ACCOUNTING AND FINANCE

LEVEL – IV
Based on November ,2023 Curriculum V – II

MODULE TITLE:Producing Job Order and

Process Costing System
MODULE CODE: LSA ACF4 M11 1123
NOMINAL DURATION: 150HRS

Prepared by: Ministry of Labor and Skills

November,2023
Addis Ababa Ethiopia

Ministry of Labor and Version -1

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Acknowledgment

Ministry of Labor and Skills wish to extend thanks and appreciation to the many
representatives of TVT instructors and respective industry experts who donated their time
and expertise to the development of this Teaching, Training and Learning Materials
(TTLM).

Ministry of Labor and Version -1

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 Table of Contents
Acknowledgment...........................................................................................................................ii
Acronym..........................................................................................................................................v
Introduction to the Module..............................................................................................................6
UNIT ONE:Nature Of Cost.............................................................................................................7
1.1. Basic concepts of cost accounting...................................................................................8
1.2. Behaviours of Cost..........................................................................................................9
1.3. Classification of costs....................................................................................................11
1.3.1 Cost system...........................................................................................................13
1.4. Cost data........................................................................................................................24
1.4.1. Extracting Data.....................................................................................................25
1.4.2. Data coding............................................................................................................26
1.4.3. Calcification of data...............................................................................................26
1.4.4. Reconciling the data..............................................................................................27
Self - Check I................................................................................................................................29
Operation Sheet-1.........................................................................................................................30
Lap-Test-1....................................................................................................................................31
UNIT TWO:Cost Allocation.........................................................................................................32
2.1. Methods for allocating costs..........................................................................................33
2.1.1. Concept of service department costs......................................................................34
2.1.2 General approach of cost allocation.......................................................................39
2.1.3. Concept of Joint Cost To Allocate Product Cost...................................................41
2.1.4. Concepts of Activity- based Costing.....................................................................43
2.1.5. Calculating activity-based costs.............................................................................44
2.2. Designing of costing system.........................................................................................48
Self – Check II..............................................................................................................................49
UNIT THREE: Produce Cost Report............................................................................................51
3.1.1. Assigning Cost..........................................................................................................52
3.2. Cost information............................................................................................................54
3.3. Structure of budget and report.......................................................................................55
3.3.1. Budget Report........................................................................................................56

Ministry of Labor and Version -1

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 3.4. Budget Variance............................................................................................................58
3.5. Error of Free Report.....................................................................................................59
Self- Check III..............................................................................................................................62
UNIT FOUR: Cost Control System...............................................................................................64
4.1. Cost Control And Cost Reduction.................................................................................65
4.1.1. Cost Control..........................................................................................................65
4.1.2. Cost reduction........................................................................................................66
4.2. Techniques of cost reduction.........................................................................................68
4.3. Area of cost reduction...................................................................................................69
4.4. Unit cost production......................................................................................................71
4.5. Methods of increasing productivity...............................................................................72
4.6. Effects of budget and standard costing..........................................................................73
4.6.1. Effect of budget.....................................................................................................73
4.6.2. Standard cost.........................................................................................................74
Self-check -VI...............................................................................................................................76
Reference......................................................................................................................................77
Developer profile..........................................................................................................................78

Ministry of Labor and Version -1

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 Acronym
ETL ------------------------------Extract transform load
ELT-------------------------------Extract load transform
DR--------------------------------Data reconciliation
DVR------------------------------Data validation and reconciliation
ASAP----------------------------As soon as possible
ABC -----------------------------Activity-based costing
TQM------------------------------Total quality management
AIMA -----------------------------Chartered institute of management accountants

Ministry of Labor and Version -1

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Introduction to the Module
Accounting and finance filed; the producing job order costing and process cost stystem ”. in the
work place helps to know the identify nature of cost,cost allocation,produce cost report,and cost
control system.Accounting and finance filed.
This module is designed to meet the industry requirement under the Accounting and Finance
occupational standard, particularly for the unit of competency produce ob order and process cost
systems.
This module covers the units:
 Nature of Cost
 Cost allocation
 Produce cost report
 Cost control system
Learning Objective of the Module
 To record operating and cost data
 To Produce cost reports
 To Identify cost categories
 To Apply cost allocation
 To Apply costing system
 To Implement Cost control reduction system
Module Instruction
1. For effective use this modules trainees are expected to follow the following module
instruction:
2. Read the information written in each unit
3. Accomplish the Self-checks at the end of each unit
4. Perform Operation Sheets which were provided at the end of units
5. Read the identified reference book for examples and exercise

UNIT ONE:Nature Of Cost

This unit is developed to provide you the necessary information regarding the following

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content coverage and topics:
 Basic concepts of cost accounting
 Behaviours of Cost
 Classification of costs
 Cost data
This guide will also assist you to attain the learning outcomes stated in the cover page.
Specifically, upon completion of this learning guide, you will be able to:
 Explaine basic concepts of cost accounting
 Analyse classification of costs
 Determine behaviours of Cost
 Determine cost data

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 1.1. Basic concepts of cost accounting
Cost accounting refers to the computation of a company's overall expenditure. This procedure
includes an assessment of a company's variable and fixed costs involved in each step of
production. Cost accounting helps in taking strategic decisions to manage a company's expenses.
Cost accounting tracks, records, and analyses the different costs of production that occur within a
business. These costs fall under three main categories: material, labour, and overhead costs. The
main goal of cost accounting is to determine the best pricing strategies for products and services.
Cost accounting is the process of capturing, recording, and analysing what it costs to produce or
supply a product or service. This process will enable your business’s management to make better
financial decisions, eliminate inefficient costs, and budget accurately.
Objectives of Cost Accounting
The main objectives of cost accounting can be summarized as follows:
 Determining Selling Price
 Determining and Controlling Efficiency
 Facilitating Preparation of Financial and Other Statements
 Providing Basis for Operating Policy
Types of Cost Accounting
There are four main types of cost accounting:
A. Standard Cost Accounting
With standard costing, rather than assigning the actual costs of direct materials, direct labor, and
overhead expenses to a product, a business assigns specific “standard” costs. These standard
costs are based on efficient use of materials and labor, under standard operating conditions,
which is essentially the planned or budgeted amount for a product.
If the variance analysis determines that your costs are higher than expected, then the variance is
unfavorable, and your business has generated less profit than expected. If the costs are less than
the standard costs, the variance is favorable, and your business has generated more profit than
anticipated.
B. Activity-Based Cost Accounting
Activity-based costing (ABC) is a costing system that breaks down overhead and indirect costs,
according to the actual consumption of each product and service. This method is typically used
in the manufacturing industry, to make a better calculation of the true cost of production per unit.
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To illustrate how this method works, let’s take a pharmaceutical company that produces two
types of medicine. Medicine A is produced at a high volume through a mostly automated process
that only consists of putting chemicals into processing equipment and waiting for the final
product.
Medicine B, on the other hand, is produced at a lower volume, as it requires a more manual setup
and hands-on effort from the pharmaceutical staff. Considering these circumstances, activity-
based costing assigns more overhead costs related to labor to medicine B and more overhead
costs related to machine use to medicine A.
C. Lean Cost Accounting
Lean cost accounting is a method that aims to eliminate waste, reduce error, speed up processes,
and replace traditional costing methods with value-based pricing. So, lean accounting makes
management decisions based on total value stream profits, rather than cost allocation. This
method not only increases profits and generates less waste, but also encourages a lean company
culture that promotes teamwork and communication.
D. Marginal Cost Accounting
Marginal costing, also known as the cost-volume-profit analysis, is a costing method that comes
in handy for short-term decisions. More specifically, marginal costing measures the difference in
cost with every new additional unit of production. It’s calculated by dividing the cost difference
by the quantity difference, as shown in the formula below:
MC = ΔC / ΔQ
The goal of marginal costing is to determine at which point a business can reach economies of
scale to optimize its production, and overall operations.

1.2.Behaviours of Cost
Cost behaviour is the manner in which expenses are impacted by changes in business activity. A
business manager should be aware of cost behaviours when constructing the annual budget, to
anticipate whether any costs will spike or decline. For example, if the usage of a production line
is approaching its maximum capacity, the relevant cost behaviour would be to expect a large cost
increase (to pay for an equipment expansion) if the incremental demand level increases by a
small additional amount. Understanding cost behaviour is a critical aspect of cost-volume-profit
analysis.

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Cost behaviour refers to the way costs change in response to changes in a company’s level of
activity or production volume. Understanding cost behaviour is essential for effective cost
management, budgeting, decision-making, and financial analysis. In management accounting and
cost accounting, costs are typically classified into three categories based on their behaviour:
A. Fixed cost
B. Variable cost
C. Mixed cost
Fixed costs: These are costs that remain constant, regardless of the level of production or
activity within a relevant range. Fixed costs do not change with fluctuations in output levels in
the short term. Examples of fixed costs include rent, insurance, salaries of administrative staff,
and depreciation of equipment or buildings. Fixed costs are incurred even if the production level
is zero.
Variable costs: These are costs that change in direct proportion to changes in the level of
production or activity. As production volume increases, variable costs increase; conversely, as
production volume decreases, variable costs decrease. Examples of variable costs include direct
materials, direct labor, and production supplies. The total variable cost depends on the number of
units produced, while the cost per unit remains constant.
Mixed costs (semi-variable costs): These are costs that have both fixed and variable
components. The fixed component remains constant, while the variable component changes with
the level of production or activity. Examples of mixed costs include utility bills (where there is a
fixed monthly charge plus a variable charge based on usage) and sales commissions (where there
is a base salary plus a commission based on the sales volume).
Understanding cost behaviour helps companies make better decisions about pricing, resource
allocation, cost control, and performance evaluation. It also aids in forecasting future costs and
developing budgets based on anticipated production levels.
Example of Cost Behaviour
Let’s consider a fictional company called “TechGadget” that manufactures and sells electronic
devices. TechGadget incurs various costs in its production process, and these costs exhibit
different behaviours based on the production volume.
Let’s examine the costs for producing 1,000 units and 2,000 units:

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 Fixed costs:
Rent for the production facility: $10,000 per month
Salaries of administrative staff: $5,000 per month
Depreciation of equipment: $3,000 per month
Regardless of the production volume, these fixed costs remain constant. Thus, the total fixed
costs for both 1,000 and 2,000 units produced would be:
Total Fixed Costs = $10,000 + $5,000 + $3,000 = $18,000
Variable costs:
Direct materials: $15 per unit
Direct labour: $10 per unit
These variable costs change in direct proportion to the production volume. The total variable
costs for each production level would be:
A. for 1,000 units:
Total Variable Costs = ($15 + $10) × 1,000 = $25 × 1,000 = $25,000
B. for 2,000 units:
Total Variable Costs = ($15 + $10) × 2,000 = $25 × 2,000 = $50,000
Now, let’s calculate the total costs for each production level:
A. for 1,000 units:
Total Costs = Total Fixed Costs + Total Variable Costs = $18,000 + $25,000 = $43,000
B. for 2,000 units:
Total Costs = Total Fixed Costs + Total Variable Costs = $18,000 + $50,000 = $68,000

1.3. Classification of costs

Cost refers to the amount of resources, typically measured in terms of money, that is required to
produce, purchase, or maintain goods and services. In business and accounting, cost is a crucial
concept used to evaluate the financial implications of various activities.

Classification of Cost by Element

In this class, costs are categorized based on the factors they are incurred for. Based on their
elements, costs may be grouped as:
A. Material cost
B. Labour cost

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 C. Expenses
Material cost refers to the cost of commodities supplied to an undertaking (e.g., in the case of a
textile mill, the cost of cotton or yarn, the cost of cotton waste to clean the machinery, the cost of
dyes, the cost of finishing material, and so on).
Labour cost refers to the cost of paying employees in an undertaking, which includes salary,
wages, and commission.
Expenses refer to the cost of services provided to an undertaking and include the notional cost of
owned assets (e.g., rent for a building, telephone expenses, depreciation of the owned factory
building, depreciation of delivery van, and so on).
Classification of Cost by Nature
In this class, costs are classified based on their identifiability with cost centres or cost units.
Costs can be grouped as follows based on their nature:
 Direct costs
 Indirect costs
Direct costs are costs that can be directly and easily traced to (or identified with) a product,
process, or department.Common examples of direct costs include the materials used and labor
employed in manufacturing an article or in a production process.
Indirect costs, on the other hand, are costs that are not traceable to any particular product,
process, or department, but which are common in a number of products, processes, or
departments.Examples of indirect costs are factory rent, factory insurance, and the salary of the
factory manager.
Cost Classification by Controllability
Under this category, costs are classified based on whether or not they are influenced by the
action of a given member of an undertaking. The classes of costs are:
A. Controllable costs
B. Uncontrollable costs
Controllable costs are costs that an entity in an undertaking can influence through their action.
An undertaking is usually divided into several departments or cost centres that are placed under
the direct control and supervision of specified persons.The person in charge of a particular
department or cost centre can control only those costs that come directly under their control.

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Uncontrollable costs, on the other hand, are costs that cannot be influenced by the action of a
specified member of an undertaking. Costs that are controllable for one person may be
uncontrollable for another person. Therefore, the issue of whether a cost is controllable or
uncontrollable is determined by the individual or level of management in question.

1.3.1 Cost system

Costing system is that system in which we calculate different cost with different methods and
also monitor cost for reducing wastage and misuse of resources. Cost system is the branch of cost
accounting which is made for achieving the objectives of cost accounting.
Types of cost system
A. Job Order Costing: This system is used when products are made based on specific
orders from customers. Each job is accounted for separately, and the company tracks the
direct materials, direct labour, and manufacturing overhead associated with each job.
This system is often used in industries like construction, shipbuilding, or custom
furniture. A job order cost sheet accumulates the costs charged to a specific job. It is used
within a job costing system. This cost sheet is most commonly compiled for single-unit
or batch-sized production runs. The information contained within the cost sheet includes
the job number, start and stop dates, the number of units produced, all direct materials
and direct labour costs associated with a job, and a factory overhead allocation.
B. Process Costing: This system is used when a company produces a large volume of
identical products. Costs are accumulated for a “process” or department, and the average
cost per unit is calculated. This system is often used in industries like oil refining, food
production, or chemical manufacturing.
Features of Process Costing:
The production is continuous
 The product is homogeneous
 The process is standardized
 Output of one process become raw material of another process
 The output of the last process is transferred to finished stock
 Costs are collected process-wise
Advantages of process costing:
 Costs are be computed periodically at the end of a particular period
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  It is simple and involves less clerical work that job costing
 It is easy to allocate the expenses to processes in order to have accurate costs.
 Use of standard costing systems in very effective in process costing situations.
 Process costing helps in preparation of tender, quotations
 Since cost data is available for each process, operation and department, good
managerial control is possible.
Limitations:
 Cost obtained at each process is only historical cost and are not very useful for
effective control.
 Process costing is based on average cost method, which is not that suitable for
performance analysis, evaluation and managerial control.
 Work-in-progress is generally done on estimated basis which leads to inaccuracy in
total cost calculations.
Table 5.1: Difference between job order costing and process costing
Job-Order Costing Process Costing
Used for custom or unique items Each job is Used for large volumes of similar products
accounted for separately Production is continuous
Measures cost based on completed job Measures costs based on a period of time
Examples: Movie, Plane, Custom house Examples: cereal, chips, paper towels,

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 Figure 5.2- the job-order cost sheet

 Materials Requisitions
Direct materials cost is assigned to each job through the use of a materials requisition form. The
form includes the description, quantity and unit cost of materials issued to each job.
The form provides essential information for assigning direct materials costs to jobs, and also
helps maintain proper control over a firm’s inventory of direct materials.

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 Figure5.3: material requisition form

 Job Time Tickets

Direct labour cost is assigned to each job through the use of a job time ticket. The form includes
the name, wage rate and hours worked on each job. These forms are only used for direct labour.

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 Figure 5.3: time tiket
Predetermined Overhead Rate
A predetermined overhead rate is an allocation rate that is used to apply the estimated cost of
manufacturing overhead to cost objects for a specific reporting period. This rate is frequently
used to assist in closing the books more quickly, since it avoids the compilation of actual
manufacturing overhead costs as part of the period-end closing process. However, the difference
between the actual and estimated amounts of overhead must be reconciled at least at the end of
each fiscal year.
The journal entries to record the costs incurred are as follows:
1) Purchase of raw materials
Raw material inventory xxx
Accounts payable xxx
2) Factory labour costs
Factory Wages Payable xxx
Employer Payroll Taxes Payable xx xxx

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3) Manufacturing overhead costs
Manufacturing Overhead xxx
Various Payable xxx
Accumulated Depreciation xxx
The journal entries to record the costs assigned to Work in Process are as follows:
4) Issue raw materials
Work-in-process inventory (direct) xxx
Manufacturing overhead (indirect) xxx
Raw materials inventory xxx
5) Labour costs assigned
Work-in-process inventory (direct) xxx
Manufacturing overhead (indirect) xxx
Factory Labour xxx
Assign Predetermined Overhead Rate
Manufacturing overhead relates to productions as a whole, and cannot be assigned to specific
jobs based on costs incurred. Therefore, it is assigned to each job on an estimated basis using:
Predetermined Overhead Rate=
Estimated Annual Overhead Costs / Estimated Annual Operating Activity
Manufacturing overhead assigned=
Actual Activity Base Used * Predetermined Overhead Rate
6)Manufacturing overhead assigned
Work-in-process inventory Xxx
Manufacturing overhead Xxx
Reconcile: Work in Process Inventory = Job Cost Sheet
Assign Costs to Finished Goods
When a job is completed, increase finished goods account, and decrease work in process
7) Assign costs to finished goods
Finished Goods Xxx
Work in Process Xxx
Assign Finished Goods to Cost of Goods Sold
When a sale occurs, increase cost of goods sold, and decrease finished goods

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 8)Assign costs to cost of goods sold
Accounts Receivable Xxx
Sales Revenue Xxx
Cost of Goods Sold Xxx
Finished Goods Xxx

Figure 5.4: flow of cost

Example: Accounting In A Job Order Cost Accounting System

A clothing manufacturer had the following transactions in its first month of operations relating to
its only job, Job #101.
a) Purchased 500 yards of silk @ $8 per yard for cash.
b) Requisitioned 300 yards of silk to produce Job #101.
c) Incurred 50 hours of direct labor to produce Job #101; the average labor rate is $9 per hour.
d) Paid various factory overhead costs, $650.
e) Applied factory overhead at the rate of 150% of direct labor costs to Job #101.
f) Completed Job #101.
g) Sold Job #101, receiving cash of $4,400.
INSTRUCTIONS
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 1. Enter the transactions in the T-accounts below. Assume the opening balance of Cash is
$9,000.
2. Determine the ending balance of each account.
3. What was the gross profit earned on Job #101?
4. What was the gross margin ratio earned on Job #101?
5. If management had expected a gross margin ratio of 20% on Job #101, do you believe the
actual results warrant further investigation by management? Why or why not?
Is factory over applied or under applied, and by how much?
SOLUTIONS TO EXAMPLE 1
Cash Raw materials inventory Work in Process
Inventory
Bal 9000 4000 (a) (a) 4000 2400 (b) (b) 2400
(h) 4400 650 (e) © 450
(f) 675 3525 (g)
Bal 8750 Bal 1600 Bal 0

Finished Goods Inventory Wages Payable Sales

(g) 3525 3525 450 440
(h) 0

Bal 0 450 Bal 4400

00
Cost of Goods Sold Factory Overhead
(h) (e 650 675

Bal 25

3. The gross profit on the job was $875 ($4,400 sales price - $3,525 cost of goods sold).
4. The gross margin ratio was 19.9%, rounded to one decimal ($875 gross profit / $4,400 sales
price).
5. The actual gross margin ratio was 19.9%, compared to the plan of 20%. Management should
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 not investigate the costs further.
6. Factory overhead is over applied by $25.
Actual costing

The actual costing system is also based on three main inputs: the cost of direct materials, direct
labor, and actual overhead costs. All the costs are actual amounts and not dependent on any
budgeted amounts. It is simple and requires no standard rate determination. However, it may
produce spikes in overhead costs, especially during winter or summer. These irregular spikes
may pose a problem for financial statements reporting quarterly income.
Companies use actual costing methods to assess their production expenses and determine
indirect/direct costs and fixed and variable costs. Knowing the actual cost of producing the goods
will help determine break-even values or the number of goods when the cost equals the revenue.
 Actual Cost Calculation
In a manufacturing setting, actual cost calculation may involve the actual costs of materials,
labor, and overhead:
 Actual material cost = (Number of units of materials) x (Price per unit)
 Actual labor cost = (Total labor hours used) x (Salary of direct workers per hour)
 Actual overhead cost = Sum of all overhead expenses = Utility fees + Rent + Insurance
Actual production cost per unit may be calculated by dividing the sum of all actual costs by the
total number of goods produced. That is:
Actual cost per unit = (actual material + actual labor + actual overhead)/ Total number of units
produced
If the information on the different types of costs is available, the actual cost is the sum of all
these expenses.

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 Figure 5.5 actual cost

Actual Cost Formula

The actual cost formula is the sum of different types of project expenses:
Actual cost = direct costs + indirect costs + fixed costs + variable costs + sunken costs

Each of the different types of project expense is described as follows:

Direct costs: These are costs that are directly associated with the project and are easily
verifiable.
 Variable costs
 Fixed costs
Indirect costs: These are the costs associated with the support resources of the project.
 Administrative management costs

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  Insurance costs
Fixed costs: These are costs that remain constant (cannot be changed) throughout the project.
These costs do not change with production or sales volume. They remain fixed throughout the
project's duration.
 Property taxes
 Rental fee for equipment
 Labor expenses such as the salary of the company secretary
 Mortgage, rent, or lease payments
Variable cost: These expenses may fluctuate during the project's duration.
 Business analyst wages and consultancy costs may be more expensive at the start of the
project
 Test execution phase salaries are expected only during its particular phase
 Project manager wages are based on man hours spent on the project
Sunken costs: These are costs that were incurred due to errors in production.
 Defective batch of products
Example: The actual product cost includes the price it took to make it. So, for example, a
manufacturing company estimated $1500 for product repair. But the actual cost was $2000. So
the company had a cost variance of $500.
Normal Costing

Normal costing uses the same three main inputs mentioned earlier: direct materials, direct labor,
and overhead costs. However, the overhead cost is calculated based on allocated or budgeted
values. The total overhead cost value is divided by an approximation or budgeted amount of the
number of man-hours used. This creates a standard overhead rate, which is budgeted over
budgeted labor hours. When the standard rate is established, the overhead costs will be easily
determined by multiplying the standard rate by the man-hours used.
Normal Costing Method
The normal costing method utilizes two main formulas: the standard overhead rate and the main
normal cost equation. The standard overhead rate is calculated by using the total budgeted
overhead cost and dividing this by the estimated length of time of production hours.
Budget overhead allocation rate = Budget overhead / Budgeted direct labor hours
Example:
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If a company spends $50,000 per year on utilities, $200,000 on the wages of the plant manager
and supervisors, and $40,000 on security, what is the budgeted overhead allocation rate if 14,000
labor hours are budgeted?
Solution:
Overhead Costs are calculated by adding the costs of utilities, wages, and security.
Overhead Costs = Cost on utilities + Wages paid to plant managers and supervisors +
Security cost
 Overhead Costs = $50,000 + $200,000 + $40,000 = $ 290,000
 Budgeted direct labor hours = 14,000 man-hours
 Budget overhead allocation rate = Budget overhead / Budgeted direct labor hours
 Budgeted overhead allocation rate = $290,000/14,000 = $20.71 per labor hour
A formula that calculates the Normal Cost of manufacturing a product is given as follows:
Normal Cost = Direct materials cost + Direct labor cost + Overhead cost

C. Activity-Based Costing (ABC): This system assigns costs to products based on the
activities used in their production. The cost of each activity is allocated to each product to
the extent that the product uses the activity. This system can be more accurate than
traditional costing systems, especially for complex, modern manufacturing processes.
D. Standard Costing: This system uses estimates or “standards” to assign costs to products.
The company then compares the actual costs with the standard costs to measure
performance.

1.4.Cost data
Cost data refers to the detailed information and records related to the expenses incurred by a
business in the process of manufacturing goods or providing services. It encompasses various
elements such as direct materials, direct labor, and overhead costs, providing a comprehensive
view of the financial aspects of production. Cost data is crucial for businesses to assess the true
expense of producing goods or delivering services, enabling them to make informed decisions,
set prices, and analyze profitability.

1.4.1. Extracting Data

Data extraction is the process of collecting or retrieving disparate types of data from a variety of
sources, many of which may be poorly organized or completely unstructured. Data extraction
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makes it possible to consolidate, process, and refine data so that it can be stored in a centralized
location in order to be transformed. These locations may be on-site, cloud-based, or a hybrid of
the two. Data extraction is the first step in both ETL (extract, transform, load) and ELT (extract,
load, transform) processes. ETL/ELT are themselves part of a complete data integration strategy.
A. Data Extraction and ETL
To put the importance of data extraction in context, it’s helpful to briefly consider the ETL
process as a whole. In essence, ETL allows companies and organizations to 1) consolidate data
from different sources into a centralized location and 2) assimilate different types of data into a
common format. There are three steps in the ETL process:
Step 1: Extraction
 Data is taken from one or more sources or systems. The extraction locates and identifies
relevant data, then prepares it for processing or transformation.
Step 2: Transformation
 Once the data has been successfully extracted, it is ready to be refined. During the
transformation phase, data is sorted, organized, and cleansed.
Step 3: Loading
 The transformed, high quality data is then delivered to a single, unified target location for
storage and analysis.
B. Data Extraction without ETL
Can data extraction take place outside of ETL? The short answer is yes. However, it’s important
to keep in mind the limitations of data extraction outside of a more complete data integration
process. Raw data which is extracted but not transformed or loaded properly will likely be
difficult to organize or analyse, and may be incompatible with newer programs and applications.
Types of Data Extraction
Data extraction is a powerful and adaptable process that can help you gather many types of
information relevant to your business. The first step in putting data extraction to work for you is
to identify the kinds of data you’ll need. Types of data that are commonly extracted include:
 Customer Data: This is the kind of data that helps businesses and organizations
understand their customers and donors. It can include names, phone numbers, email
addresses, unique identifying numbers, purchase histories, social media activity, and web
searches, to name a few.

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  Financial Data: These types of metrics include sales numbers, purchasing costs, operating
margins, and even your competitor’s prices. This type of data helps companies track
performance, improve efficiencies, and plan strategically.
 Use, Task, or Process Performance Data: This broad category of data includes
information related to specific tasks or operations.

1.4.2. Data coding

Coding is the process of assigning some symbols (either) alphabetical or numerals or (both) to
the answers so that the responses can be recorded into a limited number of classes or categories.
The classes should be appropriate to the research problem being studied. They must be
exhaustive and must be mutually exclusive so that the answer can be placed in one and only one
cell in a given category. Further, every class must be defined in terms of only one concept.
Coding for an open-ended question is more tedious than the closed ended question. For a closed
ended or structured question, the coding scheme is very simple and designed prior to the field
work. For example, consider the following question.
 What is your monthly income?
< Rs. 5000
Rs. 5000 - 8999
Rs. 13000 – 12999
Rs. 13000 or above.
We may code the class less than Rs.5000' as , 1', Rs. 5000 - 8999' as `2', `Rs. 9000 - 12999' as `3'
and `Rs. 13000 or above' as `4'

1.4.3. Calcification of data

There are two general types of data – quantitative and qualitative and both are equally important.
You use both types to demonstrate effectiveness, importance or value.
I. Quantitative data are
 Measures of values or counts and are expressed as numbers.
 Data about numeric variables (e.g. how many, how much or how often).
II. Qualitative data are
 Measures of 'types' and may be represented by a name, symbol, or a number code.
 Qualitative data are data about categorical variables (e.g. what type).

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Data collected about a numeric variable will always be quantitative and data collected about a
categorical variable will always be qualitative. Checking data
Data Check objects provide a mechanism for defining a check on specific data that you want to
flag. A data check applies to a particular object type and an advanced filter is used to define
which objects meet this data check. Power World’s expectation is that user will create filters that
look for "bad" data, but it can really be any data you want summary information on.

1.4.4. Reconciling the data

Cost reconciliation is the process of verifying and adjusting the actual costs incurred by
contractors and suppliers against the agreed budget and contract terms. It is a vital skill for cost
control, as it helps to identify and resolve any discrepancies, errors, or disputes that may arise
during or after a project. In this article, you will learn how to handle cost reconciliation issues
and disputes with contractors and suppliers effectively and efficiently.
Data reconciliation (DR) is defined as a process of verification of data during data migration. In
this process target data is compared with source data to ensure that the migration architecture is
transferring data. Data validation and reconciliation (DVR) means a technology that uses
mathematical models to process information.
Terminology associated with Data Reconciliation
 Gross Error: Gross errors in measurements. It reflects only bias errors, instrument
failures, or abnormal noise spikes if you are using only short time averaging period.
 Observability: Observability analysis can give you details about what variables can be
determined for a given set of constraints and a set of measurements.
 Variance: Variance is a measure of the variability of a sensor.
 Redundancy: It helps you to determine which measurements should be estimated from
other variables by using the constraint equations.
Data reconciliation techniques
Data reconciliation is not a one-size-fits-all process. Depending on the nature of the data, its
source, the systems in use, and the specific requirements of an organization, various techniques
can be employed to reconcile data efficiently. Some of these techniques include:
 Automated Reconciliation Software: This software can handle vast amounts of data and
can quickly identify and rectify discrepancies, ensuring that the reconciliation process is
both efficient and accurate.
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  Database Tools: Many advanced database management systems have built-in tools or
functions that aid in data comparison and discrepancy identification.
 Spread sheet-Based Reconciliation: For smaller data sets or when dealing with specific
types of financial data, spread sheets (like Excel) can be used for reconciliation. Formulas
and macros can assist in the comparison of data columns.
 Custom Scripts: In some cases, especially when dealing with unique systems or specific
reconciliation needs, custom scripts can be used to compare and reconcile data sets.

Self - Check I
Part I: True /False statement
2. In job order costing, costs are accumulated for a process or department.
3. Fixed costs change in direct proportion to changes in the level of production.
3. Activity-Based Costing (ABC) assigns costs to products based on standard costs.
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 4. Coding for open-ended questions is simpler than for closed-ended.

Part I: Choose The Best Answer

1. What is the main goal of cost accounting?

b. Maximizing revenue
c. Determining selling price
d. Facilitating financial statements preparation
e. All of the above
f. None of the above
2. Which type of cost accounting focuses on eliminating waste and promoting value-based
pricing?
B. Standard Cost Accounting
C. Activity-Based Costing
D. Lean Cost Accounting
E. Marginal Cost Accounting
F. Both A and B
3. What is the primary purpose of data extraction in the ETL process?
A. Consolidating data from different sources
B. Transforming data into a common format
C. Retrieving disparate types of data
D. All of the above
E. None of the above

Operation Sheet-1
Title : Record journal entry
Purpose: To know how to record journal entry and company record transaction systems.
Equipment:
 Pen
 Pen A4 Paper
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  Marker
 White board or filip chart
Procedure
1) Purchase of raw materials
Raw material inventory xxx
Accounts payable xxx
2) Factory labour costs
Factory Wages Payable xxx
Employer Payroll Taxes Payable xx xxx
3) Manufacturing overhead costs
Manufacturing Overhead xxx
Various Payable xxx
Accumulated Depreciation xxx
4) Issue raw materials
Work-in-process inventory (direct) xxx
Manufacturing overhead (indirect) xxx
Raw materials inventory xxx
5) Labour costs assigned
Work-in-process inventory (direct) xxx
Manufacturing overhead (indirect) xxx
Factory Labour xxx

Lap-Test-1
Instructions: Follow all necessary steps and format record journal entry and t- account
XYZ Company uses job-order costing. It applies overhead cost to jobs on the basis of
direct labor-hours. The following transactions took place during the year:
a) $300,000 of raw materials were purchased on account
b) Incurred factory labor of $250,000, $25,000 was payroll taxes
c) Utility costs for the factory were $60,000. Depreciation recorded was $200,000
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 d) Raw materials were assigned into production: $90,000 direct materials and
$4,000 indirect materials
e) Labor costs assigned: $40,000 direct, $1,000 indirect
f) Manufacturing overhead of was estimated to be $800,000 and is based on
direct labor hours. Total direct labor hours are estimated to be 200,000
hours. Actual direct labor-hours incurred were 72,000.
g) Jobs costing $30,000 were completed and transferred into the finished
goods inventory.
h) Jobs with a cost of $15,000 were sold on account for $20,000.
i) Closed the under/over applied overhead for the year.
Required: prepare necessary journal entries

UNIT TWO:Cost Allocation

This unit is developed to provide you the necessary information regarding the following
content coverage and topics:
 Methods for allocating costs
 Designing of costing system
This guide will also assist you to attain the learning outcomes stated in the cover page.
Specifically, upon completion of this learning guide, you will be able to:
 Determine methods for allocating costs
 Explain design of cost system

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2.1. Methods for allocating costs
Cost allocation is a process in which businesses and individuals identify the costs incurred by
activity and distribute them to appropriate accounts.
Cost allocation is the process of identifying, accumulating, and assigning costs to costs objects
such as departments, products, programs, or a branch of a company. It involves identifying the
cost objects in a company, identifying the costs incurred by the cost objects, and then assigning
the costs to the cost objects based on specific criteria.

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 Figure 4.1- cost allocation
Depending on the type of product or service provided by a business, different types of cost
allocation may be most useful. The three main types of cost allocation are cost allocation based
on direct labour, cost allocation based on machine time, and cost allocation based on square
footage.
Cost allocation based on direct labour allocates overhead costs based on the amount of direct
labour used on a production unit. Cost allocation based on machine time uses the amount of
machine time directly related to production as a way of allocating overhead. For each of these
first two types, there is often an industry-standard already available for use. These two methods
can present problems because production at a particular business may not match the levels used
to calculate the industry standard.
Benefits of Cost Allocation
There are many benefits to cost allocation and here are some of the main points:
 Reducing costs - by properly allocating costs and seeing the true costs of doing business,
the company can work to reduce these costs.
 Increasing profits - profits can be increased through reduction of costs as well as a proper
understanding of the costs to create the product.

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  Increasing efficiency - through a detailed understanding of the costs of doing business, the
company can increase efficiency through lessening waste and finding room for
improvement.

2.1.1. Concept of service department costs

Service department costs is an essential aspect of cost accounting, particularly in the context of
allocating overhead costs within an organization. Service departments are units within a
company that provide support services to other departments, contributing to the overall
efficiency and functionality of the organization.

A. Direct allocation method

The direct allocation method is a technique for charging the cost of service departments to other
parts of a business. This concept is used to fully load operating departments with those overhead
costs for which they are responsible.
Example: A company has 2 service departments, Maintenance and Administration, and 2
operating departments (Department 1 and 2 for simplicity).The costs of the maintenance
department are allocated based on the machine-hours used. For the administration department,
the cost allocation is based on the number of employees. The following information is provided:

Service Dep’t Operating Dep’t

Maintenanc Administration 1 2
Costs $32,000 $36,000 $8,000 $4,000
Machine-hours used 1,000 2,000 1,500 2,500
Numberof Employees 100 200 250 150

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Remember how we calculate predetermined overhead rates? We will need that same formula
again. The formula to calculate the allocation rate will be slightly modified for service
department cost but will be:
Service Dep’t Cost
TOTAL Cost Driver (operating depts. only)
Notice, we use the operating department cost drivers only since we are allocating the service
department cost to operating departments only and not to another service department.
Maintenance uses machine-hours as the cost driver or basis and Administration uses number of
employees. We can calculate the service department allocation rates as follows:
Maintenance Dep’t Cost / TOTAL Machine Hours (operating depts. only)
= $8,000/(1500 +2500) =$8,000/4000 = $2 per machine hour
Administration Dep’t Cost/ TOTAL Employees (operating depts. only)
= $4,000/(250+150) =$4,000/400 = $10 per employee
To allocate the service department costs to each operating department, we will take the amount
of the cost driver (machine hours for maintenance and employees for administration) x the
allocation rate we just calculated.

Operating Dept 1 Operating Dept 2

Maintenance $3,000 $5,000
(1,500 mach hour x $2 per mach hr) (2,500 mach hour x $2 per
Administration $2,500 mach hr)
(250 employees x $10 per mployee) $1,500
(150employees x $10
peremployee
Notice how the total maintenance amount allocated to the two departments (3,000 + 5,000)
equals the maintenance department cost of $8,000. The same applies to administration as the
total cost is $4,000 and we allocated a total of $4,000 (2,500 + 1,500). We can summarize the
changes to the costs of each department:
Service Dept Operating Dept

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 Maintenance Administration 1 2
Costs $8,000 $4,000 $32,000 $36,000
Allocation of maintenance ($8,000) 3,000 5,000
Allocation of 2,500 1,500
administration $0 ($4,000) $37,500 $42,500
Total Costs $0
B. Step-down method

The step-down method is also called the sequential method. This method allocates the costs of
some service departments to other service departments, but once a service department’s costs
have been allocated, no subsequent costs are allocated back to it. The choice of which
department to start with is important. The sequence in which the service departments are
allocated usually effects the ultimate allocation of costs to the production departments, in that
some production departments gain and some lose when the sequence is changed.
Example: Human Resources (H.R.), Data Processing (D.P.), and Risk Management (R.M.)
provide services to the Machining and Assembly production departments, and in some cases, the
service departments also provide services to each other:
Percentage of services provided by the service department listed under Service Dep’t.
Total cost Service dept.
H.R D.P R.M Machining Assembly
$80,000 H.R - 20% 10% 40% 30%
120,000 D.P 8% - 7% 30% 55%
40,000 R.M - - - 50% 50%
= $240,000
In the table below, the row for each service department allocates the total costs in that
department (the original costs incurred by the department plus any costs allocated to it from the
previous allocation of other service departments) to the production departments as well as to any
service departments that have not yet been allocated.
Percentage of services provided by the service department listed under Service Dept
Total cost H.R D.P R.M machining assembl Total
y allocated

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 Cost $80,000 $120,000 $40,00 - -
0
Allocation of ($80,000) 16,000 8,000 $32,000 $24,000
H.R
Allocation of - ($136,00 10,348 44,348 81,304
D.P 0)
Allocation of $0 $0 $58,34 $29,174 $29,174
R.M 8
Balance $0 $0 $0 $105,522 $134,47 $240,000
8
Allocation of HR costs.
H.R. was allocated 20% to D.P., 10% to R.M., 40% to Machining and 30% to Assembly.Since
the Step-Down Method only allocates service department costs to departments on its right, the
allocation basis for D.P has to be adjusted to base 92%, since 8% of its services are consumed by
H.R. (a service department on D.P.’s left). The percentages used have to be normalized on the
remaining 92% (100%-8%) as follows:
Allocation of D.P service costs
Risk Management 7% / 92% = 7.6087% 7.6087% x $136,000 = $ 10,348
Machining 30% / 92% = 32.6087% 32.6087% x $136,000 = $44,348
Assembly 55% / 92% = 59.7826% 59.7826% x $136,000 = $81,304
100.00%
Explanation of the above: The adjusted percentages are applied to D.P.’s own cost ($120,000)
plus its share of H.R. costs ($16, 0000), or $136,000.

Allocation of R.M costs

R.M. service department costs now contain R.M.’s share of H.R. and D.P. costs, and the this new
total must be allocated to the Machining and Assembly departments, Similarly, R.M. service
department costs. Each department gets 50% of these costs.
C. Reciprocal Method of Allocation

The final method is the reciprocal method. Although it is the most accurate, it is also the most
complicated. In the reciprocal method, the relationship between the service departments is
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recognized. This means service department costs are allocated to and from the other service
departments.
Example 1: Service Centres 1 and 2 wish to allocate 100% of their costs to Operational
Departments A and B, and to each other. They will use the reciprocal method to do so.
Department Overhead Before Service 1 Service 2
Distribution
Ops Dep’t A $22,000 44% 56%
Ops Dep’t B $16,000 36% 24%
Service 1/S1 $8,755 20%
Service 2/S2 $6,512 20%
TOTAL $53,267 100% 100%
Simultaneous equations calculate the values necessary to allocate 100% of service centre costs to
other service centres and operational departments. It begins by calculating the total overhead
costs of the service departments, in our examples S1 and S2:
Equation 1: Service 1, S1 = $8,755 + .2S2
Equation 2: Service 2, S2 = $6,512 + .2S1
First, solve for S1 by substituting the value of S2.
S1 = $8,755 + .2($6,512 + .2S1)
S1 = $8,755 + $1,302.40 + .04S1
S1 - .04S1 = $8,755 + $1,302.40
.96
S1 = $10,057.40
S1 = $10,057.40/0.96
S1 = $10,476.46
Next, incorporate the just-calculated value of S1 in equation 2.
S2 = $6,512 + .2($10476.46)
S2 = $6,512 + $2,095.29
S2 = $8,607.29
The value of S1 = $10,476.46 and the value of S2 is $8,607.29. Use these values to obtain the
final overhead calculations.

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 2.1.2 General approach of cost allocation
Cost allocation is the process of assigning a cost to an object. The object to which a cost is being
assigned can be any item for which you want to measure a separate cost.
Cost allocation is used for financial reporting to help inventory or spread costs among different
departments. One example of cost allocation would be a municipality distributing the costs of
their IT services to each department within the municipality. Individual departments may include
maintenance, media services, utilities, etc. Allocating costs is important for understanding the
costs of doing business as well as properly assigning prices to goods or services to ensure a
profit. Depending on the type of product or service provided by a business, different types of
cost allocation may be most useful. The three main types of cost allocation are cost allocation
based on direct labour, cost allocation based on machine time, and cost allocation based on
square footage.
Cost allocation based on direct labour allocates overhead costs based on the amount of direct
labour used on a production unit
Cost Allocation Technique

Cost allocation methods are the techniques used to assign indirect costs (also known as overhead
or shared costs) to different cost objects, such as products, services, departments, or projects, in a
systematic and rational manner. Since indirect costs cannot be directly traced to a specific cost
object or are not economically feasible to trace directly, organizations use cost allocation
methods to distribute these costs and better understand the full cost of their products or services.
Some common cost allocation technique include:
1. Direct allocation method (Single-stage allocation): This method allocates each indirect
cost item directly to the cost objects based on a single allocation base, such as direct labour
hours, machine hours, or square footage. The allocation base should have a logical
relationship with the indirect costs being allocated.
2. Step-down method (Sequential allocation): This method allocates indirect costs
sequentially, starting with the department or cost centre that provides the highest level of
support to other departments, and continuing in a hierarchical manner until all costs have
been allocated.
3. Reciprocal allocation method (Simultaneous allocation): This method accounts for the
mutual support and interdependencies between departments by using a system of
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 simultaneous equations to allocate indirect costs. The reciprocal allocation method is more
complex but provides a more accurate representation of the true cost relationships between
departments.
4. Activity-based costing (ABC): This advanced method allocates indirect costs based on the
activities that drive the costs, rather than merely distributing costs based on a single
allocation base. ABC identifies cost drivers or cost pools and assigns costs to cost objects
based on their consumption of the activities, providing a more accurate representation of the
resources consumed by different cost objects.
Example of Cost Allocation Technique
1. Suppose PrintPro chooses machine hours as the allocation base for its indirect costs. The
company first calculates the total machine hours spent on commercial printing and digital
printing during the month. Let’s say the company used 800 machine hours for commercial
printing and 200 machine hours for digital printing, totalling 1,000 machine hours.
Required: calculate direct allocation method
Solution
 If the total indirect costs for the month are $10,000, the allocation rate per machine hour
is:
Allocation rate: Total indirect cost /total machine hours
Allocation cost: $10000/1000hour = $10 per hour
Then, PrintPro allocates the indirect costs to the services using the allocation rate and the
machine hours spent on each service:
 Commercial printing: 800 hours × $10 per hour = $8,000
 Digital printing: 200 hours × $10 per hour = $2,000
2. Activity based costing
Instead of using a single allocation base, PrintPro could implement activity-based costing to
allocate its indirect costs based on the activities that drive the costs. To do this, the company
identifies cost drivers or cost pools, such as equipment maintenance, administrative support, and
energy consumption.
For example, let’s say PrintPro determines the following cost allocations for its total indirect
costs:
 Equipment maintenance: $4,000 (allocated based on machine hours)
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  Administrative support: $4,000 (allocated based on the number of jobs)
 Energy consumption: $2,000 (allocated based on square footage)
PrintPro then allocates each cost pool to the services based on their consumption of the activities:
 Commercial printing: $3,200 (equipment maintenance) + $3,200 (administrative support)
+ $1,600 (energy consumption) = $8,000
 Digital printing: $800 (equipment maintenance) + $800 (administrative support) + $400
(energy consumption) = $2,000
2.1.2. Concept of Joint Cost To Allocate Product Cost
The concept of joint cost allocation is a method used to distribute these common costs among the
various products that result from a common production process. Since the joint costs are incurred
collectively up to the split-off point, allocating them to individual products can be challenging.
Several methods are used for joint cost allocation, and each method has its own set of
assumptions and advantages.
Common methods of joint cost allocation include:
I. Physical unit method

The physical unit’s method, also known as the physical quantity method, is a cost allocation
method used to allocate joint costs among the joint products based on the physical quantities
produced. It assigns costs based on the volume, weight, or other measurable units of the
products. The underlying assumption is that the physical quantity is a reasonable measure of the
benefits obtained from the joint process.
Here’s how the physical units method of allocating joint costs works:
1. Determine the Total Joint Costs: Calculate the total joint costs incurred up to the
split-off point in the joint manufacturing process. These costs include expenses such as
direct materials, direct labour, and factory overhead that are collectively incurred for all
the joint products.
2. Identify the Physical Quantities: Determine the physical quantities of each joint
product produced during the production process. Physical quantities can be measured in
units such as weight, volume, length, or any other relevant measure.
3. Calculate the Allocation Ratio: Calculate the allocation ratio for each joint product by
dividing its physical quantity by the total physical quantities of all the joint products.

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 The allocation ratio represents the proportionate share of the joint costs that each
product should bear based on its physical quantity.
4. Allocate Joint Costs: Multiply the total joint costs by the allocation ratio for each
joint product to determine the allocated joint costs for each product.
5. Cost Assignment: Allocate the allocated joint costs to the respective joint products for
proper cost assignment.
Example: Mohammed Stationary Brothers Ltd. is a family owned company that manufactures
stationary items. The main item that Mohammed Stationary Brothers Ltd. manufactures is pens
of different colours. The initial process of manufacturing the body of pens is almost the same.
The inks of different colours cost different and this cost is allocated to the individual cost cards
of pens depending upon the demand.
The Mohammed Stationary Brother Ltd. runs a joint production batch of producing a total of
1,000,000 pens as follows:
 Blue ink pens: 200,000 units
 Red ink pens: 500,000 units
 Green ink pens: 300,000 units
 The total joint cost of the batch up to split-off point is $400,000.
Required: Allocate the joint cost among all types of pens produced using average unit cost
method.
Solution
Step1 – Computation of average cost per unit:
Average cost per unit = Total joint cost/Total number of units produced
= $400,000/1,000,000 units
= $1,200/600 units
= $0.4 per pen
Step 2 – Allocation of joint cost:
Blue ink pen: $200,000 × 0.4 = $80,000
Red ink pen: $500,000 × 0.4 = $200,000
Green ink pen: $300,000 × 0.4 = $120,000
II. Relative sale value method

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The relative sales value method is a technique used to allocate joint costs based on the prices at
which products will be sold.
Example: A production process incurs $100 of costs in order to create two products, one of
which (Product A) will sell for $400 and the other (Product B) for $100. Under this method, 80%
of the $100 joint cost is assigned to Product A. The calculation is:
$100 joint cost x ($400 ÷ ($400+$100)) = $80
The remaining 20% of the $100 joint cost is assigned to Product B. The calculation is:
$100 joint cost x ($100 ÷ ($400+$100)) = $20

2.1.3. Concepts of Activity- based Costing

Activity-Based Costing (ABC) is a costing methodology that assigns costs to products or
services based on the activities and resources that go into producing them. Unlike traditional
costing methods that allocate costs based on a single cost driver, ABC recognizes that products
consume activities, and activities consume resources.

Figure 4.1: Explaining activity base costing methods

Activity-based costing (ABC) is a costing method that assigns overhead and indirect costs to
related products and services. This accounting method of costing recognizes the relationship
between costs, overhead activities, and manufactured products, assigning indirect costs to
products less arbitrarily than traditional costing methods. However, some indirect costs, such as
management and office staff salaries, are difficult to assign to a product.
ABC is used to improve the accuracy of cost analysis by improving the tracing of costs to
products or to individual customers. It is a system which focuses on activities performed to
produce product. In this system, first costs are traced to activities and then to products, where as
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in traditional system, costs are first traced not to activities but to an organisational unit, such as
department or plant and then to products.

2.1.4. Calculating activity-based costs

Cost objects are a crucial component in activity-based costing (ABC) for measuring profitability
and making informed decisions. They are defined based on the purpose of decision support and
are structured to largely correspond to the complexity of a company’s revenue stream. Typically,
cost objects include products/services and customers, but additional items like channels may be
included depending on the field of activity. The number and structure of cost objects can vary
from organization to organization.

Figure 4.2 ABC calculating formula

In ABC, cost objects represent an object to which costs are allocated using a cause-and-effect
relationship. They are divided into two categories: external activities that create added value and
internal activities within the organization. This allows for a clear understanding of profitability
and the basis for making informed decisions.
 Steps in ABC System
For allocating/absorbing overheads to products/services under Activity-Based Costing, the
following steps are to be taken:

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1. Identifying Activities: The first stage is to identify the functional areas or major activities
involved in the production. Examples of activities include machine related activities, divert
labor related activities and various support activities like ordering, receiving, material
handling, packing, dispatching etc. Various activities are identified by carrying out activity
analysis. The activities may be basically fall into four categories as suggested by Cooper
and Kaplan’.
2. Unit Level Activities or Primary Activities: The cost of primary activities (like use of
indirect materials and consumables, testing of every item produced) may be correlated to
number of units produced (i.e. on volume-basis).
3. Batch Level Activities: These are manufacturing support activities (like material ordering,
machine set-up costs, inspection of products etc). The cost of such activities is driven by
number of batches of units produced.
4. Product Level Activities: Activities like designing of the product, keeping technical
drawings of product, activities up to date, advertising of a specific product are called product
level. The cost of these activities is driven by the creation of a new product line and its
maintenance.
5. Facility Level Activities: Certain activities cannot be related to a particular product, instead
may be related to certain facilities like maintaining the building, security of plant, salaries of
production manager, advertisement to promote organization etc.
6. Assigning Costs to Activity Cost Centers: The second stage requires that a cost center (also
called a cost pool) be created for each activity. After the activities have been identified the
cost of resources consumed over a specified period must be assigned to each activity. These
costs will have to be apportioned on some suitable basis. For example, the total costs of all
set ups might constitute one cost Centre for all setup related costs.
7. Selecting Appropriate Cost Drivers: The third stage of designing ABC system is to
identify the factors that influence the cost of a particular activity. The term cost-driver is used
to describe the significant determinant of the cost of the activity. The most suitable cost
driver in each activity under functional areas should be identified. A cost driver is any factor
that influences costs.
8. Assigning the Cost of the Activities to Products: The final stage is to trace the cost of the
activities to products according to each product’s demand for these activities using cost
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 drivers as a measure of demand. A product’s demand for the activities is measured by the
number of transactions it generates for the cost driver. The cost driver should be measurable
in a way that enables it to be identified with individual products
Benefits of ABC
Activity-based costing provides a more accurate method of product/service costing, leading to
more accurate pricing decisions. It increases understanding of overheads and cost drivers; and
makes costly and non-value adding activities more visible, allowing managers to reduce or
eliminate them. ABC enables effective challenge of operating costs to find better ways of
allocating and eliminating overheads.
In brief following are main benefits of using ABC technique:
1. ABC helps to reduce costs by providing meaningful information for cost-management. It
helps in making the right decision.
2. ABC technique provides due importance to non-manufacturing cost which constitute a
substantial portion of total cost. Traditionally non-manufacturing costs have been
allocated under volume basis and thus, high volume products have been overvalued.
3. ABC technique provides accurate and reliable cost information. This cost information is
essential for recent approaches in productivity improvement like Total Quality
Management (TQM) and Business Process Reengineering.
4. ABC enables the management in formulating an effective pricing policy while fixing
prices.
5. Cost of each activity is determined with the help of ABC. There is accuracy in indirect
cost-allocation to products. This technique is helpful in make or buys decisions and
transfer pricing.
Illustration
1. The budget overheads and cost driver volumes of S Ltd. Are as follows-
Cost Pools Budget Cost Driver Budged
Overheads Volumes
Machinery Purchased 9,00,000 No. of orders 3,000
Material Handling 4,00,000 No. of Movements 1,000
Setup 3,00,000 No. of Set-ups 600
Maintenance 10,00,000 Maintenance Hours 10,000
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Quality control 2,00,000 No. of Inspection 1,000
Machinery 10,00,000 No. of Machine Hours 20,000
The company has produced a batch of 3,000 components of AB-30. Its material cost is Rs.
1,50,000 and direct labor cost Rs.3,00,000. The usage activities of said batch are as follows-
Machine Hours 2,500 Setup 30
Material orders 30 Maintenance Hours 500
Material Movements 15 No. of Inspections 30
1. Calculate cost driver rates that are used for treating appropriate amount of overheads to the
said batch.
2. Ascertain the cost of batch of components using Activity Based Costing.
Solution:
a) Calculation of Cost Driver Rates
 Material Purchasing = 9, 00,000/3000 = Rs. 300
 Material Handling = 4, 00,000/1,000 = Rs. 400
 Setup = 3, 00,000/600 = Rs 500
 Maintenance = 10, 00,000/10,000 = Rs 100
 Quality control = 2, 00,000/1,000 = Rs. 200
 Machine = 10, 00,000/20,000 = Rs. 50
b)Calculation of Cost of Batch of 3,000 components of AB-30
Direct Materials 1,50,000
Direct Labour 3,00,000
Prime Cost 4,50,000
Overheads:
Material Procurement 30*300 9,000
Material Handling 15*1,000 = 15,000
Set-up Cost 30*500 15,000
Maintenance 500*100 = 50,000
Quality control 30*200 6,000
Machine 2,500*50 = 1,25,000 2,20,000
Total Cost 4,70,000

2.2. Designing of costing system

Implementation of activity based costing system must be initiated by top management due to two
reasons. First, without leadership from top management, some managers may not see any reason
to change. Second, if top managers do not support the ABC system and continue to play the

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game by the old rules, their subordinates will quickly get the message that ABC is not important
and they will abandon the ABC initiative. Time after time, when accountants have attempted to
implement an ABC system on their own with top-management support and active cooperation
from other managers, the results have been ignored.
For designing and implementing activity based costing system, management should carefully
study the existing cost accounting system and review the articles in professionals and trade
journals. In most of the organizations, the new activity based costing system supplement, rather
than replace, the existing cost accounting system, which continues to be used for external
financial reports. The following chart explains the general structure of activity based (ABC)
costing model.

Self – Check II
Part I: True/False Statements

1. In the direct allocation method, service department costs are allocated based on the services
provided to other departments.
2. The step-down method is also known as the simultaneous method, and it allocates costs
sequentially from one service department to another.

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3. The reciprocal method of cost allocation recognizes the mutual support and
interdependencies between service departments.
4. Activity-Based Costing (ABC) assigns costs to products or services based on a single cost
driver.
5. The physical unit method allocates joint costs based on the prices at which products will be
sold.

Part II: Multiple-Choice

1. Which cost allocation method allocates service department costs to other parts of a business
by fully loading operating departments with those overhead costs?
A. Direct allocation method
B. Step-down method
C. Reciprocal method
D. Physical unit method
2. What is the primary basis for allocating joint costs in the relative sales value method?
A. Physical quantities
B. Machine hours
C. Prices at which products will be sold
D. Maintenance hours

Part III: Practical Demonstration

1. XYZ Manufacturing produces three types of products - A, B, and C. The following

information is available for a production batch:
Product A: 5,000 units
Product B: 8,000 units

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 Product C: 3,000 units
Total Joint Cost: $150,000
Required: Using the Physical Unit Method, calculate the allocated joint cost for each product.
2. ABC Company has two products, X and Y, with the following details:
Product X will sell for $300
Product Y will sell for $150
Total Joint Cost incurred is $50,000
Apply the Relative Sales Value Method to allocate the joint cost between Products X and Y.
Required: Calculate the allocated cost for each product.

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UNIT THREE: Produce Cost Reports
This unit is developed to provide you the necessary information regarding the following content
coverage and topics:
 Assgning cost
 Cost information
 Structure of budgets and reports
 Budget variances
 Error of free reports
This guide will also assist you to attain the learning outcomes stated in the cover page.
Specifically, upon completion of this learning guide, you will be able to:
 Assgne costs to specified products and services
 Explaine cost information
 Make clear structure and format of budgets and reports
 Identify variances against budget
 Analyse making error free reports

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2.2.1. Assigning Cost
Cost assignment is the process of associating costs with cost objects, such as products, services,
departments, or projects. It encompasses the identification, measurement, and allocation of both
direct and indirect costs to ensure a comprehensive understanding of the resources consumed by
various cost objects within an organization. Cost assignment is a crucial aspect of cost
accounting and management accounting, as it helps organizations make informed decisions
about pricing, resource allocation, budgeting, and performance evaluation.

Figure 3.1- cost assigning general principle

There are two main components of cost assignment:
A. Direct cost assignment: Direct costs are those costs that can be specifically traced or
identified with a particular cost object. Examples of direct costs include direct materials,
such as raw materials used in manufacturing a product, and direct labor, such as the
wages paid to workers directly involved in producing a product or providing a
service. Direct cost assignment involves linking these costs directly to the relevant cost
objects, typically through invoices, timesheets, or other documentation.
B. Indirect cost assignment (Cost allocation): Indirect costs, also known as overhead or
shared costs, are those costs that cannot be directly traced to a specific cost object or are
not economically feasible to trace directly. Examples of indirect costs include rent,
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 utilities, depreciation, insurance, and administrative expenses. Since indirect costs cannot
be assigned directly to cost objects, organizations use various cost allocation methods to
distribute these costs in a systematic and rational manner. Some common cost allocation
methods include direct allocation, step-down allocation, reciprocal allocation, and
activity-based costing (ABC).
Average Cost of Production

Average cost of production refers to the per-unit cost incurred by a business to produce a product
or offer a service. Production costs may include things such as labour, raw materials, or
consumable supplies. In economics, the cost of production is defined as the expenditures
incurred to obtain the factors of production such as labour, land, and capital that are needed in
the production process of a product. For example, the production costs for a motor vehicle tire
may include expenses such as rubber, labour needed to produce the product, and various
manufacturing supplies. In the service industry, the costs of production may entail the material
costs of delivering the service, as well as the labour costs paid to employees tasked with
providing the service.
Types of Costs of Production
A. Fixed costs
Fixed costs are expenses that do not change with the amount of output produced. This means that
the costs remain unchanged even when there is zero production or when the business has reached
its maximum production capacity. For example, a restaurant business must pay its monthly,
quarterly, or yearly rent regardless of the number of customers it serves. Other examples of fixed
costs include salaries and equipment leases. Fixed costs tend to be time-limited, and they are
only fixed in relation to the production for a certain period. In the long term, the costs of
producing a product are variable and will change from one period to another.

B. Variable costs
Variable costs are costs that change with the changes in the level of production. That is, they rise
as the production volume increases and decrease as the production volume decreases. If the
production volume is zero, then no variable costs are incurred. Examples of variable costs
include sales commissions, utility costs, raw materials, and direct labour costs.
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For example, in a clothing manufacturing facility, the variable costs may include raw materials
used in the production process and direct labour costs. If the raw materials and direct labour
costs incurred in the production of shirts are $9 per unit and the company produces 1000 units,
then the total variable costs are $9,000.
C. Total cost
Total cost encompasses both variable and fixed costs. It takes into account all the costs incurred
in the production process or when offering a service.
For example, assume that a textile company incurs a production cost of $9 per shirt, and it
produced 1,000 units during the last month. The company also pays a rent of $1,500 per month.
The total cost includes the variable cost of $9,000 ($9 x 1,000) and a fixed cost of $1,500 per
month, bringing the total cost to $10,500.
D. Average cost
The average cost refers to the total cost of production divided by the number of units produced.
It can also be obtained by summing the average variable costs and the average fixed costs.
Management uses average costs to make decisions about pricing its products for maximum
revenue or profit. The goal of the company should be to minimize the average cost per unit so
that it can increase the profit margin without increasing costs.
E. Marginal cost
Marginal cost is the cost of producing one additional unit of output. It shows the increase in total
cost coming from the production of one more product unit. Since fixed costs remain constant
regardless of any increase in output, marginal cost is mainly affected by changes in variable
costs. The management of a company relies on marginal costing to make decisions on resource
allocation, looking to allocate production resources in a way that is optimally profitable.
For example, if the company wants to increase production capacity, it will compare the marginal
cost vis-à-vis the marginal revenue that will be realized by producing one more unit of output.
Marginal costs vary with the volume of output being produced. They are affected by various
factors, such as price discrimination, externalities, information asymmetry, and transaction costs.

2.3. Cost information

Cost Information is Within one hundred twenty (120) days after completion of a Non-Consent
Operation, the Operator shall furnish all Parties an itemized statement of the Cost of such

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operations and an inventory of the equipment pertaining thereto or, at its option, the Operator in
lieu of an itemized statement of such Costs may submit a detailed statement of monthly billings.
Information costs are costs incurred by an individual or a firm while amassing information to
help make a financial decision. If these costs are significant enough, it can affect the profitability
of a business enterprise or the soundness of a consumer's purchase. Cost information is an
important element across several activities that are involved in cost engineering (the practice of
managing costs involved on a construction project), such as cost control, budgeting, forecasting,
estimating, investment appraisal and risk analysis.
Purpose of cost information
The cost information is important for the managers for of the following three reasons:
 Based on costs it is decided the acquisition, production or abandon a product;
 The costs can be a basis for the price establishment;
 Through the costs it is identified the needs for improvement of the products or services.

2.4. Structure of budget and report

A cost budget, also known as a budgeted cost or cost estimate, is a financial plan that outlines the
expected expenditures for a specific project, activity, or business operation over a defined period.
It serves as a guideline for managing and controlling costs associated with various aspects of a
project or business.
Key aspects of a cost budget include:
A. Estimates: Cost budgets involve estimating the expenses associated with labor, materials,
equipment, overhead, and other resources required for the completion of a project or the
operation of a business.
B. Time Frame: A cost budget typically covers a specific time frame, such as a fiscal year or
the duration of a project. It provides a detailed breakdown of expected costs for each
period within the defined timeframe.
C. Allocation: Costs are allocated to different components or activities of the project or
business. This allocation helps in identifying and tracking expenses related to specific
tasks, departments, or functions.

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 D. Basis for Decision-Making: Cost budgets provide a basis for decision-making by
estimating the financial resources needed for planned activities. They help in resource
allocation, setting financial targets, and assessing the feasibility of projects or operations.

2.4.1. Budget Report

A budget report is a financial picture of a business or project over a specific time period. It
collects data related to actual spending and compares that to what’s been projected for that
period in terms of the budget.
This means that a budget report helps determine if you’re spending according to your budget or
going over or under it. The budget report has at least two columns: one for planned spending
that’s been budgeted for the reported period and one for the actual spending for that period.
Purpose of Budget Report
The main purpose of a budget report is to compile data on how much you’re spending on your
business or project over a specific period. This information is crucial to run a successful
company or project; you can’t spend blindly and expect to stay in business or deliver a
successful project.
Being able to have proper spending control is what keeps a business afloat. It’s especially true as
economies cycle through good and bad times. A business can’t ignore the economic landscape
and expect to survive; rather, regular budget reports help you stir your business through the
choppy waters of the industry.
A budget is also the best guess of what a company or project is going to spend. The accuracy is
based on research and historical data. Your budget reports can, therefore, be archived and
accessed when planning future budgets to make a better estimate of what your costs and
expenses will be.
Components of a Budget Report
A budget report can include different columns depending on the business or project. Often the
budget report is part of a larger status report that captures a more wide-ranging set of data points.
This can help to put the costs in context and provide a better picture of not only what was spent
but why. But if you were to boil a budget report down to its essential elements, it would reveal
these four components: actual costs, planned costs, budget and remaining budget. Any budget

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report that you create should include these four components. Let’s take a closer look at these four
parts of a basic budget report.
A. Actual Costs
The actual costs in a budget report are the total expenditure that the company or project spent
over the course of time reflected in the report. It’s important to understand that a forecast or a
budget tries for accuracy but it’s never completely right. There are almost always unexpected
expenses, costs, etc., which will impact your budget. The actual costs, therefore, give you hard
data on how much you spent so you can compare it to what you thought you’d spend over this
period.
B. Planned Costs
The planned costs are those that you anticipate for the business over a specific time period or for
a period of a longer project. These are estimated costs that are based on a predetermined budget
and timeline. Some of these costs include raw materials, labor costs and overhead costs, such as
utilities.
C. Budget
The budget is a financial plan that’s used by a company or project to illustrate the money needed
to operate over a period or for a project to successfully deliver its product or service. It shows
how much money is needed and the time in which that money is to be spent to carry on the
operations of a business or execute the goal of a project.
D. Remaining Budget
Finally, the remaining budget is what you’re left with in terms of your overall budget after the
expenditure of the reported period. It shows how much money you have left to continue
operating your business or deliver your project.
Example:
Here's an example of a more detailed budget report. This report outlines the organization's
projected and final income and expenses for February 2021. Analyzing the data detailed in this
report can allow us to more accurately project budget expenses and build goals for upcoming
years:
Description Budget Final Cost
Income
Product income $200,000 $350,000
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Description Budget Final Cost

Service income $500,000 $730,000

Total $700,000 $1,080,000
Total amount that you gained or earned based on your
Profit or loss total: $380,000
budget and final cost
Expenses
Sales $50,000 $30,000
Product
$100,000 $70,000
development
Total $150,000 $100,000
Costs overrun $50,000

2.5. Budget Variance

A budget variance is a periodic measure used by governments, corporations, or individuals to
quantify the difference between budgeted and actual figures for a particular accounting category.
A favourable budget variance refers to positive variances or gains; an unfavourable budget
variance describes negative variance, indicating losses or shortfalls. Budget variances occur
because forecasters are unable to predict future costs and revenue with complete accuracy.
Budget variances can occur broadly due to either controlled or uncontrollable factors. For
instance, a poorly planned budget and labour costs are controllable factors. Uncontrollable
factors are often external and arise from occurrences outside the company, such as a natural
disaster.
Types of Budget Variance
I. Adverse Variance
It’s important to discuss adverse (or negative) budget variance further because of its damaging
and potentially severe consequences for a business.
One of the most common ways that a company experiences adverse budget variance is through
poor estimations of future spending. The company may assume that a project will cost less than
it ends up costing, whether due to a lack of accurate information about costs or unexpected

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expenses. A company may also experience negative variance if it allows office or industry
politics to dictate a target spending that is unreasonably low.
II. Positive Variance
Many companies report a positive budget variance. In order to do so, most companies establish a
well-padded budget for individual projects or operations in general. They try to be as accurate as
possible in allowing for expenses, with a built-in buffer of extra funds to guard against certain
costs, namely:
 Unexpected costs connected to supplies
 Complications with a project/task
 Changes in the market
 Company-wide issues (scandal, change in management, procedural/operational changes)
Budget variance formula
To calculate budget variance, you can use one of two formulas.
 Variance = Actual Value - Projected Value Or
 Variance = Projected Value - Actual Value
Examples of budget variance
Project value Actual value
Total revenue $ 8m $8.5m
Total cost $7m $8.2m
Net profit $1m $0.3m
In this example, use the first formula: Variance = Actual Value - Projected Value.
Project value Actual value Variance
Total revenue $ 8m $8.5m $0.5m
Total cost $7m $8.2m $1.2m
Net profit $1m $0.3m ($0.7m)

2.6. Error of Free Report

Error Free means that there are no errors or omissions in the description of the phenomenon and
that the process used to produce the information presented was selected and applied without
errors in the process. In this context, error- free does not mean perfectly accurate in all aspects.

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Error free documents are beneficial as they are good to the company's reputation, customers can
have a hard time reading a document which contains a lot of Typo's, poor grammar, and invalid
numbers. Achieving an error free document is not very simple however very rewarding.
Proofreading for a document is a difficult task but can be assessed into steps for more accuracy.
First of all, by using appropriate software and software tools to ensure that documents/slides are
spellchecked, this process could be accomplished easily when you are fully aware of what your
software is capable of doing, and by using the right tools tasks such as: spelling check and
grammar check can be complete in a click of button.
However normal proof reading is still mandatory to check mistakes that computers can't detect,
to guarantee no error employees need to revise and practice entering data with 100% accuracy,
and be aware of the methods of proofread documents. Like:
 Read and proof your document thoroughly.
 Read backwards (right to left or bottom to top) to concentrate on spelling instead of
content.
 Reread the document for content to find omissions and plurals.
 Wait a couple of hours or a day to proofread what you typed. You are more likely to find
errors.
 Have others proofread your documents.
 Verify any words you are not sure of.
 Go through all these steps multiple of times (for more accuracy) before printing and
publicizing.
Benefits of Effective Error Reporting
 Reducing customer churn: If customers encounter application-breaking crashes or issues
that prevent them from quickly completing key functions, they'll churn to other options.
Pinpointing problems ASAP helps companies reduce the risk of customer churn.
 Capturing critical events: Comprehensive error reporting helps your team separate one-
off events from more widespread and problematic issues. Complete capture of these
issues allows teams to fully investigate them and find a fix.
 Creating reliable analysis: Analysis of error reporting data makes it possible to discover
trends that are impacting your operations over time. Regular and reliable analysis,

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 meanwhile, empowers teams to understand how errors are impacting your network at
scale.
 Increasing development speed: The rise of DevOps teams speaks to the need for speed.
Employees and end-users want access to new applications and updates as quickly as
possible, and teams want built-in processes that empower this effort without
compromising security.
 Identifying root causes: The biggest benefit of error reporting? Identifying root causes.

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Self- Check III
Part I: True or False statements
1. Fixed costs change with the level of production.
2. The budget is a financial plan illustrating the money needed for a project or business
operation.
3. Adverse budget variance refers to positive variances or gains.
4. Actual costs in a budget report are estimated costs based on a predetermined budget.
Part II: Multiple Choice
1. What is cost assignment?
A. Budgeting process
B. Allocating costs to cost objects
C. Profit calculation
D. Financial forecasting
2. Which of the following is an example of a direct cost?
A. Rent
B. Utilities
C. Raw materials
D. Administrative expenses
3. What does the average cost of production represent?
A. Total fixed costs
B. Total variable costs
C. Per-unit cost of production
D. Marginal cost
4. What is the purpose of cost information in managerial decision-making?
A. Calculating profits
B. Assessing market trends
C. Making informed decisions about pricing and resource allocation
D. Forecasting macroeconomic indicators
5. What is the main goal of budget variance analysis?
A. Increasing costs
B. Achieving a positive variance

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 C. Avoiding budgeting altogether
D. Ignoring actual expenses
Part III : Practical Demonstration
1. Calculate the average cost per unit:
Total production cost: $50,000
Number of units produced: 10,000
2. Determine the budget variance using the formula: Variance = Actual Value - Projected Value
Actual revenue: $120,000
Projected revenue: $100,000

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UNIT FOUR: Cost Control System
This unit is developed to provide you the necessary information regarding the following
content coverage and topics:
 Cost control and cost reduction
 Techniques of cost reduction
 Area of cost reduction
 Unit cost production
 Methods of increasing productivity
 Effects of budget and standard costing
This guide will also assist you to attain the learning outcomes stated in the cover page.
Specifically, upon completion of this learning guide, you will be able to:
 Identify the deference between cost control and cost reduction
 Apply techniques of cost reduction
 Explaine area of cost reduction
 Demonstrate unit cost production
 Apply methods of increasing productivity
 Identify effects of budget and standard costing

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2.7. Cost Control And Cost Reduction
Cost control is a managerial process designed to manage and regulate the expenses incurred by
an organization to ensure they align with the planned budget. The primary goal of cost control is
to monitor and limit expenditures, prevent unnecessary spending, and optimize the use of
resources efficiently. Cost reduction involves a deliberate and planned effort to decrease the
overall expenses incurred by an organization without compromising the quality of its products or
services.

2.7.1. Cost Control

Cost control is the process of identifying, eliminating or reducing unnecessary business expenses
in order to increase profits. Cost control starts with the budgeting process and looks at vendor
selection and negotiation, leveraging early payment and volume discounts, using spend
management systems, and improving manufacturing or construction efficiency and product
quality.

Figure 4.1: cost control

Standard costing and budgetary control are two techniques used in the cost control process. The
process is a continuous one and helps to analyse the causes for the variances. It involves:
 Determining the standards
 Comparing the standards and looking at the results
 Analysing the variances
 Establishing the action needed to be taken by the firm

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 Figure 4.2 cost control management
The major techniques used in cost control are standard costing and budgetary control. It is a
continuous process as it helps in analysing the causes for variances which control wastage of
material, any embezzlement and so on.

2.7.2. Cost reduction

Cost Reduction is a process, aims at lowering the unit cost of a product manufactured or service
rendered without affecting its quality by using new and improved methods and techniques. It
ascertains substitute ways to reduce the cost of a unit. It ensures savings in per unit cost and
maximisation of profits of the organisation. Cost Reduction aims at cutting off the unnecessary
expenses which occur during the production, storing, selling and distribution of the product.

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 Figure 4.3 : cost reduction
To identify cost reduction, the following are the major elements:
 Savings in per unit cost.
 No compromise with the quality of the product.
 Savings are non-volatile in nature.
Tools of cost reduction are Quality operation and research, Improvement in product design, Job
Evaluation & merit rating, variety reduction, etc.
 The key difference between cost control and cost reduction

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 Figure 4.4: The diference between cost control and cost reduction

2.8. Techniques of cost reduction

The process of identifying and eliminating unnecessary costs to improve the profitability of a
business is known as cost reduction.
According to the Terminology of Cost Accountancy of the Institute of Cost and Management
Accountants London, Cost reduction is to be understood as the success of real and unchanging
reduction in the unit costs of goods manufactured without impairing their suitable for the use
intended.

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 Figure 4.5 :Technic of cost reduction
There are number of cost reduction techniques, such as:
1. Budgetary Control
2. Inventory Control
3. Standard Costing
4. Job Evaluation
5. Reduction in variety of products
6. Value Analysis
7. Uniform Costing
8. Intra-inter firm Comparison
9. Operational Research
10. Productivity

2.9. Area of cost reduction

They are now seen as key business partners, providing valuable insights and strategic guidance
to help organisations achieve their financial goals. Cost reduction is a continuous process and in
this article, we will discuss several key strategies that finance teams can use to identify areas for
reducing costs.

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 A. Conduct a detailed cost analysis
The first step in reducing costs is to understand your current spending patterns. This can be
achieved by conducting a detailed cost analysis. This involves identifying all the costs incurred
by your organisation, including direct costs such as materials and labour, and indirect costs such
as rent and insurance.
B. Identify non-value-adding activities
Once you have a clear understanding of your current spending patterns, the next step is to
identify any non-value-adding activities. These are activities that do not contribute to the
delivery of a product or service and can be eliminated or reduced. Examples include unnecessary
meetings, duplicated efforts, and inefficient processes.
C. Evaluate vendor contracts
A significant portion of your costs may be associated with vendor contracts. It is essential to
regularly evaluate these contracts to ensure that you are getting the best value for your money.
This can be done by negotiating better terms, consolidating contracts with multiple vendors, or
seeking out alternative suppliers.
D. Implement automation
Automation can help reduce costs by streamlining processes, reducing manual errors, and
increasing efficiency. There are a number of different technologies available to finance teams,
including accounting software such as Subsystem’s, expense tracking systems, and digital
invoicing.
E. Utilise data analytics
Data analytics can provide valuable insights into areas for reducing costs. By leveraging data,
finance teams can identify trends, patterns and areas for improvement, allowing them to make
more informed decisions about cost management.
F. Encourage cost-saving initiatives
Encouraging cost-saving initiatives throughout the organisation can help to reduce costs. This
can be done by setting goals, recognising and rewarding cost-saving efforts, and encouraging
employees to come forward with their own cost-saving ideas.

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2.10. Unit cost production
Ways to reduce costs and increase productivity in manufacturing organization remain
competitive; all the companies must offer quality products at cutthroat prices. To make this
possible, a company can cut their manufacturing cost per unit and increase productivity with the
same amount of input.
Cost cutting isn’t restricted to stay ahead in the competition but also to survive in the market due
to new entrants today. These new entrants are externally funded and their competitive market
approach makes it hard for the already set manufacturers to keep up It is clear that every
manufacturer needs to raise up their productivity charts to stay alive. Here are the 5 best ways
that can help a manufacturer to reduce costs and increase productivity.
 Work Flow Optimization
Analyse the work flow of the manufacturing of your product. This includes everything related to
the manufacturing, from people and resources to communication and procedures. Mapping all of
these activities helps business professionals to monitor them and look out for any room for
improvement. When you are able to examine a process in detail, you tend to find many cracks
which are yet to be filled.
 Reduce labour costs
After analysing your process, if the physical labour turns out to be the biggest burden in your
cost sheets, it is better to find out ways to operate on modest labour force. Though labour force
in India is much cheaper, but in the companies where highly skilled labour is required, the costs
are much higher
 Material costs
When the material cost forms the bigger chunk in the total production costs, noticeably you need
to bring its costs down to control your expenditure. Purchase material in bulk to cut down the
unit prices. Research is a vital role to be played by a manufacturer to audit which material it
requires in what quantity and which it doesn’t.
 Overhead costs
Costs of building, utility, supply storage, traveling and administrative costs all add up to become
the overhead costs which eventually add up in the manufacturing costs. Setting a budget for
these costs and reviewing them constantly could be a measure to keep these costs under control.
 Installing Modern Equipment’s
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Sometimes to save money, you need to spend some. Investing in equipment to increase
productivity doesn’t seem a bad idea. You cannot keep using the old machinery and equipment’s
in today’s time and expects it to work wonders for you. As technology advances, better tech
keeps hitting the market.

2.11. Methods of increasing productivity

Increasing productivity involves optimizing the efficiency of processes, resources, and systems
to achieve higher output with the same or fewer inputs.
Productivity increases when you undertake the following steps that will help you work smarter,
faster, and better:
 Establish a morning routine.
 Plan your days and manage your time.
 Take care of your health.
 Work smart, and take breaks.
 Leave room for leisure time.
Best Ways to Increase Productivity
 Create the Perfect Environment
It’s important to feel comfortable when you go to work, sit down and open up your task list for
the day. If you feel good and relaxed when you work, you’ll work better and be more creative.
The same goes for your co-workers and employees too. So take steps to create a positive, warm,
happy and relaxed environment to work in.
 Take More Breaks
Frequent short bursts of good quality work are better than one long block of work. Studies show
that in the case of musical performance, intense and deliberate practice is better than drawn out
and unfocused practice. This same approach applies to work too, and if you’re taking lots of
good quality breaks then you’ll find the quality of your work will improve too.
 Find the Best Time of Day
You might not be a 9-5 person. In fact if you’re a freelancer you might find that you work best in
the evenings or night times. Whenever your most productive time of the day is then try to fit
your day around that. Obviously this doesn’t work so well if you have to be in the office at
certain times of the day, but perhaps plans your task list around your most productive time of the
day instead.
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  A Good Diet
Although it’s tempting to go out to the cafe for lunch and get that delicious burger, it will wreck
your productivity for the afternoon. What you eat throughout the day will affect how you feel
and how alert you are, and therefore will have a big effect on your productivity. Perhaps even
seek a nutritionist for the best advice on healthy nutrition and the benefits of a popular 3-day
diet, etc.
 One Task at a Time
Try to break your task list down in to small actionable items that you can approach one at at
time. Looking at the whole list of tasks you’ve got to complete before your deadline will make
you panic as you won’t be able to digest everything altogether. It’s much better to take one task,
address what you need to do, perform the task, complete it, then move on to the next task after a
short break.
 Work with Others
It’s fun to work with others to achieve a common goal. You’ll find yourself spurring one another
on and motivating each other. You’ll probably find you get more done when you work in a small
team than when you work on your own (this may not always be the case for you though). If you
work remotely then having video conferencing often will help motivate everyone and bring
productivity to the team.
 Reward Yourself!
There are lots of ways you can reward yourself and you’ll know the best way. Whatever you do
make sure you do it regularly after you achieve your goals and you’ll find that the next time a
deadline comes up you’ll be looking forward to the reward at the end of it.

2.12. Effects of budget and standard costing

Budgeting is a financial planning process that involves setting specific financial targets and
allocating resources to achieve those targets.

2.12.1. Effect of budget

The effects of budgeting on an organization are multifaceted, influencing various aspects of
financial management and overall business operations. Here are some key effects of budgeting:
A. Goal Setting and Planning:

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Effect: Budgeting involves the process of setting specific financial goals and plans for the
organization. It provides a roadmap for achieving these goals through the allocation of resources.
B. Resource Allocation:
Effect: Budgets allocate resources, including funds, manpower, and materials, to different
departments or projects based on their priority and importance. This ensures that resources are
utilized efficiently and in alignment with organizational objectives.
C. Performance Evaluation:
Effect: Budgets serve as benchmarks for evaluating actual performance. By comparing actual
results with budgeted figures, organizations can identify areas of success or areas that require
improvement.

2.12.2. Standard cost

Standard cost is defined in the CIMA Official Terminology as “'the planned unit cost of the
product, component or service produced in a period. The standard cost may be determined on a
number of bases. The main use of standard costs is in performance measurement, control, stock
valuation and in the establishment of selling prices.” From the above definition Standard costs
can be said as
 Planned cost
 Determined on a base or number of bases.
Standard costing system is widely accepted as it serves different needs of an organisation. The
standard costing is preferred for the following reasons:
i. Prediction of future cost for decision making: Standard costs are set after taking all
present conditions and future possibilities into consideration. Hence, standard cost is
future cost for the purpose of cost estimation and profitability from a proposed project/
order/ activity.
ii. Provide target to be achieved: Standard costs are the target cost which should not be
crossed by the responsibility centres. Performance of a responsibility centre is
continuously monitored and measured against the set standards. Any variance from the
standard is noted and reported for appropriate action.
iii. Used in budgeting and performance evaluation: Standard costs are used to set budgets
and based on these budgets managerial performance is evaluated. This is of two
benefits, one managers of a responsibility centre will not compromise with the quality to
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 fulfil the budgeted quantity and second, variances can be traced with the responsible
department or person.
iv. Interim profit measurement and inventory valuation: Actual profit can only be
known after the closure of the accounts. But an organisation may need to prepare
profitability statement for interim periods for managerial reporting and decision making.
To arrive at profit figure, standard costs are deducted from the revenue.

Self-check -VI
Part I: True/False
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1. Standard costs are the target cost which should not be crossed by the responsibility centres.
2. Actual profit can only be known after the closure of the accounts.
3. Cost Reduction aims at cutting off the unnecessary expenses which occur during the
production.
4. Cost control starts with the budgeting process and looks at vendor selection and negotiation

Part –II: fill in the blank space

1. _____________is any variances should be addressed straight away to ensure that spending
and expenses get back on track.
2. ______________are the target cost which should not be crossed by the responsibility centres.
3. _____________is the process of identifying, eliminating or reducing unnecessary business
expenses in order to increase profits.
4. ________________is continuously monitored and measured against the set standards.

Part- III: Give Short Answer

1. Write the difference between budget control and standard cost?
2. List at least five cost reduction techniques
3. List and define benefits of cost control management
4. Briefly write the difference between cost control and cost reduction

Reference
1. Cost accounting for Dummies 2nd edition

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 2. 4th edition of cost accounting and managerial accounting
3. Cost accounting fundamental 6th edition steven M.Bragg

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No Name Qualification Educational Region College Mobile E-mail
background number
1 Kassa Terefe MA Accounting & A.A. Kirkos 099329830 [email protected]
Gelaw Finance Manufacturing 1
College
2 Remedan MBA Accounting & A. A GENERAL 093323393 [email protected]
Abdurehman Finance WINGET PTC 9
3 Sewumehon MSC Accounting & A. A Kirkos 094803212 [email protected]
Anteneh Finance Manufacturing 6 om
College
4 Aynabeba MA Accounting Oromy Sebeta Polytechnic 091172488 [email protected]
Zewdie &Finance a College 1 om
5 Ejigu Terefe MA Accounting Oromy Burayu PTC 091344047 [email protected]
&Finance a 8
Developers profile

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