Modern Techniques of Cost & Management Accounting


By

Ms. Kamal Sodhi
(CWA)
Faculty (Finance & Accounts)
K.R. Mangalam Institute of Management
 


Cost Accounting refers to "Accounting for Costs" and Management Accounting refers to "Accounting for management". If the term Cost & Management is analysed, it consists of three words Accounting, Management and cost. 'Accounting' refers to art and science of recording, classifying, summarizing and interpreting the financial transactions of a business. 'Management' refers to planning, organizing, directing and controlling of resources to attain stated objectives. Cost refers to expenditure incurred in the business. So, it can be said that Cost and management accounting in simple terms means recording, classifying, summarizing and interpreting the cost transactions for the management's decision-making. Recent developments in cost & management accounting stands for development in the area of cost and management accounting in addition to its traditional techniques viz., Standard Costing, Responsibility Accounting, Marginal Costing, etc. Modern techniques used by the management in Cost & Management Accounting for its decision making are as follows :-

* Pareto Analysis - Pareto Analysis is a statistical technique in decision making that is used for the selection of a limited number of tasks that produce significant overall effect. It is based on the 80:20 rule, as originally noted by Vilfredo Pareto (an Italian economist). It uses the Pareto principle the idea that by doing 20% of work you can generate 80% of the advantage of doing the entire job. Pareto analysis is a formal technique for finding the changes that will give the biggest benefits. It is useful where many possible courses of action are competing for your attention. In essence, the problem-solver estimates the benefit delivered by each action, then selects a number of the most effective actions that deliver a total benefit reasonably close to the maximum possible one. It states that Decisions having long-term implications may be extremely harmful if managers do not make decisions until they have 80% of the information in respect of costs and benefits, qualitative factors, and relevant issues involved. W hen used correctly, Pareto Analysis is a powerful and effective tool in continuous improvement and problem solving to separate the 'vital few' from the 'many other' causes in terms of cost and/or frequency of occurrence.

* Alternative Costing ABC (Activity based Costing) is an alternative to the traditional way of accounting. ABC is a costing model that identifies the cost pool, or activity centers, in an organization and assigns costs to products and services (cost drivers) based on the number of events or transactions involved in the process of providing a product or service. As a result, ABC can support managers to see how to maximize shareholder value and improve corporate performance. In a business organization, the ABC methodology assigns an organization's resource costs through activities to the products and services provided to its customers. It is generally used as a tool for understanding product and customer cost and profitability. An activity-based cost system provides management with an economic map of their enterprise; it identifies where money is being made and lost. As such, ABC has predominantly been used to support strategic decisions such as pricing, outsourcing and identification and measurement of process improvement initiatives.

* Customer Profitability Analysis It refers to analysis that assigns revenues and costs to major customers or groups of customers rather than to organizational units, products, or other objects. The results may direct organizational resources toward more profitable uses. It is an application of segmented reporting in which a customer group is treated as a segment. It is needed because different customers or groups of customers differ in their profitability. This is a relatively new technique that ABC makes possible because it creates cost pools for activities. It is especially helpful when combined with an activity-based costing approach that determines which activities are performed for each group and assigns costs based on appropriate cost drivers. It can be said that a small number of customers accounted for most of the profits, identifying profitable customers is therefore very important.

* Just-In-Time (JIT)   Just In - Time system refers to taking the raw material only at the required time for the production. This system eliminates the requirement of maintaining the stock. It is a 'Pull' system of production, so actual orders provide a signal for when a product should be manufactured. Demand-pull enables a firm to produce only what is required, in the correct quantity and at the correct time.
This means that stock levels of raw materials, components, work in progress and finished goods can be kept to a minimum. This requires a carefully planned scheduling and flow of resources through the production process. Supplies are delivered right to the production line only when they are needed. Just-in-time (JIT) is an inventory strategy that strives to improve a business's return on investment by reducing in-process inventory and associated carrying costs.

* Back Flush Accounting It is a system in which costing is delayed until goods are finished. Standard costs are then flushed backward through the system to assign costs to products. The result is that detailed tracking of costs is eliminated. The system is best suited to companies that maintain low inventories because costs then flow directly to cost of goods sold. Work-in-progress is usually eliminated, journal entries to inventory accounts may be delayed until the time of product completion or even the time of sale, and standard costs are used to assign costs to units when journal entries are made, that is, to flush costs backward to the points at which inventories remain. This system is possible only with a JIT type system of operation.

* Throughput Accounting It seeks to increase the pace with which products move through an organization by eliminating the bottlenecks with in the organization. The purpose of throughput accounting is not to control costs but as to demonstrate ways of improving profit by increasing production flow. Throughput Accounting is the only management accounting methodology that considers constraints as factors limiting the performance of organizations. It is based on Theory of Constraints (TOC). The theory focuses on constraints or bottlenecks to speedy production within an organization, cost gets reduced if raw materials are turned into products for immediate shipment to customers at minimum possible time. Throughput accounting's primary concern is the rate at which a business can generate profits.

* Life Cycle Costing (LCC) -
Life-cycle costing is a method of costing that looks at a product's entire value chain from a cost perspective. The aim is to adopt a policy which will maximize the return over the cost object's total life. It thus improves management decision-making. Since the whole life cycle of the cost object is considered, the importance of cost reduction and revenue opportunity is stressed under Product Life Costing. The longer a product yields a return, the more successful is the objective of developing the product.

* Target Costing It is a device to continuously control costs and manage profit over a product's life cycle. It is defined as "a cost management tool for reducing the overall cost of a product over its entire life-cycle with the help of production, engineering, research and design". A target cost is the maximum amount of cost that can be incurred on a product and with it the firm can still earn the required profit margin from that product at a particular selling price. Target costing involves setting a target cost by subtracting a desired profit margin from a competitive market price. It aims at Profit Planning.

References:

* Saxena V. K. & C. D. Vashisht, Basics of Cost and Management Accounting, Sultan Chand & Sons.
* Robin Cooper, Target costing & Value engineering, Productivity Press.
* Bhabatosh Banerjee, Cost Accounting-Theory & Practice, Prentice hall of India.
* Thukaram Rao M.E., Cost Accounting and Financial Management, New Age International Pvt. Ltd. Publishers.
* Maheshwari S N and S K Maheshwari, Accounting for Management, Vikas Publishing House Pvt. Ltd.
* Korgaonkar, Just In Time Manufacturing, Macmillan Publishers India.
* Manash Dutta, Cost Accounting- Principles and Practice, Pearson Education.
* Paresh Shah, Management Accounting, Oxford University Press.
 


Ms. Kamal Sodhi
(CWA)
Faculty (Finance & Accounts)
K.R. Mangalam Institute of Management
 

Source: E-mail January 18, 2011

          

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