FOOTWEAR COSTING AND ANALYSIS

CONTENTS

CHAPTER I - COSTING

Costing - Definition; Need of Costing; Objectives of Costing; Advantages of Cost Accounting;

Elements of Cost – Materials; Labour; Expenses; Overheads; Overheads Recovery

Components of Total Cost - Cost Sheet; Calculation of the Element Values in the Cost Estimate
Sheet; Cost Estimate Sheet; Calculation of Machine Hour Rate; Contribution; Break - Even –
Analysis

Profit - Definition of 'Profit'; Pricing Policies; Competition; Market Constraints; Company Turn
Over; Profit Management; Profit Maximization

CHAPTER II – FINANCIAL CONTROLS

Concept of Financial Control - Importance of Financial Control; Steps of Financial Control

Material Cost Control - Salient Features of Material Cost Control; Materials Control System

Labour Cost Accounting - Introduction; Importance of Labour Cost Control; Time Keeping;
Time Booking; Measurement of Labour Efficiency and Productivity; Distinction between Direct
and Indirect Labour

Analysis of Financial Statements - Trial Balance; Profit And Loss Account; Balance Sheet;
Financial Income Statements; Fund Flow Statement

Financial Performance Analysis - Balance Sheet Ratios; Revenue Statement Ratios

Budgeting and Budgetary Control - Budgetary Control; Features of Budget & Budgetary
Control; Objectives of Budgetary Control; Advantages of Budgetary Control; Limitations of
Budgetary Control; Master Budget

Responsibilities of a Financial Controller

 CHAPTER I - COSTING

1.1.COSTING

DEFINITION:

The term "costing" refers to the technique and process of determining cost of a product or
service.

It is a system of computing cost of production or of running a business, by allocating expenditure

to various stages of production or to different operations of a firm

According to Wheldon, the definition is

COSTING IS The classifying, recording and appropriate allocation of expenditure for the
determination of the costs of the products or service; and for the presentation suitable, of
arranged data for purposes of control and guidance of management.

NEED OF COSTING

1. Global competition: There is an ever increasing amount of competition in the market both
internally and externally. Only those producers can meet the challenge who exercise stringent
control over costs and follow sound pricing policies.

2. Limited Resources of Raw Materials: There has been an acute shortage of resources which
require an effective and economic utilization by reducing wastages and losses.

3. Complex management Extra work from Labour: The management of Industrial

organizations has become an extremely complex process demanding attention and action at every
stage of operation and in every area of production.

4. Fast decisions: Correct and quick decisions are required on the basis of adequate
information's supported by reliable data.

5. Special responsibility: Every business shares a heavy social responsibility in terms of proper
quality, reasonable prices, regular supply, etc.

6. Optimum profit: All business ventures aim at maximization of profit which is mainly based
on an efficient performance in financial, personal, production and marketing activities.

OBJECTIVES OF COSTING

1. To find out determine the cost of product;

2. To help in fixation of selling price or quotation for tenders.
3. To analyze and classify the different elements of cost which constitute the total cost;
 4. To identity causes of wastage and apply appropriate course of action for checking the
wastage;
5. To control costs by analysis and comparison;
6. To communicate to the management all information relating to costs and facilitate
management
7. To judge the relative efficiency of different departments, branches, product, units, plants
and machinery and devise means of increasing their productivity ; and
8. To produce cost statements as and when required by the management for an interim
review of production, sales and profit or to plant future activities.

ADVANTAGES OF COST ACCOUNTING

An effective and organized system of costing helps:

 Helps in controlling cost

 Helps in decision making
 Helps in fixing prices
 Provides cost information
 Ascertains the total per unit cost of production
 Finds outs profitable and non-profitable operations
 Provides information for the comparison of cost
 Check the accuracy of financial accounts
 Helps invests and financial institutions/organizations
 Beneficial to workers
 Preparation of budgets and business forecasts.

1.2.ELEMENTS OF COST

There are three elements of cost (1) materials, (2) labour, and (3) expenses
MATERIALS

The substances from which the products are made are known as materials. They may be in raw
stage or partially manufactured condition. These can be either direct or indirect.

Direct Materials

Those materials which can be identified and measured or quantified directly to the product are
called direct materials.

For example, timber in furniture making, cloth in garments trade, bricks in building a house and
leather in shoe making.

Indirect Materials

In accounting, indirect material is a category of indirect cost. Indirect materials are materials that
are used in a production process, but are not directly traceable to a cost object. Indirect material
costs are considered overhead costs and treated accordingly.

Examples are cotton waste. Small tools, lubricants, oils and grease

LABOUR

Labour is the physical or mental effort expended in production. The remuneration for such
efforts is known as wages. Labour cost or wages is defined as 'the cost of employees
remuneration'. Labour is also distinguished as direct and indirect.

Direct wages

Direct wages are wages paid to the workers involved in production.

Indirect wages

Indirect wages cost is the remuneration paid to workers who do not work directly on a product
but assist in production of a product.

Examples of indirect labors are: Production supervisor, Purchasing staff, Materials handling
staff, Materials management staff and Quality control staff

EXPENSES

All expenditures other than material and labour are termed as 'expenses' Expenses can also be
direct and indirect.
Direct Expenses: It includes any expenditure other than direct material and direct labour directly
incurred on a specific job unit (product or job). These are also known as 'chargeable expenses'.
Some examples of such expense are:
 Carriage inwards,
 Production royally,
 Hire charges of special equipment,
 Cost of special drawings, layout, designs etc.

Indirect Expenses: These expenses are those incurred for the business as a whole rather than for
a particular order, job or product. All expenses other than indirect materials and labour which
cannot be directly attributed to a particular product, job, or service are termed as 'indirect
expenses'. Examples are:
 Rent of building
 Repairs of machinery
 Lighting and heating
 Insurance

OVERHEADS

Overheads are the indirect costs which cannot be allocated to any specific job, or process
because they are not capable of being identified with any specific job process.

Overheads include cost of indirect material, indirect labour, indirect expenses, which cannot be
charged to any specific jobs are called overheads. Administration, supervision, depreciation and
maintenance cost are examples of overheads.

Overheads are classified as: Factory overheads, Office and administration overheads, selling
overheads and Distribution overheads.

Production Overhead

Production overhead (also known as factory overhead, factory burden, manufacturing overhead)
involves a company's factory operations. It includes the costs incurred in the factory other than
the costs of direct materials and direct labor.

Finding ways to reduce production overhead is a frequent technique for improving the efficiency
and profitability of production

Production Overhead Cost are:

1. Building Expenses – Rent, Insurance, Repairs, Heating and Lighting and Depreciation etc
2. Indirect Labor – Supervisors, Machine Helpers, General Workers, Maintenance,
Inspectors, etc
3. Water, fuel and power (electronic, pneumatic and hydraulic)
4. Consumables stores such as cotton waste, grease etc
5. Plant Maintenance and depreciation
 6. Sundry expenses such as those of employment office, security, all forms of welfare,
recreation and rest rooms etc

Administration Overheads

Administration overhead consists of expenses incurred in direction, control and administration of

an industry.

Administration overhead is the expenses of providing a general management and clerical service

Administration overhead cost are:

1. Office rent
2. Salaries and wages of clerks
3. Directors, General Manager fees
4. Insurance
5. Legal Costs
6. Postage and Telephones
7. Audit fees
8. Bank charges etc

Selling Overhead

Selling overhead consists of expenses in order to maintain and increase the volume of sales.

Selling overhead cost are:

1. Advertising
2. Salaries of sales staff, commission of sales manager
3. Travellers agents
4. Rent of sales rooms and offices
5. Consumer service
6. Cost of participation in industrial fares and exhibitions
7. Normal bad debt etc

Distribution Overhead

Distribution overhead covers all expenses connected with transporting products to consumers,
storing them when necessary

Distribution overhead cost are:

1. Warehouse charges
2. Cost of transporting goods
3. Packing for delivery loading and unloading
4. Unkeep and running of delivery vehicles
 5. Salaries of clerks and labours
6. Depreciation
7. Freight and Insurance
8. Customs Duty

OVERHEADS RECOVERY

Cost of all such overheads are to be recovered through the price on various products of the
company. There should be some basis for such recovery. The overhead costs pertaining to one
department can be allocated to that department. Those overheads which cannot be charged to any
particular department should be apportioned to all the other departments on an equitable basis.

Basis for equitable apportionment

When we say that non allocable overheads are to be apportioned on some equitable basis, we
must find out on what basis we can make apportionments. These may be as under:

On the basis of service or utility

Benefit derived or service utilized by that department. For instance factory or office rent can be
charged to a department on the basis floor space occupied by that department.

On the basis of analysis:

When we are not able to actually ascertain services or benefits received by any department, an
analysis or survey of the expenses with reference to the impact on different department may be
made. For example, salary of works manager can be apportioned to different department on the
basis of time devoted by him to the departments.

On the basis of ability to pay

The department making higher profits will bear the burden at a higher rate.

On the basis of Efficiency

Production targets are fixed for each department.

Similarly we can apportion and recover the overhead costs on the basis of – Floor area occupied
by the department, Direct wages in the department, Number of workers, Direct Labour Hours,
Number of Machine Hours, Value of Assets, Lighting points, - Management will choose any one
of these methods which will be beneficial and feasible for the company concerned. Bur once
selected a method, they should not change. If they change frequently, results will not be reliable
1.3.COMPONENTS OF TOTAL COST

Total cost of product is the combination of direct costs (also known as prime cost) and indirect
costs (also known as overheads)

Thus, the two main components of total cost are : (1) Prime Cost, and (2) Overheads, The prime
cost which represent all direct cost, therefore, consists of direct materials, direct labour and other
direct expenses Overheads, on the other hand, consists of factory overheads, office overheads,
and selling and distribution overheads.

TOTAL COST BUILD UP

If we add various costs step by step, we get the following framework of total cost build-up.

1. Direct Material + Direct Labour + Other Direct Expenses = PRIME COST

2. Prime Cost + Factory Overheads = WORKS COST

3. Works Cost + Office and Admin Overheads = COST OF PRODUCTION

4. Production Cost + selling and Distributions Overheads = TOTAL COST or COST OF SALES

Total Cost Build – up

Thus, we get the following main components of total cost:

1. Prime Cost (also known as Direct Cost of First Cost)

2. Works Cost (also known as Factory Cost)
3. Cost of production (also known as Office Cost)
4. Cost of Sales

COST SHEET

To find out the total cost of a particular product, a statement is needed to be prepared. This
prepared statement is referred to cost sheet.
 CENTRAL FOOTWEAR TRAINING INSTITUTE
COST SHEET (1 Pair)

MENS DERBY - COST SHEET

Article Name Mens Derby

Article No SS 10
Article Colour Black
Last 50753 - R1
Leather Cow Softy Black
Sole Thermoplastic Rubber (TPR)
Construction Cemented
in INR
MATERIAL Unit Cost Per
MATERIAL DESCRIPTION UOM Norms Cost Pr
Upper & Lining
Upper Leather Cow Softy Black Sqft 2.25 120.000 270.000
Lining Leather Cow Lining Beige Sqft 1.9 80.000 152.000
Socks Lining Thick Rexin Materials SqMt. 0.049 130.000 6.370
Upper Materials
Backer Vamp & Quarter Backer SqMt. 0.1302 195.940 25.511
Cloth
Toepuff Thermoplastic SqMt. 0.0301 450.000 13.545
Stiffner Thermoplastic SqMt. 0.0334 300.000 10.020
Ornaments Eyelet (Golden Colour) Nos 16 0.500 8.000
Thread 40 Tkt Thread (Black) Meter 7.86 0.180 1.415
60 Tkt Thread (Black) Meter 3.9 0.180 0.702
60 Tkt Thread (Beige) Meter 7.65 0.180 1.377
Upper Adhesive Rubber Solution Ltrs 0.05 90.000 4.500
CF - Adhesive Dendrite Ltrs 0.05 155.000 7.750
(Stay)
Tapes Seam Tape (15mm) Meter 0.2 10.000 2.000
Adhesive Tape (25mm) Meter 0.12 12.000 1.440
Full Shoe Materials
Insole 1.75 mm Flexoplant FT SqMt. 0.0479 190.000 9.101
Shank Board T2 (2mm) SqMt. 0.0251 165.000 4.142
Steel Shank Pair 2 2.000 4.000
Sole Thermoplastic Rubber Pair 1 150.000 150.000
(TPR)
Full Shoe Hotmelt Adhesive Kg 0.02 514.760 10.295
Adhesive
PU Bostick Ltrs 0.075 168.000 12.600
Bostik 'D' Hardner Ltrs 0.002 557.000 1.114
 Cleaner M501 Ltrs 0.01 143.000 1.430
Shoe Lace Shoe Lace Black Pair 1 5.500 5.500
Finishing Meltonian Cream Ltrs 0.03 757.000 22.710
Packing
Tissue Paper Nos 4 1.400 5.600

Material Cost: 731.122

18% GST) on Material Cost: 131.602
(A) Total Material Cost: 862.724
(B) Productive Labour: 189.799
(C) Expenses for Dies, Mould & LASTS: 6.000
(D) PRIME COST (A+B+C): 1,058.523
(E) Factory Overheads: 142.900
(F) FACTORY COST (D+E): 1,201.423
(G) Office & Admin Overhead: 79.390
(H) COST OF PRODUCTION (F+G): 1,280.813
(I) Selling Expenses: 95.270
(J) COST OF SALES (H+I): 1,376.083
Profit Margin (20%) 275.217
Sales Price 1,651.300

CALCULATION OF THE ELEMENT VALUES IN THE COST ESTIMATE SHEET

Material Costs

Materials are direct inputs mainly procured for the production, so the
cost of each component or their groups (e.g. upper, lining) is computed as a
product of the requirements and the corresponding unit prices. Cost of
components cut from sheet materials such as genuine or simulated leather,
textile/canvas, rubber, card or leather-board should also include waste
occurring due to the configuration of patterns (first waste), the differences
in edges of components and materials (side or second waste) and
imperfections in the genuine leather (fault or third waste).

Assessing the required genuine leather for a specific style is normally

done by determining the so-called parallelogram area (see examples below)
comprising the net pattern area and the unavoidable waste among the
patterns which is called first waste. Special algorithms (e.g. SLM – Scientific
Leather Measurement, Shusterovich’s method) exist for computing side
waste for genuine leather, while standard percentages are used for
estimating side waste in the case of man-made materials. Fault wasts
depends on the quality (grade) of the genuine leather.

Some components (e.g. buckles, eyelets, heels, unit soles) are built into
footwear construction without any (substantial) modification. Nevertheless,
the rate of rejects in supply should be taken into consideration when their
costs are added to direct materials.

Material Allowance and Costing Methods

Material Allowances: For establishing both the "initial costing of a style" and "to control the
consumption of the material by the clickers" it is necessary to determine the amount of material
required.

A leather allowance presents unique problems as it is a natural material where no two skins are
exactly the same in either shape or surface perfections. To have accurate costing, grading of
leather must also be taken into account.

A. Parallelogram Method (Russ and Small Method)

Mainly used for finding out the cost of one or few pairs of footwear

When a pattern is interlocked with itself in a repeating system so that the two outside rows all
face the same way and the center raw faces exactly at 180degree to the others, then a
parallelogram can be drawn; which gives the minimum area from which sufficient leather for a
particular pair from that particular interlock. This area is known as the pattern scale.

1st waste: The interlocking waste within the pattern scale is known as the 1st waste.

2nd waste: (Edge Waste): The repeating system of patterns will overlap the edge of the skin,
which gives rise to an edge waste termed as 2nd waste. The magnitude of the edge waste is
directly proportional to the size of the pattern, and inversely proportional to the area of the skin.
It also includes an allowance for those parts off skin around the edges of the bellies and necks
which would not normally be used in shoes.i.e. if the pattern size is larger and the skin size is
smaller, 2nd waste will be more.

3rd waste: The third waste is the leather that is calculated as wastage or unusable leather due to
imperfections in the skin. It is directly related to the grading of the skin.
Total defect area is calculated as per percentage against the total skin area.

Procedure

Preparation of patterns: Draw a perpendicular line through the center of the pattern in order to
align the patterns in a graph sheet.

Take any one pattern and trace it on to the graph sheet aligning the perpendicular line
horizontally, vertically or diagonally.

Repeat tracing with the same pattern in the same direction/ or in opposite direction (180 o)
touching at least two points on the 1st traced pattern.

Repeat this for few times with the same patterns till you get a best interlock.

By joining the end points of the center line at different directions parallel to each other (we
get a parallelogram) pattern scale within a parallelogram.

A parallelogram is described as 4 sided figure with opposite sides being parallel. The best
interlock is the one with the least amount of wastage.

Every pattern can be drafted by several interlocks to obtain the least pattern scale.

The area of parallelogram is found by multiplying (base side X perpendicular height)

Parallelogram area (cm2) = pattern scale area including 1st waste = (cm2 /100 = dm2)

Repeat this with all the patterns and take down the values for each component

2nd waste calculation

G = S (1.205 + S/A)
G: Edge waste/ 2nd waste

S: Area of the parallelogram in dm2 (including 1st waste) A: The average size of the skin being
used

1.205: This is an area addition that forms part of this mathematical equation.

Using the 1st wastage in the formula, we get the second wastage for each component.

Get the total gross area by adding of the 2nd waste (this gives the gross pattern area in dm2)

CALCULATION OF MACHINE HOUR RATE

A separate machine hour rate is calculated for each machine or each set of identical machines.
Suppose, in a factory there are 20 types of machines 20 machine hour rates could be calculated.
Following steps are adopted for computing machine hour rate:

1. The first step is to determine effective machine hours for the base period. Effective
machine hours or precalculated machine hours for the base period - hours lost. Thus
hours lost due the repairs and maintenance, set up time and idle time are reduced from the
predetermined machine hours. Setting up time if taken as productive will not be
considered. Therefore, the formula is:
Effective machine hours = hours lost due to repairs and maintenance - unproductive
setting up time- abnormal idle time

2. Overheads specific to any machines are allocated to that machine. Such expenses may be
power, repairs etc.,

3. It is considered more logical to compute separate rate for fixed items and variable items.
Therefore, overhead costs are classified in the following group:
a. Fixed or standing expenses.
b. Variable or machine expenses.

4. Sum total of standing charges or fixed charges is divided by total number of machine
hours. This will give us expenses per machine hour.

5. Standing charges or fixed expenses per hour and variable or machine expense per hour
are added to obtain machine hour rate.

6. Depreciation of a machine per hour is arrived at by taking the original cost into account
adding installation charges to cost and detecting its resaleable value from the total and
dividing the balance by the estimated number of working hours during its life. Formula is
:
 Depreciation per machine hour = (Cost + Installation charges - Resalable
value)/Estimated working hours during machine life

How to Calculate Machine Hour Rate

To calculate machine hour rate is so easy and very useful for calculating all overheads without
checking each and every detail of different overheads. To know what is its process, we are giving
following example :

A machine costing Rs. 10000 is expected to run for 10 years. At the end of this period its scrap
value is likely to be Rs. 900. Repairs during the whole life of the machine are expected to be Rs.
18000 and the machine is expected to run 4380 hours per year on the average.
Its electricity consumption is 15 units per hour, the rate per unit being 5 paise. The machine
occupies one fourth of the area of the department and has two points out of a total of ten
for lighting. The foreman has to devote about one sixth of his time to the machine. The
monthly rent of the department is Rs. 300 and the lighting charges amount to Rs. 80 per month.
The foreman is paid a monthly salary of Rs. 960. Find out the machine hour rate,
assuming insurance is @ 1% p.a. and the expenses on oil, are Rs. 9 per month.

Solution

Ist Step: Fixed expenses per month

After searching, the question, you will find five fixed overheads which I showed in Yellow mark.
But just finding fixed cost is not sufficient to calculate machine hour rate because we also have
to calculate allocate according some basis which is given below

a) Rent: We take only one fourth total rent because our machine takes only one fourth space

300 X 1/4 = Rs. 75.00

b) Lighting: We take one fifth of the total lighting because our machine is using only two points
out of total ten points of lighting.

80 X 2/10 = 80 X 1/5 = 16

c) Foreman's salary will be one sixth of total salary because he devote only one sixth of his time
for machine.

960 X 1/6 = 160

d) Sundry Expenses - oil, waste etc. 9.00

e) Insurance 10000 X 1% X 1/12 = 8.33

----------------------------------------------------------
Total Fixed overheads = 268.33
----------------------------------------------------------

2nd Step: Calculate Total Hours of Working

Because, we calculate total fixed overheads on monthly basis, so we have also working hours of
machine on month basis.

Total number of hours machine used in a year = 4350

Total number of hours per month = 365

Fixed expenses per hour = 268 / 365= 0.735

3rd Step: To Calculate Variable Overhead per hour

a) Depreciation ( Note : it is not given in question, you calculate it with following formula)

depreciation per hour = cost of machine - scrap / useful life X 1/ total hours of working of
machine in a year= 10000 - 900 / 10 X 1 / 4380 = 0.208

b) Repairs for one hour = 18000 / 4380 X 10 years = 0.411

c) Electricity bill for one hour = 15 units X 0.05 p = 0.750

4th Step: To Calculate Machine Hour

Fixed overhead per hour + Variable overhead per hour = Rs. 2.104 per hour

CONTRIBUTION

It has already been stated earlier in the unit that the difference between selling price and variable
cost (i.e. the marginal cost) is known as 'Contribution' or 'Gross Margin' In other words,
contribution is the sum of fixed costs and the amount of profit. It can be expressed by the
following formula :

Contribution = Selling price - Variable Cost

Or = Fixed Cost - Profit

From the above, we can conclude that profit cannot result unless contribution exceeds fixed
costs, in other words, the point of 'no profit on loss' will be at a level where contribution is equal
to fixed costs, Let us take an example.

Variable cost = Rs. 5,000

Fixed Cost = Rs. 2,000
Selling price = Rs. 8,000
Contribution = Selling price - variable cost
= Rs. 8,000 - Rs. 5,000
= Rs. 3,000

Profit = Contribution - Fixed cost

= Rs. 3,000 - Rs. 2,000
= Rs. 1,000

As contribution exceeds fixed cost there is a profit of Rs. 1000 fixed cost is assumed at Rs.
4,000, the position will change as under:

Contribution - Fixed cost = Profit (Loss)

Rs. 3,000 - Rs. 4,000 = (Rs. 1,000)

The sum of Rs. 1,000 represents the extent of loss since the fixed costs are more than
contribution. At the level of fixed cost of Rs. 1,000, there shall be no profit and no loss. The
concept of Break - even Analysis emerges out of this basic fact.

BREAK - EVEN – ANALYSIS

Break - Even - Analysis (BEA) established the level of output that breaks evenly the cost and
revenue pertaining to a business and thus is an important exercise to know the level of
production or service rendered where a business neither earn any profit not incur any loss. It is
the level of production at which the turnover just covers the fixed cost and after this point it starts
earning profit. It is also helpful in price fixation and determining the margin of safety at a certain
level of capacity utilization.

If we see the cost aspect of any business activity, we can segregate the elements of cost in two
broad categories. The First one is Variable. Cost, those increase or decrease proportionally with
the corresponding changes in volumes of production. The examples are the cost attributed to the
raw material, wages, power & fuel, selling expenses, interest on working capital etc. The second
one is Fixed cost, those remain same irrespective of change in volume of production. The
examples are interest on term loan, depreciation administrative salary, insurance rent,
advertisement & publicity etc.

However there may exist some other type of cost elements those are semi - variable in nature i. e.
remain constant for a certain level of production but changes after words but not proportionately
with the production volume. The example may be, repair and maintenance, administrative
expenses, spares and stores etc. For the break - even - analysis, these semi-variable costs need to
be segregated into fixed and variable ones based on experience and analysis.

The Break - Even Analysis finds out the level of activity called Break - Even – Point (BEP),
where the contribution or gross profit (Excess of sales revenue over the variable cost) equates the
fixed cost embodied in it. In other words there is just enough the surplus after considering the
variable cost in order to meet the fixed cost. It is also helpful in price fixation and determining
the margin of safety at a certain level of capacity utilization.
Mathematically, the BEP based on the above criteria, can be ascertained as:

BEP (%) = Total Fixed Cost x 100/Contribution

Where, Contribution = Sales-total variable cost

BEP (%) = Total Fixed Cost x 100/Contribution per unit

Where, Contribution = Unit sale price - variable cost per unit.

To simplify the procedure for smaller projects. The fixed cost is ascertained by adding all clearly
identified fixed cost such as interest, depreciation, rent, insurance and the fixed portion of other
expenses (as a thumb rule, 40% of total wages bill and 40% of utilities and other expenses
excluding rent and insurance).

BEA can also he calculated taking into the consideration, the fixed cost and the expected profit.

BEP (%) = (Fixed Cost/Fixed Cost + Profit) X 100 (Profit should be before tax.)

(Explanation of this formula in context to the above:

Sales revenue = Total cost + profit = Variable cost + Fixed cost + Profit

i.e. Fixed cost + Profit = Sales - Variable cost = Contribution).

1.4.PROFIT

DEFINITION OF 'PROFIT':

Profit is the positive gain remaining for a business after all costs and expenses have been
deducted from total sales. Profit is also referred to as the bottom line, net profit or net earnings.
Profit can also called as earnings, gain, or income.

Accounting Profit: Profit is the surplus of revenue over and above all paid costs, including both
manufacturing and overhead expenses.

Accounting Profit = Total Income - Total Expenditure

Economic profit: It is the difference between a company's total revenue and its opportunity
costs

Economic profit = Accounting Profit - Opportunity cost

In simple, Profit is the making of gain in business activity for the benefit of the owners of the
business.
Profit = Total revenue - Total cost

Total revenue: Total amount of money that the firm receives from sales of its products or from
other sources

Total cost: the cost of all factors of production

Functions of Profit

 Measure of performance
 Premium to cover cost of staying in business
 Ensure supply of future capital

Reason for Aiming at Reasonable Profit

 Preventing entry of competitors

 Projecting a favorable public image
 Restraining a trade union demand
 Maintaining customer good will

Types of Profit

 Supernormal Profit
 Normal Profit
 Negative Profit / Loss
PRICING POLICIES

Pricing is one of the four elements of the marketing mix, along with product, place and
promotion. Pricing strategy is important for companies who wish to achieve success by finding
the price point where they can maximize sales and profits. Companies may use a variety of
pricing strategies, depending on their own unique marketing goals and objectives.

DIFFERENT TYPES OF PRICING POLICIES

1. Premium Pricing: Premium Pricing is the practice of keeping high prices for the
products compared to its competitor’s one in order to maintain superiority of the
products. Generally, a perception of customer is that product will be exceptionally of
high quality and thus is highly priced.

2. Penetration Pricing: Penetration pricing includes setting the price low with the goals of
attracting customers and gaining market share. The price will be raised later once this
market share is gained
3. Economy Pricing: A method of pricing in which a low price is assigned to a product
with decreased production costs. An example of economy pricing is generic food sold at
grocery stores.

4. Price Skimming: The organisation sets an initial high price and then slowly lowers the
price to make the product available to a wider market. The objective is to skim profits of
the market layer by layer. Eg. New technology, new DVD's etc.

5. Psychological Pricing: The seller here will consider the psychology of price and the
positioning of price within the market place. Eg: The seller will charge 99p instead £1 or
$199 instead of $200.

6. Value Pricing Price set in accordance with the customer perception about the value of
the product or service. Examples include status products or exclusive products.

7. Loss leader: Loss leader pricing is a marketing strategy that involves selecting one or
more retail products to be sold below cost – at a loss to the retailer – in order to get
customers in the door. The loss leaders are the products being sold at such low prices as
an enticement to buyers to step foot in the store.

8. Price Leader (Price leadership/ growing rate pricing) Growing rate pricing is
applicable where competition is limited. May follow pricing leads of rivals especially
where those rivals have a clear dominance of market share. In case of price leader, rivals
have difficulty in competing on price - too high and those loose market shares, too low
and the price leader may match the price and force smaller rival (competitor/ enemy) out
of market

9. Tender pricing It is the purchase of work by submitting the costing. Many big firms
submit their price quoted for carrying out a particular work. Purchaser then choose the
best value out of these. This is mostly done in a secret discussion. Many contracts are
awarded on a tender basis.

10. Price discrimination: This method of charging a different price for the same goods/
service in different markets. This requires each market to be impenetrable. It requires
different price elasticity of demand in each market. Eg. Prices of rail travel differs for the
same journey at different times of the day

11. Destroyer/ Predatory pricing It is deliberate price cutting or offer or free gifts/ vouchers
to force rivals (normally smaller and weaker) out of business or prevent new entrants. It
is anti - competitive and illegal, if it can be proved.

12. Absorption / Full cost pricing It is the price set to absorb some of the fixed costs of
production. The price is set to cover both the fixed and variable costs.

13. Marginal cost pricing The price is set with a marginal cost - the cost of producing one
extra or one fewer item of production. It allows lot of flexibility in recovering the
 expenses. This kind of pricing is particularly relevant in transport where fixed cost may
be relatively high.

14. Contribution pricing Contribution = Selling price - Variable (Direct cost) This is similar
in principle to Marginal Cost Pricing. Price set to ensure coverage of variable costs and a
contribution to the fixed costs. Break even analysis may be useful in such circumstances.

15. Target pricing: Set price to target a specified profit level. Estimate the cost and potential
revenue at different prices and then the break even have to be done to determine the mark
up. Mark-up = Profit/ Cost X 100

16. Cost Plus Pricing Cost set by calculating the average cost (AC) plus a mark-up.
AC = Total Cost/ Out put

Pricing Factors

Pricing is one of the most important elements of the marketing mix, as it is the only mix, which
generates a turnover for the organization. The remaining 3p's are the variable cost for the
organization. It costs to produce and design a product; it costs to distribute a product and costs to
promote it. Price must support these elements of the mix. Pricing is difficult and must reflect
supply and demand relationship. Pricing a product too high or too low could mean a loss of
sales for the organization.

Pricing should take into account the following factors into account:
1. Fixed and variable costs.
2. Competition
3. Company objectives
4. Proposed positioning strategies.
5. Target group and willingness to pay

An organization can adopt a number of pricing strategies, the pricing strategy will usually be
based on corporate objectives.

COMPETITION

In economics, competition is the rivalry among sellers trying to achieve such goals as increasing
profits, market share, and sales volume by varying the elements of the marketing mix: price,
product, distribution, and promotion.

Understanding of competitors

Knowing who your competitors are, and what they are offering, can help you to make your
products, services and marketing stand out. It will enable you to set your prices competitively
and help you to respond to rival marketing campaigns with your own initiatives.
You can use this knowledge to create marketing strategies that take advantage of your
competitors' weaknesses, and improve your own business performance. You can also assess any
threats posed by both new entrants to your market and current competitors. This knowledge will
help you to be realistic about how successful you can be.

This guide explains how to analyze who your competitors are, how to research what they're
doing and how to act on the information you gain.

All businesses face competition. Even if you're the only restaurant in town you must compete
with cinemas, bars and other businesses where your customers will spend their money instead of
with you. With increased use of the Internet to buy goods and services and to find places to go,
you are no longer just competing with your immediate neighbors. Indeed, you could find
yourself competing with businesses from other countries.

Your competitor could be a new business offering a substitute or similar product that makes your
own redundant.

Competition is not just another business that might take money away from you. It can be another
product or service that's being developed and which you ought to be selling or looking to license
before somebody else takes it up.

And don't just research what's already out there. You also need to be constantly on the lookout
for possible new competition.

Why competition is good for your business

5 Reasons Why Competition Is Good For Your Business

Competition exists in every field, and, believe it or not, can actually be good for your venture.

1. Innovation: Competition leads to innovation. If you're the only player in your field, it
can be difficult to improve. And if you're working in a crowded market, you won't
succeed by doing what everyone else does. Healthy competition encourages change
which will distinguish your company from others.

2. Customer Service: As one of several companies offering a similar product, you are
forced to compete for customers. Improving your customer service will garner loyal
followers.

3. Complacency: Competition shakes off complacency. If your company is consistently

trying to innovate and better itself, your employees will be encouraged to push
themselves.

4. Understanding Your Core Market: Competition forces you to focus on your core
audience. If you are targeting a specific geographic location or demographic, market
 challengers in that setting will encourage you to pay attention to your target group. In
doing so, you will be able to better provide for your customers.

5. Education: Seeing what your competitors do well can teach you about your business.
Their practices will provide you with valuable insight into the state of the market, and
help show you what works - and what doesn't

COMPANY TURN OVER

Business turnover is a numeric value representing total sales. It is essentially the value of sales
you make in a set period. It is generally measured over a year's period, whether that's the
calendar year, tax year or fiscal year. Business turnover is one of many ways to analyze the
quality and efficiency of a business, and provides a nice retrospective look at the revenue for a
specific time period. Turnover is another term used for what is more commonly known as gross
income or total income received.

How to calculate business turnover

Step 1
Add up the total number of items sold or services rendered. Look through your company
financial records for the given time period and calculate the total number of items, or the volume
of sales, for the given period.

Step 2
Analyze your company's financial records and compute the average price of items you sold in the
given time period.

Step 3
Calculate your business turnover by multiplying the number of items sold by the average price of
all sold items.

Sales turnover represents the value of goods and services provided to customers during a
specified time period - usually one year.
 The term is often just referred to as sales or net sales, which means revenues without
Value Added Tax
 Sales turnover is usually expressed in monetary terms but can also be in total units of
stock or products sold.
 It is often described by being converted into the company's accounting currency.

PROFIT MANAGEMENT

Profit management: Profit is an excess of revenues over associated expenses for an activity over
a period of time. Terms with similar meanings include 'earnings', 'income', and 'margin'. Lord
Keynes remarked that 'Profit is the engine that drives the business enterprise'. Every business
should earn sufficient profits to survive and grow over a long period of time. It is the index to the
economic progress, improved national income and rising standard of living. No doubt, profit is
the legitimate object, but it should not be over emphasized. Management should try to maximize
its profit keeping in mind the welfare of the society. Thus, profit is not just the reward to owners
but it is also related with the interest of other segments of the society. Profit is the yardstick for
judging not just the economic, but the managerial efficiency and social objectives also.

Concept of Profitability

Profitability is the ability of a business to earn a profit. A profit is what is left of the revenue a
business generates after it pays all expenses directly related to the generation of the revenue,
such as producing a product, and other expenses related to the conduct of the business activities.

There are many different ways for you to analyze profitability. This lesson will focus on
profitability ratios, which are a measure of the business' ability to generate revenue compared
to the amount of expenses it incurs. Let's look at a few of the primary analytical approaches.

Profitability Analysis from the View Point of Management

Profitability Analysis from the View Point of Management In order to pin-point the causes which
are responsible for low / high profitability, a financial manger should continuously evaluate the
efficiency of a firm in terms of profit. The study of increase or decrease in retained earnings,
various reserve and surplus will enable the financial manger to see whether the profitability has
improved or not. An increase in the balance of these items is an indication of improvement in
profitability, where as a decrease indicates a decline in profitability.

1. Gross Profit to Net Revenue Ratio

2. Net Operating Profit to Net Revenue Ratio
3. Return on Capital Employed Ratio

Gross Profit Ratio

Gross profit ratio is important for management because it highlights the efficiency of operation
and also indicates the average spread between the operating cost and revenue. Any difference
position in this ratio is the result of a change in the operating cost or revenue or both. The main
objective of computing this ratio is to determine the efficiency with which operations are carried
on.

Gross profit is taken as the excess of total revenue over operating expenses. It is figured as
shown below:

Gross Profit Ratio = Gross profit/ Net Revenue x 100

Gross Profit = Total Revenue - Operating Expenses

A high ratio of gross profit to revenue is a sign of good management as it implies that
(i) The operating cost is relatively low;
 (ii) increase revenue income, operating cost remains constant;
(iii) operating cost decline, revenue income remains the same.

On the contrary, a low gross profit to revenue is definitely a danger signal. It implies that
(i) the profit is relatively low;
(ii) the operating cost is relatively high (due to purchase of inputs on unfavourable terms,
inefficient utilisation of current as well as fixed assets and so on);
(iii) low revenue income (due to sever competition, inferior quality of services, lack of
demand and so on).

PROFIT MAXIMIZATION

In economics, profit maximization is the short run or long run process by which a firm
determines the price and output level that returns the greatest profit. There are several
approaches to this problem.

Through this process the companies undergo to determine the best output and price levels in
order to maximize its return. The company will usually adjust influential factors such as
production costs, sale prices, and output levels as a way of reaching its profit goal.

There are two main profit maximization methods used, and they are
 Marginal Cost-Marginal Revenue Method and
 Total Cost-Total Revenue Method.

Profit maximization is a good thing for a company, but can be a bad thing for consumers if the
company starts to use cheaper products or decides to raise prices. Economic theory is based on
the reasonable notion that people attempt to do as well as they can for themselves, given the
constraints facing them. For example, consumers purchase things that they believe will make
them feel more satisfied, but their purchases are limited (at least in the long run) by the amount
of income they earn. A consumer can borrow to finance current purchases but must (if honest)
repay the loans at a later date.

Marginal Revenue: It is the change in revenue which comes from selling an additional unit of
output.

Marginal Cost: It is the change in cost which comes from producing an additional unit of
output.

Profit Maximization & Financial goals

 To increase the owners economic welfare

 Economic welfare refers to as maximization or profit or maximization of shareholders
share.
 Maximizing the income of the firm and minimizing the expenditure
 It guides in financial decision making
 Complete utilization of the resources
  It helps in pricing related decisions
 Competition of the firm leads to equilibrium price

CHAPTER II – FINANCIAL CONTROLS

2.1. CONCEPT OF FINANCIAL CONTROL

Exercising financial control is one of the important functions of a finance manager. Financial
control aims at planning, evaluation and coordination of financial activities in order to achieve
the objective of the firm.

Concept of Financial Control:

Financial control is concerned with the policies and procedures framed by an organization for
managing, documenting, evaluating and reporting financial transactions of an organization. In
other words, financial control indicates those tools and techniques adopted by a concern to
control its various financial matters.

Importance of Financial Control:

Finance is important for any organization and financial management is the science that deals
with managing of finance; however the objectives of financial management cannot be achieved
without the proper controlling of finance.

The importance of financial control is discussed below:

i. Financial Discipline:
Financial control ensures adequate financial discipline in an organization by efficient use of
resources and by keeping adequate supervision on the inflow and outflow of resources.

ii. Co-ordination of Activities:

Financial control seeks to achieve the objectives of an organization by coordinating the activities
of different departments of an organization.

iii. Ensuring Fair Return:

Proper financial control increases the earnings of the company, which ultimately increases the
earnings per share.

iv. Reduction in Wastages:

Adequate financial control ensures optimal utilization of resources leaving no room for wastages.

v. Creditworthiness:
Financial control helps maintain a proper balance between debt collection period and the
creditors’ payment period—thereby ensuring proper liquidity exists in a firm which increases the
creditworthiness of the firm.
STEPS OF FINANCIAL CONTROL:

According to Henry Fayol, ‘in an undertaking, control consists in verifying whether everything
occurs in conformity with the plan adopted, the instructions issued and principles established’.
Thus, as per the definition of Fayol, the steps of financial control are

Setting the Standard:

The first step in financial control is to set up the standard for every financial transaction of the
concern. Standards should be set in respect of cost, revenue and capital. Standard cost should be
determined in respect of goods and services produced by the concern taking into account every
aspect of costs.

Revenue standard should be fixed taking into account the selling price of a similar product of the
competitor, sales target of the year, etc. While determining capital structure, the various aspects
like production level, returns on investment, cost of capital, etc., should be taken into account so
that over-capitalization or under-capitalization can be avoided. However, while setting up the
standard, the basic objective of a firm, i.e. wealth-maximization, should be taken into account.

Measurement of Actual Performance:

The next step in financial control is to measure the actual performance. For keeping records of
actual performance financial statements should be prepared periodically in systematic manner.

Comparing Actual Performance with Standard:

In the third step, actual performances are compared with the pre-determined standard
performance. The comparison should be done regularly.

Finding Out Reasons for Deviations:

If there are any deviations in the actual performance with the standard performance, the amount
of variation or deviations should also be ascertained along with the causes of the deviations. This
should be reported to the appropriate authority for necessary action.

Taking Remedial Measures:

The last and the final step in financial control is to take appropriate steps so that the gaps
between actual performance and standard performance can be bridged in future, i.e. in order that
there is no deviation between actual and standard performance in future.
2.2. MATERIAL COST CONTROL

Material is the most significant element of cost and accounts for anywhere between 40% to 70%
of the total cost of production. Cost control activities are, therefore, directed mostly towards
selection, purchase, storage and consumption of material.

SALIENT FEATURES OF MATERIAL COST CONTROL

The following are the salient features of material cost control:

(a) The quality and specification of materials shall commensurate with the requirements of the
product, so that neither too expensive or superior nor cheap or inferior material shall be selected
for use in product.

(b) The purchasing shall aim at minimum price to suppliers and timely procurement and shall
avoid urgent purchases at higher cost.

(c) Storage of materials shall be such that there will be neither overstocking, and thereby
blocking Capital, nor running out of stock and creating interruption in production process.

(d) Wastage and losses shall be avoided at every stage of operation i.e. from storing till usage in
production.

(e) Materials should be classified and accounted for both in physical units and value in such a
way that information about availability in stock can be obtained promptly so asto assist
production, planning as well as timely buying

Direct and Indirect Material Cost

Materials or stores control relates to both direct and indirect materials.

Direct materials are those materials which enter into and form part of the product, such as flour,
fat and sugar in biscuits, and include:

(a) All materials specially purchased for a job order or a process,

(b) All materials issued from the stores against a particular job order number or process,
(c) All components or assembly parts purchased for use in the jobs and process directly,
(d) All materials or processed materials transferred from one process or operation to the
other, and
(e) All primary packing materials such as poly bag, gunny bag cardboard box, etc.

Indirect materials are those which cannot be traced as a part of the product, such as,
 (a) Consumable stores used in the operation,
(b) Lubricating oil, grease, fuel oil, etc.
(c) Tools, jigs, and fixtures, etc.
(d) Sundry stores of small value like cotton waste, broom stick, etc.
Grouping of materials under direct and indirect may often become a matter of convenience, and
materials of small value may not be treated as direct cost even if it is possible to identify the
same. For example, thread used in stitching a shirt may be calculated and charged as direct
material cost, but the cost of such collection will not justify the segregation. Costing system has
to be cost-effective.

MATERIALS CONTROL SYSTEM

This is a system which ensures the provision of a required quantity of materials (sufficient)
which are needed at the required time with minimum amount of capital/funds tied up in materials
stored and the system also aims at minimizing material costs in general. It ensures that materials
are efficiently purchased, stored and used or consumed in the right quantities and quality

Material control consists of controls at three levels:

Quantity controls: These include policies and procedures put in place to ensure that the minimum
amount of materials is used in production and service departments,

Financial controls: These controls ensure that minimum funds are invested in materials, such
controls include the application budgets, monitoring of stock levels,

Quality controls: These cover procedures and policies put in place to ensure that material quality
standards are complied with all the time.

In materials control, it’s always important to strike the balance between two opposing needs, that
is, maintenance of sufficient inventory for efficient production and maintenance of investment in
inventory at the lowest level.

In attempt to achieve above opposing needs, material control system should endeavor to achieve
the following specific objectives that make the system more sound or effective.

The material control system should therefore ensure that:

 Materials of the desired quality will be available when needed for efficient and
uninterrupted production
 Materials will be purchased when need exists and in economic quantities
 The investment in materials will be maintained at the lowest level consistent with
operating requirements.
 Purchase of materials will be made at the most favourable prices under the best possible
terms
 Materials are protected against loss by fire, theft, handling with the help of proper
physical controls
  Materials should be stored in such a way that they can provide minimum of handling time
and cost
 Vouchers will be approved for payment if the material has been received and is available
for issue
 Issues of material are properly authorized and properly accounted for, materials are, at all
times, charged as the responsibility of some individual
 The above objectives may be achieved by the firm if the underlying controls are
effectively implemented by the firm

Proper selection of suppliers:

The firm should have in place a proper selection system or procedure of suppliers that are ready
to meet the needs of the firm all the time.

Maintenance of stock records:

Proper record of materials in the store using documents like Bin cards, stock sheets, requisition
notes, goods received notes, goods returns notes, materials transfer note, among others, is always
expected.

Regular stocktaking and monitoring of stock items:

This refers to a physical count of products actually held in stock as a basis for verification of the
stock records and accounts. Stocktaking could take two forms, that is, Continuous stocktaking
(physical counting is done on a continuous basis e.g. daily, weekly, monthly basis) and Periodic
stocktaking (counting of stock is always done ounce and at the closure of a given period).

Provision of proper storage facilities:

Depending on the materials used and maintained by the firm, appropriate storage facilities must
be in place and used in keeping the materials.

Regular Monitoring of stock levels:

There are must be J mechanism which should enable the monitoring of stock levels on a
continuous basis. Stock levels that include, minimum level, maximum levels, re-order level their
regular monitoring save the firm from stock excesses or shortages.

Segregation of duties/activities:

Departments involved in purchasing, receiving and inspection, storage, dispatch and accounting
should be separate, but have to be properly coordinated.

Centralized purchase function:

The purchase or buying of materials or stock should be done by only one department which is
headed by qualified person

Operation of perpetual inventory system:

This refers to the maintenance of systematic stock or inventory record on a continuous basis to
ensure that up-to-date information is available about the quantity of materials in stock. “The
chartered Institute of Management Accountants, London” defines perpetual inventory
system as “a system of records maintained by controlling department which reflects the physical
movement of stock and their current balance.” The perpetual inventory system is generally
supplemented by a program of continuous stock taking which ensures that physical stocks agree
with book balances.

The object of perpetual inventory system is to ensure that production is not interrupted due to
shortage of materials, to facilitate regular checking, to avoid closing down for stock-taking, and
to provide basis for verification of physical quantity in stock

Regular material audit:

This involves regular review of material control system reconciliation of physical stock against
stock records so as to detect some loopholes in the system and shortages in stock balances.

Material Losses

Some materials may be lost during the production process because of the nature of the products
or because of factors that cannot be influenced by the firm. The losses may be waste, scrap,
spoilage and defective among others.

Waste: This represents some of the materials that arc lost in manufacturing process, storage and
handling, and such amounts have no disposable value or recoverable value. Waste could be
either normal or abnormal. Normal waste in uncontrollable and expected, and it is normally
treated as a production cost, hence makes the cost of the final product. Likewise, abnormal waste
is unexpected and controllable. It is valued on the basis of cost of materials or the calculated cost
of the product and the resulting amount is treated as operating loss (i.e. debited to profit &1055
account).

Scrap: This refers to incidental residue from manufacturing processes that has insignificant or
minor recoverable value. The scrap does not require further processing and it may result from
obsolete stock, defective and broken parts and processing of materials. Scrap may be treated in
accounts using any of the following approaches.
- The net scrap value (sales value minus cost of selling scrap) can be credited to profit and
loss account as other income
- The net scrap value (sales value minus cost of selling scrap) can be deducted from
material costs incurred in production process.
Spoilage: This refers to materials that do not meet production standards because of being badly
damaged. Such goods are either disposed off at their scrap value or discarded without further
processing. The cost of spoiled goods (the difference between costs incurred up to the point of
rejection less the disposal value) may be treated by either of the fallowing methods:
- If spoilage is normal in the manufacturing process, the cost of such spoilage will be borne
by good units.
- In case of abnormal spoilage, cost of spoilage is transferred to profit and loss account

Defectives: These represent goods that do not meet production standards but which can be
processed further so as to be ready for sale. That is to attain saleable condition. Defectives may
be due to imperfections in manufacturing process which may arise because of bad workmanship,
poor quality of raw materials, careless in running the entire process and laxity in inspection. The
major difference between spoilage and defectives is that spoilages are sold without further
processing, whereas defectives can be reconditioned or reworked by the application of additional
materials, labour and overheads, and brought to the point of standard before they are sold as
'firsts' or 'seconds'.

2.3. LABOUR COST ACCOUNTING

Labor cost is an important element of cost. Till recently it constituted a significant portion of
total cost of production. However, the proportion is reducing fast with more and more firms
adopting advanced manufacturing technologies. However, in knowledge based industries
employee- compensation is the single most important element of cost of production or service.
Therefore, it is important for every firm to establish an efficient system for managing employee-
time and select the most appropriate method of remunerating employee. The productivity of all
other resources is linked to the productivity of employees who energize the otherwise dumb
assets. A wrong selection of method demotivates employees, resulting in loss of productivity.
There are many industries which are still labor intensive. For those industries, reduction in labor
cost itself significantly improves competitiveness.
In this chapter we shall discuss different systems of timekeeping and time booking. We shall also
discuss different methods of remunerating employees- their advantages and disadvantages.

Direct and indirect labors are costing terms used in budgeting, planning, and financial reporting.

Direct labor costs are so named because they are associated directly with the production of
specific units of finished goods. An assembly line worker's labor attaching sole on lasted upper,
for instance, is direct labor applied to specific footwear.

Indirect Labor: Indirect labor is the cost of any labor that supports the production process, but
which is not directly involved in the active conversion of materials into finished products.
Examples of indirect labor positions are:

 Production supervisor
 Purchasing staff
 Materials handling staff
 Materials management staff
  Quality control staff

The cost of these types of indirect labor are charged to factory overhead, and from there to the
units of production manufactured during the reporting period. This means that the cost of indirect
labor related to the production process end up in either ending inventory or the cost of goods
sold.

Indirect labor also refers to many types of administrative labor positions, such as:

 Any accounting position

 Any marketing position
 Any engineering position

The cost of these positions cannot be traced to production activities, and so are charged to
expense as incurred.

The cost of both types of indirect labor can be fully loaded with the costs of benefits and payroll
taxes for financial analysis or cost accounting purposes, since these additional costs are closely
associated with the indirect labor positions.

IMPORTANCE OF LABOUR COST CONTROL

Labor cost requires constant measurement, control and analysis because:

 Labor cost control is important to make economic utilization of labor force in production
process.
 Labor cost control is important to obtain maximum quantity of output with the least
amount of materials and other resources.
 Helps to obtain better quality output with the least effort and time of workers.
 Reduces the cost of production of products manufactured or services rendered.
 Ensures the satisfaction of the workers by creating a good working environment in the
factory.
 Helps to adopt the fair system of wage payment and to minimize labor turnover.
 Helpful in minimizing wastage of materials by workers, idle time and unusual overtime
work.
 It is helpful to maintain safety working environment.
 Labor cost control is important to keep complete records of the employees and to supply
information to the management regarding availability, efficiency, utilization
and absenteeism of the workers.
 It is very useful to increase the profitability and competitiveness of the organization.

Departments Involved
a) The Human Resource department. It is responsible for manpower planning, hiring and
firing of personnel on the recommendations of other functional heads. It is also
 responsible for management of human resource including training and deployment of
people.

b) The engineering and work study department. It is responsible for preparation of

production plans and specification for each job, supervision of all the production
activities, time and motion studies, and job analysis.

c) Time keeping department. It primarily responsible for collecting data in respect of total
and specified time worked on a job, product, and process or in a department.

d) Payroll department. It is responsible for computing total and net earnings of each worker,
preparation of payroll and maintenance of relevant records.

e) Cost accounting department. It collects and classifies all costs including labor cost. It
assigns costs to jobs, products, processes or departments based on records.

DISTINCTION BETWEEN DIRECT AND INDIRECT LABOUR

SN DIRECT LABOUR INDIRECT LABOUR

1 It can be identified with each and It cannot be identified
every job
2 He direct labour cost can be The indirect labour cost cannot be
allocated to the cost centre or allocated but only apportioned.
cost unit
3 It is a part of prime cost It is a part of overheads
4 It is primary in the production It is secondary or subsidiary to the
process production
5 Direct labour cost can be easily It is difficult
ascertained
6 It varies according to variation in It remains fixed.
output
7 It can be controlled It is difficult to control

2.4. ANALYSIS OF FINANCIAL STATEMENTS

BALANCE SHEET

Balance Sheet is one of the final accounting books which are called Final Accounts.
The final account books consist of the following:
 Trail Balance
 Profit and Loss account
 Balance Sheet

TRIAL BALANCE:
In the double entry system the debits must be equal to the credit. Put differently, the sum of all
debits in the ledger must be equal to the sum of all credit. The proof of the equality of the total of
the debit and credit balance is called Trial Balance.

A trial balance is prepared as two column schedule listing the name and balance of all accounts
in the order that the debit entries in left column and the credit balance in the right column tally.
Any discrepancy in the total indicates presence of one or more errors. A specimen simple trial
balance will be as under:

Trial balance as on 31st Jan 2001

PROFIT AND LOSS ACCOUNT

The purpose profit and loss account is to determine whether the company has earned entered on
profits or incurred loss during a financial year. A financial year is generally from April to March
next year. Expenses incurred by the company during that year are listed on the left side (Debit
side) and revenue earned is entered on the right side (credit side) A typical simple Profit and
Loss account will be as under:

Profit and Loss Account for the year ending March 2015
BALANCE SHEET

Definition: Balance Sheet is the financial statement of a company which includes assets,
liabilities, equity capital, total debt, etc. at a point in time. Balance sheet includes assets on one
side, and liabilities on the other. For the balance sheet to reflect the true picture, both heads
(liabilities & assets) should tally (Assets = Liabilities + Equity).

Description: Balance sheet is more like a snapshot of the financial position of a company at a
specified time, usually calculated after every quarter, six months or one year. Balance Sheet has
two main heads -assets and liabilities.

Let's understand each one of them. What are assets? Assets are those resources or things which
the company owns. They can be divided into current as well as non-current assets or long term
assets.

Liabilities on are debts or obligations of a company. It is the amount that the company owes to
its creditors. Liabilities can be divided into current liabilities and long term liabilities.

Another important head in the balance sheet is shareholder or owner's equity. Assets are equal to
total liabilities and owners' equity. Owner's equity is used when the company is a sole
proprietorship and shareholders' equity is used when the company is a corporation. It is also
known as book value of the company.
2.5. FINANCIAL PERFORMANCE ANALYSIS

The financial management of the company has following responsibilities:

1. To generate revenue for the working of the company.
2. To profitably deploy the surplus funds.
3. To ensure necessary working capital are generated from the sales of the products.
4. The company earns substantial profits.

If all of the above four responsibilities are fulfilled efficiently the company can come to a
conclusion that the financial performance is satisfactory. The profit and loss account and the
balance sheet provide only datas and these have no meaning unless they are properly analysed
and interpreted. To assist the interpretation and analysis, we have a system what you call the
ratio analysis.

The process of analysis involves arrangement of financial data in a systematic form so that
meaningful conclusions could be drawn from them. We have to rearrange the assets and
liabilities in groups like fixed assets, current assets, long term liabilities, current liabilities and so
on. By this systematic classification the comparison becomes easy with similar data relating to
past records.

We employ various types of analysis for determining the quality of financial performance. They
are internal and external analysis and horizontal and vertical analysis. The system we use for all
this analysis is ratio analysis. Ratio can be defined as an expression relating one number to
another. The process of ascertaining such correlation is ratio analysis. These ratios are further
classified into balance sheet ratio, revenue statement ratio and combined ratios.
BALANCE SHEET RATIOS

These are also known as financial ratios. When relationship between two items or two groups of
items, both of which are in the same balance sheet, it is called balance sheet ratio. The following
are some of the balance sheet ratios:

1. Current ratio
2. Liquid ratio
3. Proprietary ratio
4. Working capital ratio
5. Capital gearing ratio

The balance sheet ratios are worked out to ascertain the financial stability of a business.

REVENUE STATEMENT RATIOS

Revenue statement ratios are also called income statement ratios or profit and loss account ratios.
When two items or groups of items appearing in the manufacturing trading and profit and loss
account are compared with one another, the ratio used is known as revenue statement ratios.
Revenue ratios are worked out to determine the profitability and the behaviour of various
expenses in relation to sales. Some of the most important ratios in this group are as under:

1. Gross profit ratio

2. Operating ratio
3. Expenses ratio
4. Net profit ratio
5. Stock turnover ratio

It is not necessary to discuss all these ratios. We discuss only few ratios which are most
important.

Current ratio

This is also called as solvency ratio or working capital ratio. It is based on financial data
appearing in the balance sheet. It compares the total current assets of the business with its current
liabilities.

Formula Current ratio = Current assets/Current liabilities

Current assets include cash in hand, cash at bank, stock, bills receivable, short term investments
and sundry debtors. Current liabilities include trade creditors, bills payable, outstanding and
accrued expenses, provision for taxes, dividend and bank overdraft. Bank overdraft even though
enjoyed for a long period can be curtailed by the bank at any time. Therefore, the bank overdraft
is treated as current liability.
Liquid ratio

This is also known as acid test ratio or quick ratio. It is based on financial data appearing in the
balance sheet. It compares liquid assets with liquid liabilities. Liquid assets would include cash
in hand, cash at bank, sundry creditors excluding bad and doubtful debts, bills receivable, short
term investments. Liquid liabilities include all current liabilities excluding bank overdraft. This
ratio is useful to ascertain liquidity of an organization.

Proprietary ratio

This also known as net worth ratio or equity ratio. The following is the formula:

Proprietor's fund or Shareholder's fund/Total assets

The proprietor's fund includes share capital, share premium, capital reserve, general reserve and
credit balance of profit and loss account. The term total assets mean all assets including fixed or
current assets.

2.6. BUDGETING AND BUDGETARY CONTROL

BUDGETARY CONTROL

Budgetary control is the process by which budgets are prepared for the future period and are
compared with the actual performance for finding out variances, if any. The comparison of
budgeted figures with actual figures will help the management to find out variances and take
corrective actions without any delay.

FEATURES OF BUDGET

Following are the features of a budget:

 A budget is prepared for a definite future period of time.

 A budget is prepared in advance - prior to the period during which it is to operate.
 A budget is prepared in terms of money or quantity or both.
 A budget may be for a department or for the whole organization. When it is prepared for
the whole organization, it is called Master Budget.
 The purpose of a budget is its implementation.
 Budget can be revised with changes in business objectives and changes in environments.

Budget is not a forecast, because forecast needs to anticipate events whereas budget needs to
plan events. Forecast generally for a longer period, whereas the budget is for a shorter period,
say for a year. Forecast is simply a statement of anticipate events but budget is the tool of
control.
When we relate control function to budget, we find a system known as budgetary control. The
budgetary control is a technique of controlling cost through budgets.
Budgetary control involves- establishment of budgets, continuous comparison of actuals with
budget provisions for achievement of targets. It places the responsibility on certain executives to
achieve budget requirements. There will be provision to amend the budgets in the light of
changing circumstances. To be effective budgetary control activity will be as follows:

FEATURES OF BUDGETARY CONTROL

1. The effectiveness depends on accurate data.

2. It focuses it is implemented, it is compared on specific and time bound targets.
3. It involves comparison of actual results with budget standards.
4. It is a pervasive activity. Executives at all levels have to participate in the budget
preparation and control.
5. It is a continuous exercise. A budgeted plan is framed, it is implemented, it is compared
with actual results. It is revised and forward by another plan.

OBJECTIVES OF BUDGETARY CONTROL

The main objectives of budgetary control are given below:

 Defining the objectives of the enterprise.

 Providing plans for achieving the objectives so defined.
 Coordinating the activities of various departments such as Purchase, Production, Sales
and Finance etc., to ensure continuity in the organization
 Operating various departments and cost centres economically and efficiently.
 Increasing the profitability by eliminating waste.
 Centralizing the control system.
 Correcting variances from sit standards.
 Fixing the responsibility of various individuals in the enterprise.

ADVANTAGES OF BUDGETARY CONTROL

 Efficient use of resources is ensured by minimizing wastages.

 It defines the goals, plans and policies of the enterprise.
 Budgetary control fixes targets. Each and every department is forced to work efficiently
to reach the target.
 It secures better co-ordination among various departments.
 In case the performance is below expectation, budgetary control helps the
management in finding up the responsibility.
 It helps in reducing the cost of production by eliminating the wasteful expenditure.
  By promoting cost consciousness among the employees, budgetary control brings in
efficiency and economy.
 Budgetary control facilitates centralized control with decentralized activity.
 As everything is planned and provided in advance, it helps in smooth running of business
enterprise.
 It tells the management as to where action is required for solving problems without delay.

LIMITATIONS OF BUDGETARY CONTROL

The following are the limitations of budgetary control:

 It is really difficult to prepare the budgets accurately under inflationary conditions.

 Budget involves a heavy expenditure which small business concerns cannot afford.
 Budgets are prepared for the future period which is always uncertain. In future,
conditions may change which will upset the budgets. Thus, future uncertainties minimize
the utility of budgetary control system.
 Budgetary control is only a management tool. It cannot replace management in decision-
making because it is not a substitute for management.
 The success of budgetary control depends upon the support of the top management. If
there is lack of support from top management, then this will fail.

MASTER BUDGET

Every executive who is responsible for meeting the budgeted performance has to prepare a
budget. When all the budgets are prepared by respective staff these are coordinated with each
other and summarized into a budget which is known as Master budget. Thus a master budget is a
consolidated summary of all the functional budget.

Normally, master budget consists of following three parts:-

 Budgeted Income statement

 Budgeted expenditure statement
 Budgeted Balance sheet
 Budget ratios
 Flexible budget

A flexible budget is also known as dynamic budget, variable budget, sliding budget, step budget
or expenses control budget. It means a budget which is prepared to give the budgeted cost for
any level of activity.
RESPONSIBILITY OF A FINANCIAL CONTROLLER

 A financial controller is responsible for ensuring that all accounting allocations are
appropriately made and documented.

 In smaller companies, the controller may also perform cash management functions and
oversee accounts payable, accounts receivable, cash disbursements, payroll and bank
reconciliation functions.

 Every company should maintain a separation of duties with regards to accounting

functions to insure that there are checks and balances in the system.
 For instance, if the controller is responsible for preparing cash disbursements, he should
not be a signatory on the account; the owner, chief executive or chief financial officer
should be required to sign all checks.
Internal Controls
 A financial controller is responsible for establishing and executing internal controls over
the company’s accounting and financial procedures. This includes reviewing and
approving all invoices to be paid, as well as reviewing accounts receivable aging reports.
 In smaller companies, the controller will often handle collections on invoices, especially
ones that are 45 days to 60 days overdue.
 A financial controller is also responsible for coordinating with external tax accountants
for income tax preparation and auditors who prepare internal audits of the company. This
includes keeping company records organized and readily available for examination.

Financial Planning and Reporting

 Financial controllers in smaller companies are responsible for all banking and finance
activities. This includes negotiating lines of credit and vendor agreements, as well as
reviewing all financial contracts, financing agreements and insurance policies.

 She is also responsible for providing accurate and comprehensive financial information to
executive management for long-term financial strategizing. Unless a company has a CFO
to provide the leadership for long-term financial planning, the controller will be required
to fulfill this responsibility as well.

 In any case, she must provide crucial financial data and work with executive management
to coordinate all financial planning functions with business operations.

 Financial reporting duties include preparing financial statements, balance sheets, cash
flow reports, budgets, budget-to-actuals and financial projections.
Financial Analysis
 In addition to financial reporting, a controller must be skilled at in-depth financial
analysis and providing expert financial perspective and opinions. This means that a
financial controller must be proficient in spreadsheet design that is often complex.
 While a CFO is responsible for finalizing financial policy, a controller’s financial
analysis skills are instrumental in helping to assess risk, analyze efficiency and inform
decisions made by executive management.