TARGET COSTING

 Setting a target cost for a product or service

 Once the target selling price and profit margin are determined, the target cost is
calculated
 Target cost is calculated by subtracting the desired profit margin from the selling price.
 This target cost becomes the financial goal for the production team.
Example: In a competitive market, ABC determines it can only charge Rs10 per unit of
shampoo. To meet its financial goals, it needs a 10% profit margin, or Rs 1 per unit. The target
cost is calculated as the selling price minus the target profit margin, or Rs 10 – Rs 1 = Rs 9
RESPONSIBILITY ACCOUNTING:

Segmentation of the organization into responsibility centers, with each center assigned to a
specific manager or department. The core principle lies in holding managers accountable for
the financial outcomes of their designated responsibility centers.

 Human resources: Responsible for managing employee expenses

 Information technology: Responsible for IT-related expenses

 Research and development: Responsible for product development and innovation

 Customer service: Responsible for ensuring customer satisfaction

 Accounting: Responsible for managing payroll and other accounting-related expenses

 Maintenance: Responsible for office maintenance

 Production: Responsible for manufacturing or producing physical goods

 Sales and marketing: Responsible for sales, advertising, and marketing

 Distribution and logistics:

INFLATION ACOUNTING

 Inflation accounting is the practice of adjusting financial statements according to price

indexes.
 There are two main methods used as inflationary accounting methods. The first is
current purchasing power (CCP), and the second, being current cost accounting (CCA).
 The current purchasing power method involves adjusting the financial statements and
associated numbers to the current price. For non-monetary items, this is done by taking
the historical figures and applying a specific conversion rate based on a price index.
 The conversion rate is found by dividing the index price at the end of the period by the
index price at the beginning of the period. Monetary items are subject to a net gain or
loss during adjustment.
  The current cost accounting method takes the fair market value (FMV) instead of the
historical cost. With this method, all monetary and non-monetary assets must be
adjusted to their current values.

Practical Example

A company is using inflation accounting to adjust its equipment value in 2020. The equipment
was purchased for $10,000 in 2005 when the price index was at 300. In 2020, the price index
is now 600.

To find the new value using the CPP method, multiply the historical cost by the conversion
factor.

The new value of the equipment in 2020 would be $20,000 based on the conversion factor of
2 (600/300). The new value would be recorded on the balance sheet as the closing equipment
balance at the end of the period.

QUALITY COSTING:
Cost of quality (COQ) is defined as a methodology that allows an organization to determine
the extent to which its resources are used for activities that prevent poor quality, that appraise
the quality of the organization’s products or services, and that result from internal and external
failures.
Prevention costs
Prevention costs are incurred to prevent or avoid quality problems. These costs are associated
with the design, implementation, and maintenance of the quality management system. They are
planned and incurred before actual operation, and they could include:
 Product or service requirements: Establishment of specifications for incoming
materials, processes, finished products, and services
 Quality planning: Creation of plans for quality, reliability, operations, production, and
inspection
 Quality assurance: Creation and maintenance of the quality system
 Training: Development, preparation, and maintenance of programs
Appraisal costs
Appraisal costs are associated with measuring and monitoring activities related to quality.
These costs are associated with the suppliers’ and customers’ evaluation of purchased materials,
processes, products, and services to ensure that they conform to specifications. They could
include:
 Verification: Checking of incoming material, process setup, and products against agreed
specifications
 Quality audits: Confirmation that the quality system is functioning correctly
 Supplier rating: Assessment and approval of suppliers of products and services
Internal failure costs
Internal failure costs are incurred to remedy defects discovered before the product or service is
delivered to the customer. These costs occur when the results of work fail to reach design
quality standards and are detected before they are transferred to the customer. They could
include:
 Waste: Performance of unnecessary work or holding of stock as a result of errors, poor
organization, or communication
 Scrap: Defective product or material that cannot be repaired, used, or sold
 Rework or rectification: Correction of defective material or errors
 Failure analysis: Activity required to establish the causes of internal product or service
failure
External failure costs
External failure costs are incurred to remedy defects discovered by customers. These costs
occur when products or services that fail to reach design quality standards are not detected until
after transfer to the customer. They could include:
 Repairs and servicing: Of both returned products and those in the field
 Warranty claims: Failed products that are replaced or services that are re-performed
under a guarantee
 Complaints: All work and costs associated with handling and servicing customers’
complaints
 Returns: Handling and investigation of rejected or recalled products, including
transport costs
HUMAR RESOURCE ACCOUNTING:

Objectives of Human Resource Accounting

 Facilitate people management.

 Help management make decisions about acquiring, assigning, developing, and
maintaining human resources.
 Provide information to management about the cost and value of human resources.
 Ensure the effective use of human resources.
 Eee if HR produces a return on investment from interested people in the organization.
  Provide accounting details of human resources to people outside the company, such as
bankers, financial institutions and creditors, etc.

Human resource accounting (HRA) is a type of accounting that seeks to determine the cost and
value of the people, also known as human capital, working in an organization.

HRA is an economic indicator of what an organization spends on its human capital. It indicates
money spent on recruiting, training, salary and benefits of existing employees in previous
months and years.

Human Resource Accounting Methods:

 Present Value Method – This method estimates the present value of the future cash
flows an employee must generate for the company.

 Value to the Organization Method – In this method, the most valuable employee of the
organization is determined and measured whether the organization is earning premium
profits from the services of that employee and helps in finding the value of that
employee.

 Expense Model Method – This method divides the employees into two categories:
Decision-making and decision-execution. It then determines the actual cost incurred in
both categories and whether it benefits the organization.

 Historical Cost Method – The historical cost method involves calculating the cost
incurred by the company in recruiting, training, and developing its employees. This
approach is easy to apply but does not reflect human assets’ true value.

 Replacement Cost Method – This method involves estimating the cost of replacing an
employee with a similar level of skill and experience.

 Opportunity Cost Method – The opportunity cost method estimates the potential
earnings an employee could have earned if they pursued a different career.

LIFE CYCLE COSTING

Life Cycle Costing (LCC) is a cost management technique that considers the total costs
associated with a product or project throughout its entire life cycle, from inception to disposal.
It encompasses costs related to design, production, distribution, maintenance, and disposal,
providing a holistic view of expenses and aiding in strategic decision-making and sustainability
initiatives.

An example of Life Cycle Costing (LCC) could be the comparison between two different
vehicle options for a fleet management company: a conventional gasoline-powered vehicle and
an electric vehicle (EV). LCC would involve assessing the total costs associated with each
vehicle over its entire life cycle, including acquisition, fuel or electricity consumption,
maintenance, insurance, and eventual disposal. By comparing the LCC of both options, the
company can determine which vehicle offers the most cost-effective and sustainable solution
over its lifetime.
VALUE CHAIN ANALYSIS

 A value chain is a step-by-step business model for transforming a product or service

from idea to reality.
 Value chains help increase a business’s efficiency so the business can deliver the most
value for the least possible cost.
 The end goal of a value chain is to create a competitive advantage for a company by
increasing productivity while keeping costs reasonable.

Primary Activities

Primary activities consist of five components, all essential for adding value and creating
competitive advantage:

1. Inbound logistics include functions like receiving, warehousing, and managing

inventory.
2. Operations include procedures for converting raw materials into a finished product.
3. Outbound logistics include activities to distribute a final product to a consumer.
4. Marketing and sales include strategies to enhance visibility and target appropriate
customers—such as advertising, promotion, and pricing.
5. Service includes programs to maintain products and enhance the consumer
experience—like customer service, maintenance, repair, refund, and exchange.

Support Activities

The role of support activities is to help make the primary activities more efficient. When you
increase the efficiency of any of the four support activities, it benefits at least one of the five
primary activities. These support activities are generally denoted as overhead costs on a
company’s income statement:

1. Procurement concerns how a company obtains raw materials.

2. Technological development is used at a firm’s research and development (R&D)
stage—like designing and developing manufacturing techniques and automating
processes.
3. Human resources (HR) management involves hiring and retaining employees who will
fulfill the firm’s business strategy and help design, market, and sell the product.
4. Infrastructure includes company systems and the composition of its management
team—such as planning, accounting, finance, and quality control.

Activity-Based Costing (ABC):

 Activities – things that must be done to produce the product. This can be a job, event
or set of work that has a specific objective and consumes resources.

Activity-based costing (ABC) is a method of assigning overhead and indirect costs—

such as salaries and utilities—to products and services. This system of cost accounting
is based on "activities"; an activity is any event, unit of work, or task with a specific
goal.
Example: House Construction

Identify Activities Involved in House Construction

In house construction, activities can include:

 Site Preparation: Clearing, grading, and excavation.

 Foundation Laying: Installing footings and concrete slabs.
 Framing: Erecting walls, beams, and roof structures.
 Electrical and Plumbing: Installing electrical wiring, lighting, water pipes, and drainage
systems.
 Interior Finishing: Drywall, painting, flooring, and cabinetry.
 Exterior Finishing: Roofing, siding, and landscaping.
 Final Inspection and Cleaning: Ensuring compliance with building codes and cleaning
up the site.

2. Assign Costs to Each Activity

For each of the above activities, direct and indirect costs are identified:

 Direct Costs: Materials, labor, and specific tools used in each activity.
 Indirect Costs: Overheads like equipment maintenance, utility costs, and project
management.

3. Determine Cost Drivers for Each Activity

In ABC, cost drivers (the factors that cause costs) are identified for each activity. For house
construction, common cost drivers might include:

 Labor Hours: For activities like framing, interior, and exterior finishing, where labor-
intensive work is required.
 Machine Hours: For site preparation and foundation laying, where heavy machinery is
used.
 Square Footage: For flooring and painting, as these depend on the area to be covered.
 Materials Volume: For foundation and framing activities, where the volume of
concrete, wood, and steel varies by project specifications.

4. Calculate the Cost per Unit of Each Activity

Once the cost drivers are identified, allocate costs to each activity based on their cost drivers.
For example:

 Site Preparation: Total cost of excavation machines, labor for setup and operation,
divided by the number of hours used.
 Foundation Laying: Cost of concrete and steel divided by cubic yards or volume
poured.
 Electrical and Plumbing: Total labor and material costs divided by the number of square
feet or linear feet of piping.