary activities and support services. It also segments business into strategic
business units (SBUs). Value-chain concept focuses on weak links in the chain (“A chain is as
strong as its links”).

5. Management by objectives (MBO)

a. Peter Ducker’s concept of MBO was quite popular in 50’s. It advocates four steps viz. (1)
set clear organizational objectives (2) cascade these to employees (3) monitor & evaluate
performance (4) reward.

b. MBO was criticized on the ground that it does not addressconstraintsthat limit realization
of objectives (Ref. Theory of Constraints below).

c. MBO was also criticized on the ground that it focuses on results but not on the processes.
As Deming suggested, process produces results (Ref ‘Quality System’ below)

6. Theory of Constraints (TOC)

a. The concept was shaped by Goldratt during 80-90’s. It views business as a system which
converts money to ‘inventory’ of money (investment) and re-converts such inventory into
money. Such reconversion takes place through operating expenses and sales. In the
process, the system is limited by at least one constraint.

b. Constraints can be external or internal. These are defined in terms of demand-supply.

External constraint operates when demand for products is less than enterprise’s capacity
to supply. Internal constraint exists when supply is less than demand.

c. TOC favors SCM. It questions engineering controls in scorecard keeping as these do not
recognize the needs for organizational changes.

d. TOC advocates throughput accounting.

It is noteworthy that O.R. also deals with problem-solving for constrained objectives. But
TOC focuses on management process of breaking the constraints. TOC was criticized as
‘old wine in a new glass’ since it borrows heavily from management theories developed over
last 50 years. Another view is that the topics were covered in cost & management
accounting over decades.

7. Balanced Score Card (BSC)

Kaplan introduced Balanced Score Card (BSC) using Key Indicators (KI) in 90’s. BSC gives a
practical shape to MBO by quantifying objectives and integrating interests of all stakeholders
(customers, suppliers, owners, employees, society). It involves employees by making them
accountable for definite responsibilities measurable in terms of KI.

Notes : (1) KI may not correspond to engineering standards like input-output norms, quality parameters, cycle-
time standards, etc adopted by an enterprise. If these standards fall short of KI, other enablers must be put
in place for making up the short fall. This may virtually mean re-engineering processes (2) BSC may include
wide spectrum of measures including customer satisfaction, employee satisfaction, Corporate Social
Responsibility (CSR), etc.
.

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8. Supply-Chain Management (SCM)
a. The slogan popularized in SCM is “do your best and outsource the rest”(i.e.
focus more on core activities that give competitive edge than on non-core activities
which can be outsourced).
b. SCM involves decision-making on two prime alternative courses viz. in-souring and
outsourcing. Sometimes, even core activities are more strengthened through vendor
partnering or collaboration. SCM encourages sharing of vendors’ resources (Since there is
hardly any enterprise which is self-sufficient in resources in all situations).
c. Outsourcing may take different forms like technical collaboration, contract manufacturing,
job work, equipment leasing, maintenance contract, labour supply, etc. Often technical
collaborations involve foreign direct investments (FDI) against firm allotment or private
placement of shares. Sometimes, outsourcing may involve demerging of activities into
different companies either as independent entities or under the same management.
(Example : An integrated steel plant may retain steel making including sintering plant, blast furnace and
rolling mills as its core activity. It may outsource mining of iron-ore, coal, limestone, etc and manufacture
of coke. Outsourced activities may be sold out to different entrepreneurs or demerged into separate
companies under the same management).
d. SCM brings Purchase, Stores, Production, Warehousing and Despatch under the same
umbrella for a seamless chain of supplies stretching from suppliers to customers. These
are regrouped as in-bound, in-house and out-bound logistics.
e. SCM leverages supply network to which an enterprise belongs through information
system. An enterprise is a ‘supplier’ after all.
f. Outsourcing changes cost-structure as fixed costs reduce while variable costs increase.
There may be issues regarding qualities of outsourced services which need to be
addressed through adequate contracts and periodic performance reviews.

SCM is increasingly being considered as one of the important risk management

strategies.

9. Works Study

It comprises method study and work measurement. Former is the pre-requisite of latter.
Method study involves recording and examination of existing and proposed work for
improving efficiency and economy (and ultimately productivity). Work measurement involves
work-time determination through the following techniques :

a. Work sampling- repeated random observation of engagement & idleness of man,

machines, materials, etc)
b. Time-study - watch-time study (macro-motion study by direct observation) and micro-
motion study (frame-to-frame examination of films on motion).

Steps of work study :select work, record all relevant facts by direct observation, examine
recorded facts critically, develop&measure improved work method, compile&define time
standards, install new work method (agreed Standard Practice), maintain the standards
(Control).

‘Motion’ refers to movement associated with distinct body part(s) and direction. For
convenience of study, it is classified into 18 basic elements called ‘THERBLIG’s. Principles
of motion economy as formulated in ‘Ergonomics’(a science for developing most convenient
work environment for minimum human fatigue), are taken into account for standardising
work.

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 Watch-time study establishes standard time as follows :
Standard-time = Basic Time + Relaxation Allowance + Contingency Allowance.
Basic Time = Observed Time X Efficiency Rate
Relaxation Allowance = Fatigue Allowance + Personal Needs Allowance.
The allowances essentially depend on the work and the workplace and may range between
5%-12% in aggregate of the basic time.
Efficiency rate can be improved through training of workman, incentives for work and
workplace arrangement on Ergonomic principles. Improvement in efficiency rate reduces
observed time.
In the context of training or learning, Ergonomics offers an interesting finding on ‘effects of
learning’ popularly displayed in ‘learning curve’ representing Y=abx where x=No. of cycles,
Y=average time per cycle and a>0 & b <1 are constants. As ‘x’ increases, leaning increases.
This reduces ‘Y’.

10. Value Engineering

It is a practice of improving product’s worth through the following steps :

 Examining all factors that affect product’s usefulness, esteem and cost (Product should not
cost more than its worth).
 Identifying areas for improvements.
 Evolving alternative solutions for improvements.
 Selecting the best solution.
 Implementing selected solution with trials, training and rewards.

It uses group creativities (‘brain storming’) without hierarchy and adopts certain principles like
“avoid generalities”, “use applicable standards”, “blast, create and refine”, “prevent
roadblocks” and lastly the question “should I spend my money that way ?”.

Value engineering has similarities with quality management as it combines quality

improvement and cost reduction. Quality management is a broader technique, often extending
to whole enterprise.

Some models which are used for conceptualizing quality-value-cost are as follows :

Intrinsic value = Use value + Esteem value

Extrinsic value = Exchange value = Price
But, extrinsic value = intrinsic value (in commercial world)
Therefore, Price = Use value + Esteem value
Since, Profit = Price – Cost
Therefore, Profit = Use value + Esteem value – Cost

11. Quality System

Quality refers to need-satisfying power of any product. It may be difficult to measure quality
in absolute terms and it often means relative worth. It refers to objective attributes like
usefulness and esteem which are subjectively evaluated. The meaning of ‘quality’ changes
with person, placeandtime.
‘Quality’ is co-related to ‘utility’ in economics which also holds two different views :(1) utility is
measureable absolutely in terms of price(2) utility is measurable relatively in comparison to
alternate articles& their prices. Strictly speaking, former view is also a relative view since it is
not ‘utility’ per se but a buyer’s choice with a given budget that determines price.

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 Quality movement started with Quality Control (Statistical) for input and output. Later, it
extended to entire process from input to output as ‘Quality Assurance’, including reliability
and efficiency of machineries. Institutionalization of quality management started with awards
and certification programs like that of Malcom-Baldridge award of US, Demings prize in
Japan, Kaizen system, ISO(Geneva) certifications, six-sigma (6) certifications, etc. There
are many other fundamental systems like 5‘S’ system and ‘lean enterprise’, etc extending
to Total Productive Maintenance (TPM). [Note :Kaizen system has a conceptual
importance : Plan-Do-Check-Act (PDCA) cycle brings continuous improvements through
‘Check’ element slated to identify and solve problems encountered instead of carrying these
forward to next cycle].

Today, quality system includes all activities as in Total Quality Management(TQM)(“from

the smile of the receptionist to the smell of the toilet”). TQM holds that ‘quality’ is
everybody’s business irrespective of organizational hierarchy. Itfavors decentralized controls
with trained and motivated employees. Deming’s principles along with the views of others
like Juran and Crossby, laid the foundation of TQM.Taking their ideas together, quality is
‘fitness for purpose’ and an ‘effect of processes’. Latest development in the field is iTQM
(Integrated TQM) which uses integrated information technology, data mining, forced training
and governance.

Important points in quality management are summarized below :

 ‘Quality’ is difficult to be measured in absolute terms though in practice, it means “fitness

for a purpose” or conformance to some standards like dimension, composition, layout,
model, practice, etc (Ref. also Deming, Juran and Crossby). Often, it means ‘relative
worth’.
 Quality has reference to place and time as well as person evaluating it. Supplier-customer
may differ on ‘quality’ but “customer is right”.
 High quality need not mean high cost (Deming’s findings). Also, a supplier limits quality to
an optimum level within marketable range for maximum profit.
 ‘Process produces result’ (Refer works of Deming-Juran-Crossby).
 TQM encourages small but continuous improvements through trained and motivated
employees often in groups or ‘Quality Circles’. It favours decentralized control. TQM is
different from big one-time or revolutionary change as in Business Process Re-
engineering (BPR) undertaken through a central team. But both TQM and BPR use
common tools & techniques like brainstorming, benchmarking,information-analysis, trial,
implementation and rewards.
 Quality Management uses all tools & techniques of management. Certain specific tools
adoptedare as follows : Pareto analysis, defect-failure-accident analysis, cause-effect
analysis and affinity analysis.

Notes :
(1) Usefulness refers to operational efficiency as prime or basic value including productivity, reliability,
speed and ease (user-friendliness). Secondary and auxiliary usages are life (including maintainability and
preservability) and logistics (storability and transportability : size, weight, etc).
(2) Kaplan’s Balanced Score Card or BSC (1990) using quantitative Key Indicators (KI) gives practical shape to
Drucker’s MBO (1954). BSC integrates interests of all stakeholders and it can incorporate various
standards, engineering or otherwise. It also makes employees accountable for definite responsibilities
measurable in terms of KI.
(3) Works of Demings, CrossbyandJuran (Process-orientation for quality output, 1965-2008) and of Goldratt
(“Theory of constraints” or TOC, ‘90s) may also be viewed as complementing Drucker’s MBO. It is not
only the objective but also processes for its realization and constraints limiting it are important
considerations. It is noteworthy that ‘Activity Based Costing’ (ABC) assumes constraints in cost drivers,
O.R. optimizes objective with constraints and TOC seeks to break constraints. [It is important to note that
ABC, a technique that has grown over last few decades expanding the scope of BSC, tends to establish a

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 cause-effect relationship between an activity and its cost through well adopted measures (sometimes
referred to as ‘cost drivers’). Such measures may be derived from scientific studies for removing
assumptions & arbitrariness. ABC may appear to be costly and time-taking, but it can be driven through
an ERP system.
(4) ‘Tipping point theory’ (Gladwell, 2000) reveals that small but continuous improvements
progress faster than big one-time change through ripple effect and virtuous learning. This is in
sharp contrast to Business Process Re-engineering (BPR) explained later.

In short, Quality Management is not just test-certification or warranty compliance. It is a

balanced and continuous approach for satisfaction of all stakeholders of an enterprise. It
fosters employee motivation, organizational learning (even from failures) and culture for
using knowledge (including experimentation) as the basis. The diagram below illustrates a
typical TQM model :

12. Business Process Re-engineering (BPR)

a. BPR is a practice of changing business processes down the value-chain on a ‘clean slate’
without status quo. It is adopted for removing processes not adding to competitiveness,
instead of accelerating these through technology.Many enterprises hire international
consultants for facilitating access to global practices for bench marking (including best
practices, industry average, etc).

b. BPR not only means iterative improvements (as in TQM) but a fundamental and
revolutionary change including overhauling of organizational structure and culture,
management systems, business practices, etc.

c. BPR is not without criticisms. A blind drive for change may prove fatal (Goldratt and many
proponents of anti-Taylorism are critics of BPR). Very often, shortening of processes may
lead to downsizing and employee unrest.

14
 d. BPR is still regarded as an useful tool specially for enterprises facing bankruptcy and
closure. For success, it has to be undertaken after thorough analysis of business needs
and with best of the talents selected from different fields.

13. Standardization
a. It refers to specifying products and services objectively in clear and sufficient details
eliminating undesirable varieties. Engineering specifications use geometrical dimensions,
physical and chemical measures as appropriate.

b. Standardization is effective if products are produced continuously in few varieties.

c. Often standards are codified for easy reference e.g. coded shades of a colour in paint.
Use of bar codes has also facilitated inventory management.

d. In practice, engineering standards specify tolerance limits within which variations in inputs
and outputs are acceptable. Higher the precision required, tighter the tolerances allowed.

e. Besides engineering standards, standards for prices of materials and products may also
be developed for control during a period. These are based on current market prices
adjusted for anticipated changes (Sometimes, these are called current standards as
opposed to basic standards which remain operative over a number of years). Standards
may also extend to systems, layout, workplace, logos, code of conduct, etc.

f. An enterprise may adopt standards of its own or of others (benchmark, standards of ISI,
BSI, ISO, etc). Standards should be adopted during steady growth of a new product and
after employee training for new technology. These may be used for BSC and budgets.

g. Standardization has the following advantages :

 Uniform applications (as required for mass production)

 Interchangeability of parts
 Objective evaluation of performance (as in inspection)
 Elimination of wastes and undesirable varieties.

h. The main disadvantages of standardization are that it reduces human initiative and skill
and that it may become unreliable if not revised as situations change.

Standards to be effective should not be too tight to motivate employees nor too loose to be
relied upon for control. Updating standards is important in driving continuous improvement
like TQM, Kaizen and Six Sigma models. Standardization should strike a balance between
its worth and its costs (Techniques of Value Engineering are available for such cost-benefit
analysis).

14. Life-Cycle Costing

It is a long-term approach for strategy-making and considers life of a product or equipment. A
product needs appropriate strategies during its introduction, growth, maturity and decline
phases. Each phase reflects a distinct pattern of financial result (losses or lower profits during
early phases, gradual increase in profits till maturity is reached after which profits start
reducing or losses set in). Appropriate strategies include maintaining the product during
growth, renewal of product during decline, etc.

15
 Similarly, a machinery has initial period of teething followed by a trouble-free period and finally
a troublesome period. Economic life of the machinery is based on annual average discounted
cash outflows on the following machinery purchase (outright or against loan with periodic
repayments), its operation and maintenance over life. Such average is initially high for capital
outflow or loan repayments and for the operators’ learning phase. It reduces later and
acquires a steady state. After some years, the average increases sharply due to falling
efficiency of the machinery and increased repairs & maintenance. It is advisable to replace the
machinery when the average starts increasing. [Notes :(1) Sometimes, identical replacement
is difficult due to technological advancements. Often, funds reserved for replacement, may not
be sufficient due to inflation and price increase. This points to the need for valuation of assets
at replacement costs (2) The above model applies to equipment depreciating with time.
Replacement model for items that fail completely after a given time (e.g. electric bulb) is
different].

In Diagram 2 below, an example of LCC of a machinery is cited, taking year-wise running &
maintenance costs in cash discounted from second year to present values. In this example,
the average annual discounted cash outflow increases after 6th year and rapidly after 7th year
which is its economic life. Note that, a machinery which directly contributes to revenue
earning, can be evaluated by taking Internal Rate of Return (IRR) of net cash inflows. This has
been discussed later.

15. Techno-Commercial Analysis

It combines technical and commercial analysis for any new project like product replacement,
diversification, expansion, modernization etc. Such analysis is required as technical
feasibility and commercial viability are the prime considerations for capital expenditure. It
includes the following :

 Selection of technology, vendors and site

 Researches on market and availability of resources (physical and human)
 Financial evaluation
16
 Usually, techno-commercial analysis is undertaken in a team of experts drawn from all
relevant fields from within an enterprise and also from outside (consultants).

16. Corporate Social Responsibility (CSR)

a. CSR corresponds to corporate conscience. Every enterprise must be accountable for its
actions right from its published statements (prospectus, advertisements and financial
statements) to product quality, employee compensations and use of environment &public
money.

b. The key concept behind CSR is stakeholder orientation covering customers, suppliers,
employees, owners, community and society at large. BSC in many companies include
CSR.

c. There are standards formulated by ISO and other international bodies on environment
management, occupational health & safety systems (OHSAS). After world-wide financial
scams, International Financial Reporting Standards (IFRS) have been drastically modified
and enlarged. Many countries are increasingly mandating directors and auditors of
companies to report on specific aspects including related party transactions, inter-
corporate loans and investments, taxes, employee payments and other matters. Many
companies are also adopting ethical values beyond legal requirements. (In India, CSR
has been mandated for certain companies under Companies Act, 2013 for certain
specified societal activities).

17. Risk Management

Risk is perceived as probable adverse impact of an action. It has two components or factors
viz. probability of adverse impact of a threat confronting the action and its impact of resource
losses. Both these factors are taken together in assessing risk. The probability factor is due
to uncertainty (ignorance) of operation of the threat.

In business, changes in technology, demand, regulations as well as competition are potential

threats. An enterprise may have internal and external threats. Other common risks are
catastrophe, war, riots, accidents, etc. Normally, more the time horizon considered, more is
the risk.

Strategies for managing risks involve analysis of strength, weakness, opportunity and threat
(acronym ‘SWOT’). Such analysis develop ‘scenarios’ (options) for achieving the objectives.
The best option is selected. In such selection, pains in not bearing the risk is weighed
against gains in bearing risk.

Risk is managed through one or more of the alternative strategies like risk avoidance (e.g.
avoiding rough weather in sailing), risk minimization (e.g. safety arrangements), risk sharing
(e.g. insurance, corporate business, diversification and outsourcing) and risk bearing (i.e.
accepting the risk with preparations for contingencies). Too much stress on risk management
may delay projects. ISO 31000 lays down standards for risk management.

We can see from the above that there are a number of disciplines which have influenced modern
management as well as cost & management accounting. Quality system itself envelops most of
the other disciplines.

Implications in Cost & management accounting :

17
(1) BSC as organizational standards are used in budgetary control by several organizations
(2) Value-quality trade off through appropriate costing technique, is an important application in
Management Accountancy.
(3) O.R. provides a quantitative solution to a constrained objective while TOC focuses on
processes for breaking the constraints. On the other hand, ABC takes into account
constraints or bottlenecks in ‘cost drivers’.
(5) Quality management tools are also applicable for various analysis
(6) Continuous improvement assumes learnings from the past or even from failures. Therefore,
Incremental Budgeting is more appropriate than Zero-Based Budgeting (ZBB).
(7) Early indications of risks can be derived from adverse financial ratios, unabsorbed overheads,
negative contribution, liquidity crisis, erosion of net worth, etc. Adverse variances under
budgetary control with standard costing, may also throw useful lights.
(8) Risk provisioning includes risks of obsolescence, inflation, downfall in investment price, bad
debt, exchange devaluation, etc. Contingent liabilities are also important aspects.

We close this section with a diagram below illustrating interplay of cost & management
accounting with other disciplines:

18
 QUALITY-VALUE-COST : THE THREE PRIME FACTS
UNDERPINNING BUSINESS STRATEGIES & THEIR
IMPLICATIONS IN COST & MANAGEMENT ACCOUNTANCY

It follows from the foregoing section that ‘quality’ and ‘cost’ are two related facts underlying
demand-supply. In quality movement, it was well established that high quality need not mean
high cost (Deming’s findings). In fact, quality-cost can be traded off for optimum value of the
product (This is well recognized in value engineering).
It is important here to note that ‘value’ of a product is influenced not only by quality and cost of
the product but also by competitors’ products. In the first place, it is the customers who evaluate
a product as the supreme judge. Supplier’s evaluation of its product is based on financial
performance of the product.
Diagram 1 shows a bird’s eye-view of quality-cost relationship and their influence on ‘value’.

19
Thus, quality and cost are two major areas of strategies affecting the product which itself is the
result of enterprise’s strategy. Therefore, in competitive edging of a product, the factors
influencing its quality and cost need proper evaluation. Such factors and their evaluationcriteria
are narratedbelow :

1) Product Design :

Aproduct acquires esteem (by its brand name) after successful use of it by a large number of
customers over a period. Product’s life span in the market is greatly enhanced if its design
addresses factors like efficiency, reliability, user-friendliness, maintainability, durability etc as
appropriate for the product on one hand and cost to customer on the other hand. Design has
to address one question at last : how is it better than competitors’ products ?

2) Technology Selection:

Selection of machineries and materials have far reaching effects on quality and cost of
product. Technology absorption process includescollaboration and knowhow development.
Modernization of plant is another area for technology renewal. Since these commit an
enterprise for long, a detailed techno-commercial analysis and feasibility studies may be
necessary with professionals or consultants drawn from different fields. A project report is
normally drawn up for Board’s approval and such report forms the basis of financing including
share issue (initial or subsequent), bank loans, royalty & lease payments, etc.

Some important facts for cost-benefit analysis in regard to technology selection are as follows
:

a) Automation reduces direct labour but increases production overheads.

b) Life-cycle cost of technology -
Employee training and preventive maintenance functions are important in reducing
downtime and spoilage costs.
For new technologies specially those absorbed through collaborations, it is necessary to
document standard operating procedures, trouble-shooting check lists and part
replacements & assembly overhauling schedules.
c) Chances of obsolescence of machineries may badly affect costs, if spares are not
available in future. Therefore, vendor selection and their commitments are also important
considerations.
d) Phases in product life effect technology selection.
e) Time value of money is an important consideration. Usually, Internal Rate of Return (IRR)
is adopted for evaluation of financial feasibility (after considering inflation factor in
estimated cash flows over life). IRR can be compared with risk-free return rates or interest
rate.

Examples :
 Bogie bolster for railway wagon can be produced by casting steel or by fabricating it by
forging steel and welding the parts. In casting, gross steel weight will be more while
fabrication requires additional wield material, though both methods must have same net
weight after machining. Selection of the right technology would depend on the volume of
production, investment in plant & machineries, operating costs, quality of the parts
20
 produced (in terms of dimensions with tolerance, mechanical properties, etc) and other
factors.
 Steel plant may have a captive coke-oven plant or it may blend imported and domestic
coke. For coke-oven, it may own captive colliery or blend imported and domestic coal.
Selection of the right option would depend on cost per unit of steel, assuming there are no
qualitative differences amongst the options.

3) Plant Location, Layout &Ergonomics :

Appropriate location of a plant reduces inbound & outbound logistics costs. Appropriate layout
reduces in-house logistics costs and handling time. Layout should also consider ventilation,
light, space, waste disposal and other human conditions (some of these are regulated by
statutes). Workplaces should be designed appropriately for safe working with minimum
fatigue. Such health, safety and ergonomic measures have favorable effects on both quality
and cost.

4) Process Planning &Control :

Use of digital technology with computers and networks help better planning & control of
machine conditions, workflow, vehicle positions, employee-attendance and inventory. These
have considerable effects on cycle-time and costs. (Modern trends have been discussed in
details under “Information & Communication technology” in the previous section).

5) Materials Handling :

Mechanized or automated handling contributes to phenomenal increase in productivity and

reduction of cycle-time. Volume of handling should justify mechanization or automation. A
cost-benefit analysis is desirable before making major investments [In automated production
processes as also in flexible manufacturing systems (FMS), automated materials handling is
almost inseparable from processes and it plays significant role for in-process feeds].

6) Supply Chain Management :

This was discussed in details in the last section. We will complement the last discussion with a
an illustration in diagram 2 to explain various options that are available in strategic decision for
making or buying a product or its key component/ input. We can see from the diagram that
such a decision may drill-down to technology selection, in-souring vis-à-vis outsourcing.

21
7) Management Practices :

Organizational culture emanates from the enterprise’s leaders. A leader should provide complete
road map for achieving enterprise’s envisioned mission. It should encourage learning, continuous
innovation and excellence in performance with adequate rewarding system. A regular review of
performance is of paramount importance in preventing failures. It is said “The speed of an
enterprise is the speed of its leader”.

Conclusion

At the outset, we have discussed that quality-cost can be traded off as done through value
engineering technique. We will now refer an example with Diagram 4 below adapted from an
iron-ore mine. The mine has a processing plant for enriching iron (Fe) content comprising primary
screening, re-screening & washing. Sales revenue increases with Fe% in ore, though not
proportionately. In the case cited below, profit earning is maximum at 62% Fe. This happens after
primary screening. Therefore, the enterprise may well decide to abandon re-screening & washing
or review these for cost reduction. It may even outsource re-screening & washing, if found
cheaper.

22
23
 BASIC TOOLS & TECHNIQUES OF COST &
MANAGEMENT ACCOUNTING

Cost & management accounting tools & techniques may be grouped as follows :

1. Those adapted from financial & cost management.

2. Those adapted from other systems.

We will consider the first group of tools in this section since the second group of tools has been
discussed in a previous section on other disciplines influencing cost & management accounting.

1. Financial Management Techniques

a. FUNDS FLOW ANALYSIS

i. Analysis of sources and uses of funds

ii. Cash-flow analysis as special case of funds flow analysis :
 Direct and indirect methods
 Short-run analysis
 Long-run analysis (using discounted cash flow technique)
- Net Present Gains method
- Internal Rate of Return (IRR)method : Elaborated later.

b. RATIO ANALYSIS

i. Ratios used for measuring state and trend of enterprise’s financial affairs, are
derived from Profit & Loss Account (P/L) and Balance Sheet (BS). Major ratios are
described below :

Sl Measure Ratio Source

1 Profitability Return On Capital Employed (ROC), Gross Profit P/L and BS
Ratio, Profit-Volume Ratio, Expense Ratio
2 Liquidity Current Ratio, Quick Ratio BS
3 Stability Proprietary Ratio (or Equity Ratio), Debt-Equity BS
Ratio, Asset Cover
4 Others Turnover Ratios (Asset Turnover and Liability P/L and BS
Turnover)

[Notes :(1) Proprietary Ratio (or Equity Ratio) = NW (or SF or Proprietor’s funds
incld both equity &pref)/Total Assets (excluding fictitious assets) : Ratio signifies
degree of creditors’ protection. Higher the ratio, higher is the enterprise’s capital
to pay debts (creditors – both money lenders & goods/ service suppliers (2)
Asset Coverage Ratio = (Total tangible assets – current liabilities)/ Total debt. It
should be min 1.5 and sometimes even 2.0 is preferred. Specific to fixed
assets, Capital Turnover Rate (CTR) is normally considered for gauzing
utilization of capital assets (3) Debt Servicing Coverage Ratio (DSCR) or Debt
Coverage Ratio (DCR) = Net Operating Income/ Debt Service. It measures
cash flow available for interest, principal & lease payments. It is normally
considered by banks for lending.]

24
 ii. Review of components ratios explaining the main ratio (Following Du Pont Control
Chart) – e.g. ROC may be broken down to profit-sales and sales-capital employed
(CTR). These may be further broken down to other fundamental ratios.

iii. Review of ratios as measures for planning and control (Merits and demerits of
ratios in financial forecasting and performance evaluation).

c. AGE ANALYSIS OF CURRENT ASSETS

d. BUSINESS VALUATIONS

i. Going concern basis, reconstruction basis, liquidation basis

ii. Income method and asset method

2. Cost Management Techniques

b. COST ANALYSIS

i. Cost-Volume-Profit relationship

 Break-Even and Margin of Safety analysis - using Marginal Costing

 Special cases : Analysis of certain costs like power, fuel, maintenance,
purchasing & storing, set-up & set-down, tooling.

ii. Time-cost analysis

 Capital expenditure (CAPEX) projects analysis - using Network

 Life-cycle costing of products and equipment

iii. Quality-cost-value analysis

iv. Activity Based Costing (ABC)

v. Differential cost analysis

c. REPSONSIBILITY ACCOUNTING (USING BUDETARY CONTROL & STANDARD

COSTING)

i. Master budget and functional budgets :

 Top-down, bottom-up and group approaches

 Use of standards (pre-determined norms, targets and budgetary standards)
 Physical and financial budgets
 Incremental budgeting (traditional) and Zero-Base budgeting (ZBB)

ii. Fixed and Flexible budgets

 Capacity considerationand activity-based costing (ABC) in budgeting

 Analysis of fixed, variable and semi-variable costs – using Marginal Costing

iii. Accounting controls in performance measurements : (Reviewed in the light of

computerized data processing).

25
 iv. Variance Analysis : Cause-Responsibility analysis

v. Performance Management (Reporting)

Note on DCF techniques with IRR

We will explain below DCF technique with IRR in brief for its importance as one of the key
techniques of Cost & Management accounting :

Net Cash-flows (=Cash inflow- Cash outflow) over a period (T) discounted at internal rate of
return (R) is used widely for life cycle costing, long-term pricing and outsourcing. For example
for new investment in a machinery, taking net cash inflow (I) for any year (t) over machinery’s
life (T), ‘R’ can be calculated with the help of any standard software. Anticipated inflation is
considered in cash flows for realistic analysis. R below minimum expected rate of return (r) is
rejected.

For long-term pricing, price can be fixed for desired R and for long-term outsourcing contracts
like collaboration & leasing, rate for desired R can be negotiated. The analysis is also helpful
for developing project report for loans, share issue, etc.

The model can be formulated as follows :

 (1  R)
It
t 1
0 (t  1,2,3,.....,T , r  R  1, 0  r  1)
t 1

(Further details avoided since contained in appropriate module of the curriculum)

26
 EMERGING TRENDS IN COST & MANAGEMENT
ACCOUNTING : INTEGRATION OF ENGINEERING, FINANCE &
OTHER SYSTEMS FOR MANAGERIAL ANALYSIS

Growing practice of integrated management & its impact on cost &

management accounting:

Three most important enablers for integrated management are as follows :

 ICT-enabled production processes, e-Commerce & informatics – Already explained in

one of the previous sections. It is suffice here to note that today, almost all information need
for an enterprise can be tracked through appropriate software with global and local networks.
We will consider further examples later.

 Supply Chain Management (SCM)– Already explained in one of the previous sections. The
point emphasised here is that SCM presupposes appropriate ICT. Enterprise as a ‘supplier’ is
required to explore supply network catering to the target markets & customers through
networked integrated information system. It has to complement its resources with that of the
suppliers in improving supplies, drawing relevant information from such system.

 Organizational learning - Progressive companies are increasingly recognizing virtuous

learning throughout the organization with every employee involved in continuous
improvements sometimes in groups and circles. ICT is well utilized as a medium for it.
Organizational learning brings togetherness which also helps integration.

Thus, ICT plays a very important role in integrating fragmented functions of an enterprise. A
simple illustration of bar coding/ decoding is depicted in Diagram 1 below. It can facilitate online
sales ordering, invoicing with all details of customer, product & mode of despatch, sales
accounting & inventory management with data drawn from marketing, production & quality
control.

27
Diagram 2 below shows how benefits of integrated information can be reaped in analysing
process costs for a ferro-chrome arc-furnace. This is explained below :

Sample results of laboratory analysis for a batch of 400 Kgs of dry chrome ore (lumpy and
friable) indicate 32.84% chromium (Cr) in ore out of which 172.42 Kgs ferro-chrome containing
64% Cr is obtained. Similar analysis is available for spillage, slag and flue gas. If 85% Cr
recovery is considered normal, ferro-chrome short produced is 2.04 Kgs [=172.42-
32.84×0.85×400/64]. Such loss has cost implications depending on input costs with labour &
overheads, and should be examined by verifying furnace and operational efficiencies. Similar
analysis can be made for coke (Flux used for separating Silicon present in ore, is not shown in
the diagram).

28
Engineering standards & analysis adoptable in cost & management
accounting
 Types & sources of engineering standards - Matching cost-revenue, analyzing their
relationship and controlling wasteful expenditure, require accounting of expenditure-income
not only in financial terms but also in terms of enterprise’s performance standards. These
include following physical or engineering standards :
1. Specifications for products, materials, processes & machineries.
2. Norms for input-output, ma-machine, time-work, capacity utilization, etc.
Various sources of physical standards are as follows :
a. Enterprise’s product literature (drawings, formulae, etc).
b. Patent document.
c. Technical collaboration agreements.
d. Equipment manufacturer’s norms for input-output, operation & maintenance.
e. Norms published by Bureau of Indian Standards & manufacturers’ associations.
f. Standard input-output norms (SION) considered in Govt’s EXIM policy.

 Uses of engineering standards in cost & management accounting - Some of the

important areas for use of engineering standards, are as follows :
 Enterprise’s budgets (OPEX, CAPEX and Working Capital).
 Project reports for bank loans and share issue.
 Declarations to Pollution Control Boards &tax authorities.
 Cost-benefit analysis of all forms – from contribution analysis to projected internal rate of
return (IRR). Diagram 4 in the concluding sub-section of this section illustrates use of
integrated information for cost-benefit analysis.

We have seen in Diagram 1 above how relevant information including sales orders, test
results, invoices, etc are integrated through bar codes in a steel plant. We have also seen in
Diagram 2 how laboratory analysis captured in information system can be used for
analysingcosts in a ferro-chrome plant. We will also consider another example later illustrating
various standards in an engineering works with Diagrams 3.1, 3.2 & 3.3 in a separate sub-
section on ABC below.

 Scientific approaches in Activity Based Costing (ABC) – ABC is gaining popularity in

industries for its scientific measures of activities that give rise to costs. Such scientific
measures (referred to as “Cost Vectors”) not only remove arbitrariness of cost allocations but
also establish activity-cost relationship. Owing its origin to Kaplan &Bruns (1987), ABC takes
into account constraints described in Goldratt’s TOC, transfer pricing needs and target cost
validation. Because of work volume in ABC, integrated software (ERP) is of immense help
specially in big plants and multi-product situations. ABC is an opportunity as well as a
challenge in service sector for difficulties in defining and recording cost vectors.
We will now review an example of cost vectors adopted in an engineering works. Diagram 3.1
shows top and front views of a flanged conical hopper made from mild steel sheet in an
engineering works. D, d, l, f are the prime parameters from which value for and finally,
values for ‘a’ and ‘c’ are determined (Refer sheet layout drawing in Diagram 3.2). Accordingly,
appropriate sheet size is selected for minimum scrap. Various cost vectors like length of cut,
hopper area & weight, etc derived from drawing as well as operation-wise time-standards fixed
after Works Studies for D=500 mm, d=100 mm, l=1200 mm and f=150 mm using sheet
thicknesses of 2 mm & 4 mm are shown in Diagram 3.3.

To elaborate the use of cost vectors, let us take welding for 4 mm quality. It takes 7.53 man-
hours approx (= 8.5 man-minutes × 53.15 inches : Ref Diagram 3.3). [Note : Man-machine is
standardized through Works Studies]. Similarly, painting quantity (primer & enamel) and time
29
can be calculated from hopper area, handling time from hopper weight & distance moved, and
so on. Thus, costs (including labour & overheads) can be easily linked to cost vectors. In
wielding for example, electrode consumption is directly related to sheet thickness and length
of weld while labour & overheads may be absorbed on man-hourly basis (Ref calculation
above). Different thicknesses (viz. 2 mm & 4 mm) account for differences in costs of steel,
welding electrodes, cutting operation (gas cutting for 4 mm and nibbling for 2 mm) and other
costs. Interestingly, cost per Kg is lower for 4 mm quality compared to that of 2 mm quality due
to doubling of weight in former while total cost does not increase proportionately. Some
reasons for these can be found out from Diagram 3.3 e.g. fixed work-times for marking &
painting.

30
 Techno-Commercial analysis of Quality-Cost-Value projects - Competitive edging focuses
on three prime and inter-related areas viz. Quality-Cost-Value. Often it involves capital
projects like modernization, diversification, simplification, etc supported by R&D,
benchmarking or collaboration as appropriate. Normally, such projects call for detailed
Techno-Commercial analysis in a group for the enormity of factors like market, product,
technology, plant location & layout, process control, supply-chain, organization, etc. Cost
&Management accountants have important roles to play for evaluation of such capital projects.

Latest trends (Some important topics elaborated)

Cost analysis requires relevant data besides monetary expenditure. We will review below a
few major points concerning accounting and analysis of costs in light of today’s information
needs :

a. Multi-entry accounting

Besides give-take aspects of a transaction (as reflected in ‘Debit’-‘Credit’ duality), modern

integrated information systems record other aspects as follows :

 Quality standards & test results

 Quantities of input, output, wastages, etc.
 Purchase & sales orders
 Warranty complaints

Some of the above, are not ‘transactions’ in traditional accounting, but useful for analysis
including Activity Based Costing (ABC). A few illustrations are cited from different fields :

Illustration1 :Procuring materials from alternative sources (example from steel industry)

If imported coke with 87% carbon costs Rs 4,680 per ton as against domestic coke with 84% carbon Rs
4,585, then imported coal is cheaper. It will be wrong to go by monetary figure alone since carbon
directly impacts steel output.

Illustration2 :Standard Input-output for product costing

Integrated information can conveniently capture data on input mix for given output, broadening
production accounting. Refer example above for a ferro-chrome plant.

Illustration3 :Cost drivers in decision-making

 Various overheads enter into quantitative analysis for cost minimization. For example, taking
fixed order quantity model for inventory with average purchasing cost (P) in Rs. per order and
annual storing cost (S) in Rs. per rupee of inventory, any stores item with price ‘r’ and annual
2 AP
requirement (A) in units will have economic ordering quantity ( EOQ)  . Therefore, it
rS
is imperative to know overheads like purchasing and storing costs and respective cost drivers
viz. number of orders p.a. and average inventory (in money value).

31
  Above model can also be applied with little variation for optimizing batch-size of production
where it is necessary to know the costs of setting a machine up and down. Compiling such costs
would involve Work Study for data on setting times.

 In project scheduling, it is necessary to crash activities for minimum cost where time-cost are
important parameters for trade-off.

 Scientific and engineering standards are well used in ABC (Refer example above taken from a
sheet-metal works with Diagrams 3.1, 3.2 & 3.2).

b. Non-linear cost behaviour in some cases

In some cases as illustrated below, cost does not behave linearly with production :

 Maintenance cost :

Expenditure on equipment maintenance depends on various factors like practices adopted for
maintenance & safety, equipmenttechnology & age, operator’s skill, spares availability, etc. A
trade-off is necessary between preventive & contingency measures (including stand-by facilities
and insurance spares) on one hand and downtime costs (including liquidated damages and loss
of profits & goodwill) on the other hand.

Maintenance policy varies with equipment, depending on its failure probability. Normally, such
probability multiplies with failure probabilities of its critical parts. Some parts (like fasteners,
shafts, pulleys, bearings, gears, machine tools, etc) wear and corrode in varying degrees with
time, while some others (like electrical bulbs) fail completely after a time-period. Equipment
manufacturers usually suggest maintenance and renewal schedules of parts. Modern plants also
have software (PLC) for monitoring relevant parameters (like lubricant & coolant levels, etc).

One important model for predicting equipment failures using Poisson probability function is
P(n, t )  et (t ) n / n! where P(n.t) is probability of ‘n’ number of failures of a machine in
time ‘t’ and ‘  ’ is the average failure rate.

It follows, planned maintenance cost of equipment is likely to correspond to a pattern like

Y  a  bX  cX 2 where Y=Maintenance Cost (in money value), X =Production (in units)
during a given time period and a,b,c represent regression constants for the period (expanding
the above probability function, introducing X substituting ‘t’ suitably. Note : terms with higher
powers of X are ignorable for negligible values).

For a new man-machine or technology, operators should be sufficiently trained for reduction of
initial mis-handlings and consequent downtime and maintenance costs.

 Power & Fuel Costs

In machine controlled (automated) operation, power cost is fairly proportional to volume of

output, if constant machine efficiency is ensured through maintenance. In labour-controlled
machine operation, power cost also depends on labour efficiency besides machine condition.
Fuel-driven machineries have similar characteristics though for mobile equipment, several
external factors like plant layout, route, terrain, traffic density, weather, etc can come into play.

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 Industrial tariff for power usually stipulates a minimum charge irrespective of power
consumption.

Let us take the fundamental machine law (P = aW + b) where ‘P’ and ‘W’ represent input energy
spent and output work achieved respectively. ‘a’ and ‘b’ are regression constants, depending on
the machine, work, operating conditions, etc. We may apply this simple rationale for analysing
energy costs in different situations. For example, if a crusher in a mine is run by a generator set,
norms can be set for diesel consumption in generator and electricity consumption in crusher
(estimating with generator’s Kilo-Watt and crusher’s Horse-Power capacities, efficiency factors
of these machineries as may be studied form supplier’s published literatures). Thus, diesel cost
can be co-related to mineral quantity (tonnage) crushed.

 Direct labour cost is normally assumed to be variable. However, many industries employ labour
on fixed monthly payment basis (though there may be performance linked payments as well).

 There are many other examples of non-linearity of costs.

Changing standards for financial reporting, auditing & governance :

Adequacies of traditional accounting, finance & auditing are seriously questioned after rampant
global scams and repeated economic melt-downs. Several countries have since revisited
standards for financial reporting & auditing, instituted concurrent checks including forensic
accounting & auditing and have reviewed finance discipline.
India has also started implementing various measures some of which are summarized below :
 Overhauling of Companies Act in 2013 – The new Act enshrines corporate governance
through responsive key managerial personnel (KMP), directors, independent directors (in
specified public companies), statutory auditor, internal auditor and Audit Committee (in
specified public companies) [Some of the specific provisions are included in points below].
 Directors’ duties have been made more specific u/s 166 and enlarged in different sections of
Companies Act, 2013. Many of these attract penal liabilities for contraventions.
 Auditors are subject to penal liabilities for willful contravention of provisions relating to audit
report (regarding its contents u/s 143 and signing requirements u/s 145) and non-audit
services (u/s 144).
 Introduction of secretarial audit in listed and prescribed public companies (S. 204).
 Auditor rotation (S. 139) & adjudication of alleged misconduct of statutory auditors by NFRA, a
new body (S. 132).
 Fraud reporting and investigation – External auditors are now obliged to report frauds, if
any, to Central Govt (S. 143). It is noteworthy that even omission of material fact in
statements, report, return, prospectus, etc may become ‘false statement’ u/s 448 attracting
penal liabilities for ‘fraud’ u/s 447, a new provision. Further, offences of fraud are non-bailable,
the cognizance of which can be taken by Special Court (set up u/s 435) against complaint by
Director of SFIO or any other officer authorized by Central Govt. S. 212 details such offences
and provides for investigation by SFIO.
 Valuation of assets-liabilities by registered professionals – Audit Committee, if any, or the
Board of directors may initiate such valuations (S. 247).
 Revamped provisions on transactions with related parties & insiders (Companies Act 2013 &
SEBI guidelines include disclosure & approval of related party transaction and prohibition of
insider trading. Different tax laws address arm’s length price or ‘fair value’ in their own ways).
 Use of electronic system is now on anvil for accounting, voting in GM, notice & proceedings of
Board meetings and inspection of minutes under Companies Act.

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 New reporting standards –
 Erstwhile Accounting Standards (AS) have been replaced with Indian Accounting
Standards (Ind AS), drawing mainly from IFRS and Indian GAAP [Note :Standards for
accounting and auditing shall be prescribed by Central Govt in consultation with NFRA u/s
133 and 143 respectively].
 Board’s report has been enlarged to include matters relating to loans, investments, related
party contracts, unspent CSR amount, if any, audit qualifications, extract of Annual Return,
observance of internal financial controls & legal requirements (S. 134 read with S. 92, 135,
186 & 188).
 Income computation standards (ICD) have been introduced by CBDT.
 Revisions in RBI guidelines for Non-Banking Financial Companies (NBFCs).
 Penalties for non-disclosure of foreign assets & income by Indian residents under Income-Tax
Act.
 Appointment of SIT by Supreme Court on black money – The SIT has since made some
recommendations after reviewing various provisions of Income-Tax Act, Customs Act, FEMA,
Security Laws, etc. These are under considerations of concerned authorities. Further, tax
evasions above threshold limit are being considered for predicate offence under Prevention of
Money Laundering Act.

Way forward
In today’s context, information from all relevant sources are considered in strategy-making,
operational planning and performance management. This is the key principle for effecting TQM
and integrated management which in turn, presupposes appropriate information system. As cost
& management accounting is the main information-link between accounting & management and
since it interprets enterprise’s business economics in accounting language, therefore, its role is
enlarging with modern trends. Regulatory changes of recent times for checking financial scams
also provide for definite responsibilities of key managerial personnel, accountants and auditors.
These are making cost & management accounting more and more a sophisticated discipline. It is
imperative to note that cost & management accountants should keep pace with such emerging
trends.

We will end the discussion with an illustration on a typical information-analysis with integrated
approach, the practice that is emerging in modern cost & management accounting. Diagram 4
below explains how several informationconverges on cost-benefit analysis of any form in an
integrated environment:

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 NEED FOR THIS CURRICULUM &ITS OBJECTIVES
(WHY SHOULD ENGINEERS PURSUE THIS CURRICULUM?)

Need for the curriculum

We have seen in the introduction that Cost & Management Accountancy today is the most
important information-link between accounting and management and it draws upon various
branches of knowledge for strengthening financial management of an enterprise. In the past,
when the discipline was known as Cost & Works Accountancy in Britain, India and many other
nations, the curriculum contained reasonable inputs for adapting accounting to various works.
Thus, cost accounting method for a foundry works would be quite different from that of a machine
shop. It may so happen that a foundry also has a machine shop for machining foundry products.
But cost accounting method in each would be different from the other. This is one of the features
that distinguish cost accounting from traditional or financial accounting. (It was observed in the
introduction that traditional or financial accounting is bound by certain fixed principles).

In today’s era of integrated and networked information systems, the scope of the discipline got
enlarged and enriched. All sub-systems are now accessible for drawing various information
relevant to financial management.Let us consider three most important sub-systems (other than
accounts) as follows :

1. Engineering -

The information from this sub-system includes standards for input-output and man-
machine ratios, work-cycle time, equipment availability, capacity utilization, specifications
of materials, machineries & product. Such standards are used for justifying actuals drawn
from other sub-systems.

2. Production (for information like process-wise output, in-process inventory, downtime

&idle time, extra-work or rework, scrap, wastages, etc)

3. Purchase & Stores (for information like rates of purchased items, storesinventory,
cases of stock-outs, obsolescence, etc)

It can be seen from the above illustrations that Cost & Management Accountancy today calls for
professionals who have basic knowledge for understanding the following besides Accounting,
Taxation &Finance :

1. Materials & processes of production

2. Machineries used in each process including those deployed for in-process feeds.
3. Product details (as reflected in drawing, formulae, technology agreement, patent
document, manufacturer’s catalogue and other published literature including those
submitted to statutory authorities).
4. Plant layout
5. Maintenance practices (including understanding maintenance needs from equipment
manufacturer’s maintenance manual).
6. Information system
7. Quantitative techniques
8. Modern management practices

In fact, industries expect CMAs to have reasonable understanding of all relevant disciplines
stated above.
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Objectives of this curriculum
The objective of this curriculum is to prepare engineers for Cost &Cost & management
accounting so that they are equipped with latest tools and techniques of the discipline as well as
withaccounting, financial management, business laws & indirect taxesand project management.
The curriculum in a short treatise, covers all that CMAs should know. The curriculum has been
carefully designed so that the engineers get fullest benefits out of the short treatise which is
considered enough for their backgrounds.

Why should engineers pursue this curriculum?

We have observed in the foregoing sections that rapid technological advancements have
confronted almost all sectors of business. From farming to mining, manufacture and logistics,
everywhere technology plays some role or the other. When we talk about technology, it is not
only the core technology of the sector but also Information & Communication technology,
Computer Science and Digital Electronics which are available today for driving integrated
information system of an enterprise. Hence, the role of technology and for that matter, the role of
engineers in managing an enterprise needs hardly any emphasis.

In the context of Cost & Management Accountancy, we have seen that a number of disciplines
are drawn into the practice of such discipline.These include Engineering practices (including
Production technology, Plant engineering & Maintenance practices), Operations Research,
Statistical techniques, Works Study, Ergonomics, Value Engineering, etcwhich have profound
influences on Cost &Cost & management accounting practices. Apart from Engineering practices
which are core areas in engineering discipline,other branches of knowledge mentioned above are
reasonably covered in any engineering stream.Thus, engineers have definite advantages in
leveraging above branches of knowledge for effective application of Cost & Management
Accountancy.

Therefore, there are more than one reason as to why engineers should pursue this curriculum.
Engineers desirous of complementing their skills with cost & financial management for
applications to their own businesses or professions or for higher responsibilities in employments,
are expected to be benefitted by this curriculum. Many members of the Institute of Cost
Accountants of India are engineers as well and they have praiseworthy track records of
successes in their own fields.

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