Auditing MCQs

SCHOOL OF BUSINESS MANAGEMENT

DEPARTMENT OF COMMERCE

MODEL QUESTION - ANSWER BANK

M.Com FC 01

COST & MANAGEMENT ACCOUNTING

Cost & Management Accounting

1. “Cost may be classified in a variety of ways according to their nature and the information needs of management.” Explain and discuss this statement giving examples of classification required for different purposes.

Answer:

The term ‘cost’ means the amount of expenses [actual or notional] incurred on or attributable to specified thing or activity. As per Institute of cost and work accounts (ICWA) India, Cost is ‘measurement in monetary terms of the amount of resources used for the purpose of production of goods or rendering services. To get the results we make efforts. Efforts constitute cost of getting the results. It can be expressed in terms of money; it means the amount of expenses incurred on or attributable to some specific thing or activity. The term cost is used in this very form. In reference to production/manufacturing of goods and services cost refers to sum total of the value of resources used like raw material and labour and expenses incurred in producing or manufacturing of given quantity.

Cost accounting is the classifying, recording and appropriate allocation of expenditure for the determination of the costs of products or services, and for the presentation of suitably arranged data for purposes of control and guidance of management. It includes the ascertainment of the cost of every order, job, contract, process, service or unit as may be appropriate. It deals with the cost of production, selling and distribution.

Thus, cost accounting has the following features:

1. It is a process of accounting for costs.

2. It records income and expenditure relating to production of goods and services.

3. It provides statistical data on the basis of which future estimates are prepared and quotations are submitted.

4. It is concerned with cost ascertainment, cost control and cost reduction.

5. It establishes budgets and standards so that actual cost may be compared to find out deviations or variances.

6. It involves the presentation of right information to the right person at the right time so that it may be helpful to management for planning, evaluation of performance, control and decision making.

Objectives of Cost Accounting:

Objectives of cost accounting are ascertainment of cost, fixation of selling price, proper recording and presentation of cost data to management for measuring efficiency and for cost control and cost reduction, ascertaining the profit of each activity, assisting management in decision making and determination of break-even point.

The aim is to know the methods by which expenditure on materials, wages and overheads is recorded, classified and allocated so that the cost of products and services may be accurately ascertained; these costs may be related to sales and profitability may be determined. Yet with the development of business and industry, its objectives are changing day by day.

Following are the main objectives of cost accounting:

1. To ascertain the cost per unit of the different products manufactured by a business concern;

2. To provide a correct analysis of cost both by process or operations and by different elements of cost;

3. To disclose sources of wastage whether of material, time or expense or in the use of machinery, equipment and tools and to prepare such reports which may be necessary to control such wastage;

4. To provide requisite data and serve as a guide for fixing prices of products manufactured or services rendered;

5. To ascertain the profitability of each of the products and advise management as to how these profits can be maximised;

6. To exercise effective control if stocks of raw materials, work-in-progress, consumable stores and finished goods in order to minimise the capital locked up in these stocks;

7. To reveal sources of economy by installing and implementing a system of cost control for materials, labour and overheads;

8. To advise management on future expansion policies and proposed capital projects;

9. To present and interpret data for management planning, evaluation of performance and control;

10. To help in the preparation of budgets and implementation of budgetary control;

11. To organise an effective information system so that different levels of management may get the required information at the right time in right form for carrying out their individual responsibilities in an efficient manner;

12. To guide management in the formulation and implementation of incentive bonus plans based on productivity and cost savings;

13. To supply useful data to management for taking various financial decisions such as introduction of new products, replacement of labour by machine etc.;

14. To help in supervising the working of punched card accounting or data processing through computers;

15. To organise the internal audit system to ensure effective working of different departments;

16. . To organise cost reduction programmes with the help of different departmental managers;

17. To provide specialized services of cost audit in order to prevent the errors and frauds and to facilitate prompt and reliable information to management; and

18. To find out costing profit or loss by identifying with revenues the costs of those products or services by selling which the revenues have resulted.

Classification of cost

Costs can be classified based on the following attributes:

By Nature

In this type, material, labor and overheads are three costs, which can be further sub-divided into raw materials, consumables, packing materials, and spare parts etc.

By Degree of Traceability of the Product

Direct and indirect expenses are main types of costs come under it. Direct expenses may directly attributable to a particular product. Leather in shoe manufacturing is a direct expenses and salaries, rent of building etc. come under indirect expenses.

By Controllability

In this classification, two types of costs fall:

• Controllable - These are controlled by management like material labor and direct expenses.
• Uncontrollable - They are not influenced by management or any group of people. They include rent of a building, salaries, and other indirect expenses.

By Relationship with Accounting Period

Classifications are measured by the period of use and benefit. The capital expenditure and revenue expenditure are classified under it. Revenue expenses relate to current accounting period. Capital expenditures are the benefits beyond accounting period. Fixed assets come under category of capital expenditure and maintenance of assets comes under revenue expenditure category.

By Association with the Product

There are two categories under this classification:

• Product cost - Product cost is identifiable in any product. It includes direct material, direct labor and direct overheads. Up to sale, these products are shown and valued as inventory and they form a part of balance sheet. Any profitability is reflected only when these products are sold. The Costs of these products are transferred to costs of goods sold account.
• Time/Period base cost - Selling expenditure and Administrative expenditure, both are time or period based expenditures. For example, rent of a building, salaries to employees are related to period only. Profitability and costs are depends on both, product cost and time/period cost.

By Functions

Under this category, the cost is divided by its function as follows:

• Production Cost - It represents the total manufacturing or production cost.
• Commercial cost - It includes operational expenses of the business and may be sub-divided into administration cost and selling and distribution cost.

By Change in Activity or Volume

Under this category, the cost is divided as fixed, variable, and semi-variable costs:

• Fixed cost - It mainly relates to time or period. It remains unchanged irrespective of volume of production like factory rent, insurance, etc. The cost per unit fluctuates according to the production. The cost per unit decreases if production increases and cost per unit increases if the production decreases. That is, the cost per unit is inversely proportional to the production. For example, if the factory rent is Rs 25,000 per month and the number of units produced in that month is 25,000, then the cost of rent per unit will be Rs 1 per unit. In case the production increases to 50,000 units, then the cost of rent per unit will be Rs 0.50 per unit.
• Variable cost - Variable cost directly associates with unit. It increases or decreases according to the volume of production. Direct material and direct labor are the most common examples of variable cost. It means the variable cost per unit remains constant irrespective of production of units.
• Semi-variable cost - A specific portion of these costs remains fixed and the balance portion is variable, depending on their use. For example, if the minimum electricity bill per month is Rs 5,000 for 1000 units and excess consumption, if any, is charged @ Rs 7.50 per unit. In this case, fixed electricity cost is Rs 5,000 and the total cost depends on the consumption of units in excess of 1000 units. Therefore, the cost per unit up to a certain level changes according to the volume of production, and after that, the cost per unit remains constant @ Rs 7.50 per unit.

2. “Management Accounting is concerned with accounting information that is useful to management.” Explain the term management accountancy and states its main objectives.

Answer:

Management accounting can be viewed as Management-oriented Accounting. Basically it is the study of managerial aspect of financial accounting, "accounting in relation to management function". It shows how the accounting function can be re-oriented so as to fit it within the framework of management activity. The primary task of management accounting is, therefore, to redesign the entire accounting system so that it may serve the operational needs of the firm. If furnishes definite accounting information, past, present or future, which may be used as a basis for management action. The financial data are so devised and systematically development that they become a unique tool for management decision

Management Accounting is the process of analysis, interpretation and presentation of accounting information collected with the help of financial accounting and cost accounting, in order to assist management in the process of decision making, creation of policy and day to day operation of an organization. Thus, it is clear from the above that the management accounting is based on financial accounting and cost accounting.

FUNCTIONS OF MANAGEMENT ACCOUNTING

 The basic function of management accounting is to assist the management in performing its functions effectively. The functions of the management are planning, organizing, directing and controlling. Management accounting helps in the performance of each of these functions in the following ways:

(i) Provides data: Management accounting serves as a vital source of data for management planning. The accounts and documents are a repository of a vast quantity of data about the past progress of the enterprise, which are a must for making forecasts for the future.

(ii) Modifies data: The accounting data required for managerial decisions is properly compiled and classified. For example, purchase figures for different months may be classified to know total purchases made during each period product-wise, supplier-wise and territory-wise.

(iii) Analyses and interprets data: The accounting data is analyzed meaningfully for effective planning and decision-making. For this purpose the data is presented in a comparative form. Ratios are calculated and likely trends are projected.

(iv) Serves as a means of communicating: Management accounting provides a means of communicating management plans upward, downward and outward through the organization. Initially, it means identifying the feasibility and consistency of the various segments of 8 the plan. At later stages it keeps all parties informed about the plans that have been agreed upon and their roles in these plans.

 (v) Facilitates control: Management accounting helps in translating given objectives and strategy into specified goals for attainment by a specified time and secures effective accomplishment of these goals in an efficient manner. All this is made possible through budgetary control and standard costing which is an integral part of management accounting.

(vi) Uses also qualitative information: Management accounting does not restrict itself to financial data for helping the management in decision making but also uses such information which may not be capable of being measured in monetary terms. Such information may be collected form special surveys, statistical compilations, engineering records, etc.

Following are the objectives of Management Accounting:

1) Measuring performance: Management accounting measures two types of performance. First is employee performance and the second is efficiency measurement. The actual performance is measured with the standardized performance and a report of deviation from the standard performance is reported to the management for the effective decision making and also to indicate the effectiveness of the methods in use. Both types of performance management are used to make corrective actions in order to improve performance.

2) Assess Risk: The aim of management accounting is to assess risk in order to maximize risk.

3) Allocation of Resources: is an important objective of Management Accounting.

4) Presentation of various financial statements to the Management.

Limitations of Management Accounting:

1) Management Accounting is based on financial and cost accounting, in which historical data is used to make future decisions. Thus, strength and weakness of the managerial decisions are based on the strength and weakness of the accounting records.

2) Management Accounting is useful only to those people who are in the decision making process.

3) Tools and techniques used in management accounting only provide information and not ready made decision. Thus, it is only a supplementary service.

4) In Management Accounting, decision is based on the manager’s institution as management try to avoid lengthy courses of scientific decision making.

5) Personal prejudices and bias affect the decisions as the interpretation of financial information is based on personal judgment of the interpreter

3. Distinguish between cost accounting & financial accounting.

Answer

Both cost accounting and financial accounting help the management formulate and control organization policies. Financial management gives an overall picture of profit or loss and costing provides detailed product-wise analysis.

No doubt, the purpose of both is same; but still there is a lot of difference in financial accounting and cost accounting. For example, if a company is dealing in 10 types of products, financial accounting provides information of all the products in totality under different categories of expense heads such as cost of material, cost of labor, freight charges, direct expenses, and indirect expenses. In contrast, cost accounting gives details of each overhead product-wise, such as much material, labor, direct and indirect expenses are consumed in each unit. With the help of costing, we get product-wise cost, selling price, and profitability.

The following table broadly covers the most important differences between financial accounting and cost accounting.

Point of Differences	Financial Accounting	Cost Accounting
Meaning	Recoding of transactions is part of financial accounting. We make financial statements through these transactions. With the help of financial statements, we analyze the profitability and financial position of a company.	Cost accounting is used to calculate cost of the product and also helpful in controlling cost. In cost accounting, we study about variable costs, fixed costs, semi-fixed costs, overheads and capital cost.
Purpose	Purpose of the financial statement is to show correct financial position of the organization.	To calculate cost of each unit of product on the basis of which we can take accurate decisions.
Recording	Estimation in recording of financial transactions is not used. It is based on actual transactions only.	In cost accounting, we book actual transactions and compare it with the estimation. Hence costing is based on the estimation of cost as well as on the recording of actual transactions.
Controlling	Correctness of transaction is important without taking care of cost control.	Cost accounting done with the purpose of control over cost with the help of costing tools like standard costing and budgetary control.
Period	Period of reporting of financial accounting is at the end of financial year.	Reporting under cost accounting is done as per the requirement of management or as-and-when-required basis.
Reporting	In financial accounting, costs are recorded broadly.	In cost accounting, minute reporting of cost is done per-unit wise.
Fixation of Selling Price	Fixation of selling price is not an objective of financial accounting.	Cost accounting provides sufficient information, which is helpful in determining selling price.
Relative Efficiency	Relative efficiency of workers, plant, and machinery cannot be determined under it.	Valuable information about efficiency is provided by cost accountant.
Valuation of Inventory	Valuation basis is ‘cost or market price whichever is less’	Cost accounting always considers the cost price of inventories.
Process	Journal entries, ledger accounts, trial balance, and financial statements	Cost of sale of product(s), addition of margin and determination of selling price of the product.

4. Distinguish between cost accounting & Management accounting.

Answer

Management accounting collects data from cost accounting and financial accounting. Thereafter, it analyzes and interprets the data to prepare reports and provide necessary information to the management.

On the other hand, cost books are prepared in cost accounting system from data as received from financial accounting at the end of each accounting period.

The difference between management and cost accounting are as follows:

S.No.	Cost Accounting	Management Accounting
1	The main objective of cost accounting is to assist the management in cost control and decision-making.	The primary objective of management accounting is to provide necessary information to the management in the process of its planning, controlling, and performance evaluation, and decision-making.
2	Cost accounting system uses quantitative cost data that can be measured in monitory terms.	Management accounting uses both quantitative and qualitative data. It also uses those data that cannot be measured in terms of money.
3	Determination of cost and cost control are the primary roles of cost accounting.	Efficient and effective performance of a concern is the primary role of management accounting.
4	Success of cost accounting does not depend upon management accounting system.	Success of management accounting depends on sound financial accounting system and cost accounting systems of a concern.
5	Cost-related data as obtained from financial accounting is the base of cost accounting.	Management accounting is based on the data as received from financial accounting and cost accounting.
6	Provides future cost-related decisions based on the historical cost information.	Provides historical and predictive information for future decision-making.
7	Cost accounting reports are useful to the management as well as the shareholders and creditors of a concern.	Management accounting prepares reports exclusively meant for the management.
8	Only cost accounting principles are used in it.	Principals of cost accounting and financial accounting are used in management accounting.
9	Statutory audit of cost accounting reports are necessary in some cases, especially big business houses.	No statutory requirement of audit for reports.
10	Cost accounting is restricted to cost-related data.	Management accounting uses financial accounting data as well as cost accounting data.

5. Distinguish between Financial accounting & Management accounting.

Answer:

‘Accounting’ is a process of systematically identifying, recording, classifying, reporting, analyzing and interpreting the results thereof to the users of the financial statement. The two major branches of Accounting are Financial Accounting and Management Accounting. The former, is an accounting system which gives true and a fair view of the financial position of the company to various parties. The latter, is an accounting system which provides both the quantitative and qualitative information to the managers. Here we are going to discuss about the differences between Financial Accounting and Management Accounting.

Comparison Chart

BASIS FOR COMPARISON	FINANCIAL ACCOUNTING	MANAGEMENT ACCOUNTING
Meaning	Financial Accounting is an accounting system that focuses on the preparation of financial statement of an organization to provide the financial information to the interested parties.	The accounting system which provides relevant information to the managers to make policies, plans and strategies for running the business effectively is known as Management Accounting.
Is is compulsory?	Yes	No
Objective	To provide financial information to outsiders.	To assist the management in planning and decision making process by providing detailed information on various matters.
Format	Specified	Not specified
Time Frame	Financial Statements are prepared at the end of the accounting period which is usually one year.	The reports are prepared as per the need and requirements of the organization.
User	Internal and external parties	Only internal management.
Reports	Summarized Reports about the financial position of the organization	Complete and Detailed reports regarding various information.

6. What do you mean by marginal costing? Differentiate between marginal costing and absorption costing?

Answer

The costs that vary with a decision should only be included in decision analysis. For many decisions that involve relatively small variations from existing practice and/or are for relatively limited periods of time, fixed costs are not relevant to the decision. This is because either fixed costs tend to be impossible to alter in the short term or managers are reluctant to alter them in the short term.

Marginal costing - definition

Marginal costing distinguishes between fixed costs and variable costs as convention ally classified.

The marginal cost of a product –“ is its variable cost”. This is normally taken to be; direct labour, direct material, direct expenses and the variable part of overheads.

Marginal costing is formally defined as:

‘the accounting system in which variable costs are charged to cost units and the fixed costs of the period are written-off in full against the aggregate contribution. Its special value is in decision making’.

The term ‘contribution’ mentioned in the formal definition is the term given to the difference between Sales and Marginal cost. Thus

MARGINAL COST =

VARIABLE COST DIRECT LABOUR + DIRECT MATERIAL + DIRECT EXPENSE + VARIABLE OVERHEADS

CONTRIBUTION SALES - MARGINAL COST

The term marginal cost sometimes refers to the marginal cost per unit and sometimes to the total marginal costs of a department or batch or operation. The meaning is usually clear from the context.

Alternative names for marginal costing are the contribution approach and direct costing In this lesson, we will study marginal costing as a technique quite distinct from absorption costing.

Features of Marginal Costing

The main features of marginal costing are as follows:

1.     Cost Classification
The marginal costing technique makes a sharp distinction between variable costs and fixed costs. It is the variable cost on the basis of which production and sales policies are designed by a firm following the marginal costing technique.

2.     Stock/Inventory Valuation
Under marginal costing, inventory/stock for profit measurement is valued at marginal cost. It is in sharp contrast to the total unit cost under absorption costing method.

3.     Marginal Contribution
Marginal costing technique makes use of marginal contribution for marking various decisions. Marginal contribution is the difference between sales and marginal cost. It forms the basis for judging the profitability of different products or departments.

Advantages and Disadvantages of Marginal Costing Technique

Advantages

1.     Marginal costing is simple to understand.

2.     By not charging fixed overhead to cost of production, the effect of varying charges per unit is avoided.

3.     It prevents the illogical carry forward in stock valuation of some proportion of current year’s fixed overhead.

4.     The effects of alternative sales or production policies can be more readily available and assessed, and decisions taken would yield the maximum return to business.

5.     It eliminates large balances left in overhead control accounts which indicate the difficulty of ascertaining an accurate overhead recovery rate.

6.     Practical cost control is greatly facilitated. By avoiding arbitrary allocation of fixed overhead, efforts can be concentrated on maintaining a uniform and consistent marginal cost. It is useful to various levels of management.

7.     It helps in short-term profit planning by breakeven and profitability analysis, both in terms of quantity and graphs. Comparative profitability and performance between two or more products and divisions can easily be assessed and brought to the notice of management for decision making.

Disadvantages

1.     The separation of costs into fixed and variable is difficult and sometimes gives misleading results.

2.     Normal costing systems also apply overhead under normal operating volume and this shows that no advantage is gained by marginal costing.

3.     Under marginal costing, stocks and work in progress are understated. The exclusion of fixed costs from inventories affect profit, and true and fair view of financial affairs of an organization may not be clearly transparent.

4.     Volume variance in standard costing also discloses the effect of fluctuating output on fixed overhead. Marginal cost data becomes unrealistic in case of highly fluctuating levels of production, e.g., in case of seasonal factories.

5.     Application of fixed overhead depends on estimates and not on the actuals and as such there may be under or over absorption of the same.

6.     Control affected by means of budgetary control is also accepted by many. In order to know the net profit, we should not be satisfied with contribution and hence, fixed overhead is also a valuable item. A system which ignores fixed costs is less effective since a major portion of fixed cost is not taken care of under marginal costing.

7.     In practice, sales price, fixed cost and variable cost per unit may vary. Thus, the assumptions underlying the theory of marginal costing sometimes becomes unrealistic. For long term profit planning, absorption costing is the only answer.

Marginal Costing versus Absorption Costing

After knowing the two techniques of marginal costing and absorption costing, we have seen that the net profits are not the same because of the following reasons:

1. Over and Under Absorbed Overheads

In absorption costing, fixed overheads can never be absorbed exactly because of difficulty in forecasting costs and volume of output. If these balances of under or over absorbed/recovery are not written off to costing profit and loss account, the actual amount incurred is not shown in it. In marginal costing, however, the actual fixed overhead incurred is wholly charged against contribution and hence, there will be some difference in net profits.

2. Difference in Stock Valuation

In marginal costing, work in progress and finished stocks are valued at marginal cost, but in absorption costing, they are valued at total production cost. Hence, profit will differ as different amounts of fixed overheads are considered in two accounts.

The profit difference due to difference in stock valuation is summarized as follows:

a.      When there is no opening and closing stocks, there will be no difference in profit.

b.     When opening and closing stocks are same, there will be no difference in profit, provided the fixed cost element in opening and closing stocks are of the same amount.

c.      When closing stock is more than opening stock, the profit under absorption costing will be higher as comparatively a greater portion of fixed cost is included in closing stock and carried over to next period.

d.     When closing stock is less than opening stock, the profit under absorption costing will be less as comparatively a higher amount of fixed cost contained in opening stock is debited during the current period.

Comparison Chart

BASIS FOR COMPARISON	MARGINAL COSTING	ABSORPTION COSTING
Meaning	A decision making technique for ascertaining the total cost of production is known as Marginal Costing.	Apportionment of total costs to the cost center in order to determine the total cost of production is known as Absorption Costing.
Cost Recognition	The variable cost is considered as product cost while fixed cost is considered as period costs.	Both fixed and variable cost is considered as product cost.
Classification of Overheads	Fixed and Variable	Production, Administration and Selling & Distribution
Profitability	Profitability is measured by Profit Volume Ratio.	Due to the inclusion of fixed cost, profitability gets affected.
Cost per unit	Variances in the opening and closing stock does not influence the cost per unit of output.	Variances in the opening and closing stock affects the cost per unit.
Highlights	Contribution per unit	Net Profit per unit

7. Define budget, budgeting and budgetary control. Give the advantage of budgetary control in a manufacturing organization.

BUDGET

A budget is a plan expressed in quantitative, usually monetary term, covering a specific period of time, usually one year. In other words a budget is a systematic plan for the utilization of manpower and material resources.

In a business organization, a budget represents an estimate of future costs and revenues. Budgets may be divided into two basic classes: Capital Budgets and Operating Budgets.

Capital budgets are directed towards proposed expenditures for new projects and often require special financing. The operating budgets are directed towards achieving short-term operational goals of the organization, for instance, production or profit goals in a business firm. Operating budgets may be sub-divided into various departmental of functional budgets.

The main characteristics of a budget are:

1. It is prepared in advance and is derived from the long-term strategy of the organization.

2. It relates to future period for which objectives or goals have already been laid down.

It is expressed in quantitative form, physical or monetary units, or both.

Different types of budgets are prepared for different purposed e.g. Sales Budget, Production Budget, Administrative Expense Budget, Raw-material Budget etc. All these sectional budgets are afterwards integrated into a master budget, which represents an overall plan of the organization.

ADVANTAGES OF BUDGETS

A budget helps us in the following ways:

1. It brings about efficiency and improvement in the working of the organization.

2. It is a way of communicating the plans to various units of the organization. By establishing the divisional, departmental, sectional budgets, exact responsibilities are assigned. It thus minimizes the possibilities of buck passing if the budget figures are not met.

3. It is a way or motivating managers to achieve the goals set for the units.

4. It serves as a benchmark for controlling on-going operations.

5. It helps in developing a team spirit where participation in budgeting is encouraged.

6. It helps in reducing wastage and losses by revealing them in time for corrective action.

7. It serves as a basis for evaluating the performance of managers.

8. It serves as a means of educating the managers.

Budgetary Control: 

         Throughout the budget period, the use of budgets & budgetary reports for the purpose of coordinating, evaluating & controlling day-to-day operations according to the goals which are specified by the budget is involved by budgetary control. The mere presentation of budget doesn’t have much value, its real value lies in the aspects of the planning & its utilization during the period for the purposes of control & coordination. Under budgetary control, actual results are constantly checked & evaluated & comparison of actual result is made with the budgeted goals & wherever indicated, corrective action should be undertaken. The following steps are involved in the process of budgetary control:

• (a) The objectives which are required to be achieved by the business should be defined & specified by budgetary control.
  
  (b) For the purpose of ensuring that the desired objectives are accomplished, business plans are needed to be prepared by budgetary control.
  
  (c) Budgetary control translates the plans into budgets & relates to particular sections of the budget, the responsibilities of individual executives & managers.
  
  (d) Budgetary control constantly compares the actual results with the budget & the differences between the actual & budgeted performance are calculated.
  
  (e) For the purpose of establishing the causes, the major differences are investigated by budgetary control.
  
  (f) In a suitable form, budgetary control presents the information to the management, relating to variances to individual responsibility.
  
  (g) In order to avoid a repetition of any over-expenditure or wastage, management takes corrective actions. Alternatively, where due to the change in circumstances, the budgeted targets cannot be achieved, the budget is revised.

Difference between Budget, Budgeting & Budgetary control:

         Individual objectives of a department etc. are indicated by budget, whereas the act of setting the budgets is known as budgeting. All are embraced by budgetary control & also the science of planning the budgets themselves & as an overall management tool, the utilization of such budgets, for the purpose of business planning & control are included in budgetary control. Thus, the term by budgetary control is wider in meaning & both budget & budgeting are included in by budgetary control.

Objectives of Budgetary Control:

         The objectives of budgetary control are:

• (1)Compel for planning: As management is forced to look ahead, responsible for setting of targets, anticipating of problems & giving purpose & direction to the organization, this feature is the most important feature of budgetary control.
  
  (2)Communication of ideas & plans: Communication of ideas & plans to everyone is effected by budgetary control. In order to make sure that each person is aware of what he is supposed to do, it is necessary that there is a formal system.
  
  (3)Coordinating the activities: The budgetary control coordinates the activities of different departments or sub-units of the organization.   The coordination concept implies, for example, on production requirements, the purchasing department should base its budget & similarly, on sales expectations, the production budget should in turn be4 based.
  
  (4) Establishing a system of control: A system of control can be established by having a plan against which progressive comparison can be made of actual results.
  
  (5) Motivating employees: Employees are motivated for improving their performances by budgetary control.

Advantages of Budgetary control:

The advantages of budgetary control system are as follows:

• (1) The objectives of the organization as a whole & the results which should be achieved by each department within this overall framework are defined by the budgetary control.
  
  (2) When there is a difference between actual results & budget, then the extent by which actual results have exceeded or fallen short of the budget is revealed by the budgetary control.
  
  (3) The variances or other measures of performance along with the reasons of difference between the actual results with those from budgeted is indicated by the budgetary control. Also, the magnitude of differences is established by it.
  
  (4) As the budgetary control reports on actual performance along with variances & other measures of performance; for correcting adverse trends, a basis for guiding executive action is provided by it.
  
  (5) A basis by which future budget can be prepared or the current budget can be revised is provided by the budgetary control.
  
  (6) A system whereby in the most efficient way possible the resources of the organization are being used is provided by the budgetary control.
  
  (7) The budgetary control indicates how efficiently the various departments of the organization are being coordinated.
  
  (8) Situations where activities & responsibilities are decentralized, some centralizing control is provided by the budgetary control.
  
  (9) The budgetary control provides means by which the activities of the organization can be stabilized, where the organization’s activities are subject to seasonal variations.
  
  (10) By regularly examining the departmental results, a basis for internal audit is established by the budgetary control.
  
  (11) The standard costs which are to be used are provided by it.
  
  (12) For the purpose of paying a bonus to employees, a basis by which the productive efficiency can be measured is provided by the budgetary control.

Limitations of Budgetary Control:

The main limitations of budgetary control are:

• (1) It used the estimates as a basis for the budget plan.
  
  (2) In order to fit with the changing circumstances the budgetary programme must be continually adapted. Normally for attaining a reasonably good budgetary programme, it takes several years.
  
  (3) A budget plan cannot be executed automatically. Enthusiastic participation is required by all levels of management in the programme.
  
  (4) The necessity of having a management & administration will not be eliminated by any budgetary control system. The place of the management is not taken by it; rather it is a tool of the management.

8. “Standard costing is always accompanied by a system of budgeting but budgetary control may be operated in business where standard costing is not applicable.” Comment and elucidate the importance of standard costing.

Meaning of Standard Costing:

It is a method of costing by which standard costs are employed. According to ICMA, London, Standard Costing is “the preparation and use of standard costs, their comparison with actual cost and the analysis of variances to their causes and points of incidence”.

According to Wheldon, it is a method of ascertaining the costs whereby statistics are prepared to show:

(i) The standard cost;

(ii) The actual cost;

(iii) The difference between these costs which is termed the variance.

But W. Bigg expresses:

“Standard Costing discloses the cost of deviations from standards and clarifies these as to their causes, so that management is immediately informed of the sphere of operations in which remedial action is necessary.”

Thus, from the above, it becomes clear that Standard Costing involves:

(i) Ascertainment and use of Standard Costs;

(ii) Recording the actual costs;

(iii) Comparison of actual costs with standard costs in order to find out the variance;

(iv) Analysis of variance; and

(v) After analysing the variance, appropriate action may be taken where necessary.

Objectives of Standard Costing:

The objectives of Standard Costing for which it is implemented are:

(a) It helps to implement budgetary control system in operation;

(b) It helps to ascertain performance evaluation.

(c) It supplies the ways to utilise properly material, labour and also overhead which will be economic in character.

(d) It also helps to motivate the employees of a firm to improve their performance by setting up a ‘standard’.

(e) It also helps the management to supply necessary data relating to cost element to submit quotations or to fix up the selling price of a firm.

(f) It also helps the management to make proper valuations of inventory (viz., Work-in- progress, and finished products).

(g) It acts as a control device to the management.

(h) It also helps the management to take various corrective decisions viz., fixation of price, make-or-buy decisions etc. which will be more beneficial to the firm.

Development of Standard Costing:

Importance of Standard Costing cannot be ignored for the following and that is why the same is well-developed in the present-day world: 

(i) Compilation of Historical Cost is very expensive and difficult:

A manufacturing firm making large number of parts requires too much clerical work which is required in order to compile the materials, labour and overhead charges to each and every cost of parts produced for ascertaining the average cost of the product.

(ii) Historical Costs are inadequate:

In order to measure the manufacturing efficiency, historical costs are not practically adequate. It fails to explain the reasons of increased cost or any change in cost structure.

(iii) Historical Costs are too old:

In many firms, costs are determined and selling prices are ascertained even before the production starts—which is not desirable.

(iv) Historical Costs are not typical:

This is due to the wide fluctuation in market for which there is no relation between the selling price per unit and cost price per unit.

Advantages of Standard Costing:

The following advantages may be derived from Standard Costing:

(i) Standard Costing serves as a guide to the management in several management functions while formulating prices and production policies etc.

(ii) More effective cost control is possible under standard costing if the same is reviewed and analysed at regular intervals for improvements and immediate action can be taken if deviations from standards are found out which, ultimately, leads to cost reduction.

(iii) Analysis of variance and its measurement helps to detect inefficiencies and mistakes which enable the management to investigate the reasons.

(iv) Since standard costs are predetermined costs they are very useful for planning and budgeting. It also helps to estimate the effect of changes in Cost-Price-Volume relationship which also helps the management for decision-making in future.

(v) As standard is fixed for each product, its components, materials, process operation etc. it improves the overall production efficiency which also ultimately reduces cost and thereby increases profit.

(vi) Once the Standard Costing System is implemented it will lead to saving cost since most of the costing work can be eliminated.

(vii) Delegation of authority and responsibility becomes effective by setting up standards for each cost centre as the supervisors or executives of each cost centre will know the standard which they have to maintain.

(viii) This system also helps to prepare Profit and Loss Account promptly for short period in order to know the trend of the business which helps the management to take decisions promptly.

(ix) Standard costing also is used for inventory valuation purposes. Stock can be valued at standard cost which can reduce the fluctuation of profit for different methods of valuation for the same.

(x) Efficiency of labour is promoted.

(xi) This system creates cost-consciousness among all employees, executives and top management which increase efficiency and productivity as well.

Disadvantages of Standard Costing:

The alleged disadvantages of Standard Costing are:

(i) Since Standard Costing involves high degree of technical skill, it is, therefore, costly. As such, small organisations cannot, introduce the system due to their limited financial resources. But, once introduced, the benefits achieved will be far in excess to its initial high costs.

(ii) The executives are liable for those variances that are found from actions which are actually controllable by them. Thus, in order to fix up the responsibilities, it becomes necessary to segregate variances into non-controllable and controllable portions although that is not an easy task.

(iii) Standards are always changing since conditions of the business are equally changing. So, standards are to be revised in order to make them comparable with actual results. But revision of standards creates many problems, particularly in inventory adjustment.

(iv) Standards are either too liberal or rigid since the same are based on average past results, attainable good performance or theoretical maximum efficiency. So, if the standards are very high, it will adversely affect the morale and motivation of the employees.

9. Discuss responsibility accounting. What are its features and advantages and also explain the kinds of responsibility centres?

RESPONSIBILITY ACCOUNTING

Responsibility accounting is a management control system based on the principles of delegating and locating responsibility. The authority is delegated on responsibility centre and accounting for the responsibility centre. Responsibility accounting is a system under which managers are given decisions making authority and responsibility for each activity occurring within a specific area of the company. Under this system, managers are made responsible for the activities of segments. These segments may be called departments, branches or divisions etc., one of the uses of management accounting is managerial control. Among the control techniques “responsibility accounting” has assumed considerable significance. While the other control devices are applicable to the organization as a whole, responsibility accounting represents a method of measuring the performance of various divisions of an organization. The term ‘division’ with reference to responsibility accounting is used in general sense toinclude any logical segment, component, sub-component of an organization. Defined in this way, it includes a decision, a department, a branch office, a service centre, a product line, a channel of distribution, for the operating performance it is separately identifiable and measurable is some what of practical significance to management. Robert Anthony defines responsibility accounting as that type of management accounting which collects and reports both planned andactual accounting information in terms of responsibility centers. According to Charles T. Horongrent, Responsibility Accounting or profitability accounting or activity accounting which means the same thing, is a system that recognizes various decision or responsibility centers throughout the organization and traces costs (and revenue, assets and liabilities) to the individual managers who are primarily responsibility for making decisions about the costs in question. 

Significance of Responsibility Accounting

The significance of responsibility accounting for management can be explained in the following way:

Easy Identification: It enables the identification of individual managers responsible for satisfactory or unsatisfactory performance.

Motivational Benefits : If a system of responsibility accounting is implemented, consider-able motivational benefits are assured.

Data Availability: A mechanism for presenting performance data is provided. A framework of managerial performance appraisal system can be established on that basis, besides motivating managers to act in the best interests of the enterprise.

Ready-hand Information: Relevant and up to the minutes information is made available which can be used to estimate future costs and or revenues and to fix up standards for departmental budgets.

Planning and Decision Making: Responsibility accounting helps not only in control but in planning and decision making too.

Delegation and Control: The twin objectives of management are delegating responsibility while retaining control is achieved by adoption of responsibility accounting system.

Objectives of Responsibility Accounting :

Responsibility accounting is a method of dividing the organizational structure into various responsibility centers to measure their performance. In other words responsibility accounting is a device to measure divisional performance measurement may be stated as under:

1. To determine the contribution that a division as a sub-unit makes to the total organization.

2. To provide a basis for evaluating the quality of the divisional managers performance. Responsibility accounting is used to measure the performance of managers and it therefore, influence the way the managers behave.

3. To motivate the divisional manager to operate his division in a manner consistent with the basic goals of the organization as a whole.

Responsibility Centre :

For control purposes, responsibility centers are generally categorized into:

1. Cost centres

 2. Profit centers

3. Investment centers.

1. Cost Centre or Expense Centre: An expense centre is a responsibility centre in which inputs, but not outputs, are measured in monetary terms. Responsibility accounting is based on financial information relating to inputs (costs) and outputs (revenues). In an expense centre of responsibility, the accounting system records only the cost incurred by the centre but the revenues earned (outputs) are excluded. An expense centre measures financial performance in terms of cost incurred by it. In other words, the performance measured in an expense centre is efficiency of operation in that centre in terms of the quantity of inputs used in producing some given output. The modus operandi is to compare actual inputs to some predetermined level that represents efficient utilization. The variance between the actual and budget standard would be indicative of the efficiency of the division.

2. Profit Centre: A centre in which both the inputs and outputs are measured in monetary terms is called a profit centre. In other words both costs and revenues of the centre are accounted for. Since the difference of revenues and costs is termed as profit, this centre is called profit centre. In a centre, there are financial measures of the outputs as well as of the input, it is possible to measure the effectiveness and efficiency of performance in financial terms. Profit analysis can be used as a basis for evaluating the performance of divisional manager. A profit centre as well as additional data regarding revenues. Therefore, management can determine whether the division was effective in attaining its objectives. This objective is presumably to earn a “satisfactory profit”. Profit directly traceable to the division and voidable if the division were closed down. The concept of divisional profit is referred to as ‘profit contribution’ as it is amount of profit contribution directly by the division. The performance of the managers is measured by profit. In other words managers can be expected to behave as if they were running their own business. For this reason, the profit centre is good training for general management responsibility .

Measurement of Expenses :

Another problem with profit centers may relate to the measure of certain type of expenses which have to be involved in the computation of profit centres. There is a scope for difference of opinion relating to the treatment of those type of expenses which are not traceable or attributable should be ignored in working out the profit of the division as a profit centre.

Transfer of Prices :

A transfer price is a price used to measure the value of goods and services furnished by a profit centre to other responsibility centers within a company. In other words, when internal exchange of goods and services takes place between the different divisions of a firm, they have to be expressed in monetary terms. The monetary amount for these interdivisional exchange transfers is called the transfer prices. The measurement of profit in a profit centre type or responsibility accounting is also complicated by the problem of transfer prices. The implication of the transfer price is that for the selling division it will be a source of revenue, where as for the buying division (the division which is receiving, acquiring the goods and services) it is an element of cost. It will therefore, have a significant bearing on the revenues, costs therefore, have a significant bearing on the revenues, costs and profits of responsibility centres. Hence, there is a need for correct determination of transfer prices. The determination is, however, complicated because of wide variety of alternative methods are available. They are explained as under :

Types of Transfer Price:

There are two general approaches to the determination of a transfer price :

1. Cost based and

2. Market based, Based on these, there are five basic methods of transfer price :

o   Cost

o   Cost plus a normal mark-up

o   Incremental cost

o   Market price, and

o   Negotiated price

3. Investment Centers

A centre in which assets employed are also measured besides the measurement of inputs and outputs is called an investment centre. Inputs are accounted for in terms of costs, outputs are calculated on investment centre. Inputs are accounted for in terms of costs, outputs are accounted for in terms of revenues and assets employed in terms of values. It is the broadest measurement, in the sense that the performance is measured not only in terms of profits but also in terms of assets employed to generate profits. An investment centre differs from a profit centre in that as investment centre is evaluated on the basis of the rate of return earned on the assets invested in the segment while a profit centre is evaluated on the basis of excess revenue over expenses for the period.

Controllability :

As is evident from the above description, the notion controllability is prime in a system of responsibility accounting. A responsibility centre is accountable for controllable factors only. It is but natural also, since how can one be held responsible for factors beyond one’s control. Therefore, it is essential to identify which costs are controllable and which costs are not controllable. A cost is treated as controllable only when the person responsible for incurring it can exercise his influence over it. Costs which cannot be so influenced are termed as uncontrollable costs.

Problems in Responsibility Accounting

While implementing the system of responsibility accounting, the following difficulties are likely to be faced by the management:

1. Classification of costs: For responsibility accounting system to be effective a proper classification between controllable and non controllable costs is a prime requisite. But practical difficulties arise while doing so on account of the complex nature and variety of costs.

2. Inter-departmental Conflicts: Separate departmental persuits may lead to inter-departmental rivalry and it may be prejudicial to the interest of the enterprise as a whole. Managers may act in the best interests of their own, but not in the best interests of the enterprise.

3. Delay in Reporting: Responsibility reports may be delayed. Each responsibility centre can take its own time in preparing reports.

4. Overloading of Information: Responsibility accounting reports may be overloading with all available information. This danger is inherent in the system but with clear instructions by management as to the functioning of the system and preparation of reports, etc., only relevant information flow in.

5. Complete Reliance will be deceptive: Responsibility accounting can’t be relied upon completely as a tool of management control. It is a system just to direct the attention of management to those areas of performance which required further investigation