Month: October 2022

Management Notes

Duties and Responsibilities of Stores Manager

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Management of employees:

Managing employees is the foremost duty of a retail manager. This includes the management of store’s employees working at various levels such as sales staff, store staff, cleaning staff and clerical staff.

Maintaining the sales environment:

It involves implementation of store layout plans, displaying merchandise, replenishment/refilling of stock, visual merchandising task and maintaining the sales record effectively.

Cost minimization:

It involves controlling expenses that are essential to run a store. By way of applying cost effective policies, expenses can be reduced resulting in increased profitability. It is possible by elimination of waste, errors and accidents. This task of minimizing cost becomes necessary when store is running on low price policy, like in case of Wall Mart stores where EDLP (every day low prices) policy is being applied.

Recruitment, Training and Development:

The very first duty of any retail store manager is to handle the job of recruiting the right persons at right jobs. Then train and adjust them according to the store’s policies and working environment. If they need any training, they must be provided in or outside the store. These new entrants are those who make the store either an achievement or can mar the whole business.

Therefore, retail manager should ensure that be it cashier, or sales executive or store keeper, they should be hired after considering their minimum qualification and experience in the concerned field. If after recruiting, training and development, still these employees are not performing well after several warnings, they must be fired from the store.

In addition to these duties, store manager must ensure that all the employees at different level are honestly doing their duties and are not creating any problem for store or other employees.

If any retail manger, employee or group of employees are lacking in some managerial skill/know how, he/they must be provided with proper training, as trained employees work fast and in more effective way. Also it is the working staff that ultimately put policies/store’s objectives into action.

Budgeting and Forecasting:

The store manager is more suitable for predicting the store’s future performance, calculating future expenses and accordingly setting budgets. Explaining the set targets and the funds available to departmental heads and collecting their performance at regular interval comes under implementation of retail strategy.

Implementing Marketing plans:

This involves implementation of marketing policies devised in order to pursue store’s strategic marketing objectives. For example, to allocate space for sales promotion activities, inspecting effectiveness of sales distribution programs etc.

Team Leadership:

The store manager also has the task of motivating his employees and reducing any resistance to change in working methods that may be required when new strategic directions are set. Retail manager ensures that his all employees should work like a team, leaving any personal grudge.

Maintaining Leave and Salary Record:

Another important job of a retail store manager is to have the proper balance and written record of the money comes in the store by way of selling the goods. He is also responsible for keeping the whole record of all the employees with regard to their working hours, no of days worked by each and every employee.

He will take care that each employee is getting the salary according to the number of days and hours served them for the store so that there should not be any partiality with any type of store employee. He will oversee that the provisions related to casual or earned leaves (if any) are applicable to all employees.

The necessity of proper and updated records (both sales and purchase) is that it helps in estimating the money which has come in to the store by way of selling goods or providing services to customers and gone out of the store by way of bills and salary payments to employees.

Holding Inventory:

Inventory control is another important activity performed by a retail manager. To ensure regular availability of inventory in the store, retail manager maintains appropriate level of inventory all the time in the store. Since a store’s earning is through selling of goods, it becomes the duty of a sales manager to have the full record of incoming and outgoing inventory.

So that there should not be any shortage of inventory in the store and side by side there may not excess of a particular good which results in unnecessary blockage of money and also needs storage area. Normally in the small Indian cities, most of the retail managers have practice of keeping the inventory with the nearby godowns to avoid any shortage.

The reason is that these cities are not well connected with rail or road networks. But on the other side, retailers in the metros or developed cities avail of just-in-time deliveries with the help of efficient customer response systems, which reduce the practice of having huge inventories in stock all the times. In addition to maintaining appropriate level of inventory, he should make sure that payment has been made for the supplies/ordered goods.

Extending Customer Services:

The retail sales manager being on the senior position is responsible for providing multiple services to immediate customers and the other members of his retail value chain. These services differ from store to store and location to location. Some of the services familiar to all stores are (a) credit facility, (b) free home delivery, (c) after-sale service, and (d) trade discount to bulk buyers or small traders and information and new offers to its regular and loyal customers.

For instance, the Titan watch company in India set up its service centers in its own retail chain stores of Titan wrist watches with the name of Time Zone. This has not only thinned the importance of local and unorganized service providers but has also increased the confidence of the retail customers in these chain stores considering after sales service an integral part of watch purchase.

Maintaining Store Harmony:

The retail manager is also responsible for maintaining harmony among different levels of store staff. He ensures that the floor staff is cooperative and has corporate spirit of team work. Store harmony not only includes the good relation between different types of employees but also involves relation between store management and its employees, between public and store, between public and store’s employees, store and the government, and also between various stores.

Ensuring Safety of Employees and Inventory:

Since the retail store manager is supposed to be present physically on the store’s premise on daily basis, is the suitable individual to ensure the safety of the store including the safety of employees and inventory. He is the appropriate person to inform the corporate office how his store is doing and where and when the changes are needed to introduce in the store.

Store manager ensures that all the safety provisions with regard to requirement of local authorities like municipal corporation, state and central government are duly met. These safety provisions relate to installation of firefighting systems and provision of emergency exits etc.

In nutshell, a retail store manager is responsible for day-to-day activities of the retail store. He undertakes various activities and performs functions that add value to the offerings they make to their potential customers. The retail store manager also serves the manufacturer by performing the function of distributing the goods to the ultimate consumers. For several goods where brand loyalty is not very strong, the retail store manager’s recommendation could be very vital in buying decisions of the customers.

Management Notes

Highest-In-First-Out Method (HIFO)

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Highest-In First-Out (HIFO) is a type of stock distribution and valuation method. The HIFO method follows the concept that stock or inventory with the greatest purchasing costs is first to be sold, used, or removed from the stock or inventory count. The use of HIFO is not recognized by GAAP (Generally Accepted Accounting Principles) and is hardly used in accounting.

This method is based on the assumption that closing stock should always remain at the minimum value, so materials with higher value are issued first and get exhausted at the earliest. But this method is not popular as it always undervalues the stock which amounts to creating secret reserves. This method may be used in case of cost plus contracts or monopoly products.

Management Notes

Material Cost Control, Scope, Advantages, Principles, Need

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Material control is the process of systematically controlling materials over the stages of procurement, storage, and usage so as to help maintain the regular and uninterrupted flow of the materials in the production pipeline.

No system of costing is complete without an effective material control system. Material control is a system that ensures the provision of the required quantity of materials of the required quality at the required time with the minimum capital investment.

Materials are all the commodities consumed in the production department to produce items either directly or indirectly. Inventory is a common term used for raw materials, components, work-in-progress, and finished goods stocked in the store.

Materials are also vital for calculating the cost of production. In some cases, materials account for more than 65% of a product’s cost, and so proper control over them is necessary.

An efficient material control system helps to substantially reduce the cost of materials and, in this way, limits the total production cost.

Systematic and effective control over materials also helps to maintain production schedules, meet market demand, and avoid excessive investment in inventories.

A few definition of the term are given as under:

“Material control is a systematic control over purchasing, storing and consumption of materials, so as to maintain a regular and timely supply of materials, at the same time, avoiding overstocking.”

“Material control refers to the management function concerned with acquisition, storage, handling and use of materials so as to minimise wastage and losses, derive maximum economy and establish responsibility for various operations through physical checks, record keeping, accounting and other devices.”

In simple words, material control refers to the various measures adopted to reduce the amount of loss of materials at the time of receiving, storing and issuing the raw materials. Material control in practice is exercised through periodical records and reports relating to purchase, receipt, inspection, storage and issuing direct and indirect materials. Proper control over material can contribute substantially to the efficiency of a business.

Scope of Material Control

  • Purchasing or procurement of materials
  • Receiving of materials
  • Inspection of materials
  • Storage of materials
  • Issuing of materials
  • Maintenance of material records
  • Materials or stock audit

Objectives of Material Control

The uninterrupted supply of materials is essential for the smooth flow of production, which is important for the success of any business.

To Provide Required Quality of Materials

The second objective of material control is to ensure the availability of all types of materials of the required quality. If the quality of the materials is low, it will affect product quality. In turn, this will affect the company’s reputation and sales.

To Ensure Uninterrupted Production

The first objective of material control is to ensure smooth production by making available all types of required materials in the required quantity at the right time.

To Control Investment in Stock of Materials

An important aim of material control systems is to minimize the capital investment in the stock of materials.

Materials are purchased and stored before the actual production commences. A large amount of capital may be locked up in materials that may not be required at that time.

Similarly, there may be sometimes be under-investment in materials, leading to interruptions in production due to non-availability of the required quantity of materials.

An efficient material control system helps to ensure the optimal investment of capital in the purchase of materials.

To Minimize Wastage and Loss of Materials

Material control systems also aim to control or minimize all types of wastages and losses of materials that may arise due to carelessness in the storing, issuing, and handling of materials.

Advantages of Material Control System

  • Prevents production delays due to lack of materials by ensuring steady supply of required quantities of materials at the right time
  • Ensures the production of high-quality products by purchasing high-quality materials
  • Eliminates wastage in the use of materials
  • Reduces the risk of loss from fraud and theft
  • Reduces the cost of storing and issuing materials
  • Minimizes capital investment in the stock of materials
  • Quickly and accurately assists in valuing materials used in other departments
  • Helps to keep perpetual inventory and other records to facilitate the preparation of accurate material reports

Principles of Material Control

To ensure the effective and efficient operation of the material control system, it is important to follow these principles:

  • There should be proper coordination among various departments, particularly the production department, purchasing department, inspection department, stores department, and cost department.
  • There should be a centralized purchasing set up under the authority of an experienced and competent purchase manager.
  • Standard printed forms should be in use for making requisitions, placing orders, receiving materials, inspection of materials, and issue of materials for consumption.
  • There should be a proper system for classification, codification, and standardization of materials.
  • There should be an efficient arrangement for storing materials to avoid the possibility of deterioration of quality, theft, and wastage.
  • There should be an effective system of internal checks covering every aspect, thus ensuring proper control over transactions at every stage. Each transaction relating to materials must be approved by the relevant authority.
  • Different stock levels (e.g., maximum level, re-order level, and minimum level) should be fixed for each item of material in the stores.
  • There should be a proper system for the valuation of materials issued to production since it strongly influences costing records.
  • A perpetual inventory system should be used to ensure that the stocks of various items of material are recorded after each transaction.
  • Regular reports should be prepared on the quantity and value of materials received and issued, as well as the balance in hand.
  • There should be regular reconciliation of the reports on materials with corresponding accounting records.

Necessity and importance of material control:

In a productive undertaking the need of materials control arises on account of the following reasons:

  1. For keeping the stock of raw materials within limits in the stores i.e., to avoid overstocking and understocking of raw materials, materials control is significant.
  2. It ensures proper storage of materials. For the proper preservation and safety of materials, adequate storage facilities are to be provided. With the help of proper storing of materials, quantity of materials as and when required can be issued to various jobs.
  3. For knowing proper cost of production, control over materials is indispensable.
  4. Certain techniques and methods are developed under the system of materials control thereby ensuring optimum utilisation of materials.
  5. In order to undertake continuous checking of materials, the necessity of a proper system of materials control cannot be ignored.
  6. A well managed system of materials control ensures the availability of different kinds of materials without delay.

As already pointed out while explaining the scope of material management that it includes purchases of materials, storekeeping and inventory control etc.

Management Notes

Realizable Price Method, Standard Price Method, Inflated Price Method

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Realizable Price Method

Net realizable value (NRV) is the value for which an asset can be sold, minus the estimated costs of selling or discarding the asset. The NRV is commonly used in the estimation of the value of ending inventory or accounts receivable.

The net realizable value is an essential measure in inventory accounting under the Generally Accepted Accounting Principles (GAAP) and the International Financing Reporting Standards (IFRS). The calculation of NRV is critical because it prevents the overstatement of the assets’ valuation.

NRV and Lower Cost or Market Method

Net realizable value is an important metric that is used in the lower cost or market method of accounting reporting. Under the market method reporting approach, the company’s inventory must be reported on the balance sheet at a lower value than either the historical cost or the market value. If the market value of the inventory is unknown, the net realizable value can be used as an approximation of the market value.

Calculation of NRV:

The calculation of the NRV can be broken down into the following steps:

  • Determine the market value or expected selling price of an asset.
  • Find all costs associated with the completion and the sale of an asset (cost of production, advertising, transportation).
  • Calculate the difference between the market value (expected selling price of an asset) and the costs associated with the completion and sale of an asset. It is a net realizable value of an asset.

Net realizable value (NRV) = Expected Selling Price – Total productions and Selling Cost

Standard Price Method

Calculate of a pre-determined price, and this price is kept constant for a definite time period. In this method of inventory valuation, we post all receipts into the stock ledger account and sales/ issues are valued at the pre-determined price (standard price). If there is any difference between the actual price and standard price, it is transferred to the material price variance account.

At that standard price materials issued are valued. For establishing standard price, the factors usually considered are:

(a) Due to possible changes in market conditions, apprehended changes in price.

(b) Depending upon the quantity to be ordered, the amount of discount that may be available from the suppliers.

(c) Expenses which are related to purchases i.e. freights & carriage, customs duty, godown expenses, packing, handling etc.

Difference, if any, between the standard price & the actual purchase price, is known as material variance. However, the variance which arises due to the difference between standard rate of purchase & the actual rate of purchase is known as rate variance. On the other hand, variance due to difference between total actual material cost & total standard material cost, there being no difference in rates, the variance is called usage variance. Either at the time of actual purchase or at the end of accounting period, the variance may be worked out. The variance is analyzed into causative reasons & by taking suitable measures its recurrence is prevented.

Advantages:

(a) Efficiency of the purchase department can be revealed.

(b) As all the issues are charged at a standard price, the method is easy to apply.

(c) Even if standard costing method is not applied in any industry, the method can be used there.

(d) By setting the standard price, control on material cost may be exercised by the method, which may be called the price that should be.

Disadvantages:

(a) At actual cost, the issues are not charged.

(b) Profit or loss on materials may be there.

(c) The purpose for which it is set may be spoiled by a very low or high standard price.

(d) Fixing a reliable standard price is difficult, since upon a number of unknown variable factors, the price depends.

Inflated Price Method

There are some materials which are subjected to natural wastage. Examples are: (1) material lost due to loading and unloading, and (2) timber lost due to seasoning. In such cases, the materials are issued at an inflated price (a price higher than the actual cost) so as to recover the cost of natural wastage of materials from the production.

In this way, the total cost of the material is recovered from the production. For example, if 100 tonnes of coal are purchased at Rs 75 per tonne and if it is expected that 5 tonnes of coal will be lost due to loading and unloading, the inflated issue price in this case will be Rs 78.95 (i.e. 100 x Rs 75/95) per tonne. With the actual issue of 95 tonnes of coal the actual cost of Rs 7,500 (100 tonnes purchased @ Rs 75 per tonne) will be recovered from production (95 tonnes @ Rs 7 78.95).

Specific Price Method of Stock Valuation:

When materials are purchased fora specific job or work order, they should be issued to that specific job or work order at their actual cost. This method is used where job costing is in operation and the actual materials issued can be identified.

Base Stock Price Method of Stock Valuation:

Each concern always maintains a minimum quantity of material in stock. The minimum quantity is known as safety or base stock and this should be used only when an emergency arises. The base stock is created out of the first lot of the material purchased and therefore, it is always valued at the cost price of the first lot and is carried forward as a fixed asset.

Management Notes

Specific Price Method

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The specific identification method relates to inventory valuation, specifically keeping track of each specific item in inventory and assigning cost individually instead of grouping items together the manner of calculation that is typically done in the first in, first out (FIFO) and last in, first out (LIFO) methods.

The specific identification method is useful and usable when a company is able to identify, mark, and track each item or unit in its inventory. While the specific identification method can be utilized by larger companies with electronic tags or stickers with serial numbers that can be scanned into an electronic inventory tracking system, it is most common with smaller businesses that can easily identify or count items in their inventory.

Sometimes, the process can be done simply by an employee laying eyes on the items and marking them down on a piece of paper. In an age where technology and computer programs seem to run everything, the specific identification method is used in a similar way; however, inventory counts are recorded in a database.

Under the specific identification method, it’s also necessary that the cost of each purchased item can be determined on an individual basis. The cost must be easily associated with a number or other identifying feature of the item so that it can be directly connected to that item. Likewise, the item must be easily tracked, found, and available when the promise of sale is made.

The Pros and Cons of the Specific Identification Method

The primary drawback to the specific identification method is that its use requires a definitive ability to easily and consistently identify all the individual items within a company’s inventory, track their cost, and produce them upon sale or the promise of sale.

Both the cost of the item and the amount received for the sale of the item must be attached to a specific item with some form of a unique identifier that singles it out. The process is incredibly difficult for larger businesses such as big box stores to achieve because of the sheer volume that such companies move on a daily basis.

It is an issue that smaller businesses don’t generally face, which is why such companies are the ones that commonly utilize the specific identification method. One benefit of the method is a much higher degree of accuracy when it comes to the actual numbers of items in inventory and then, of course, a higher degree of accuracy when it comes to the numbers of dollars in earned income or profit, as well as any lost revenue if items are damaged, lost, or returned. The chances of losing or misplacing inventory under such a system are almost obliterated because of its accuracy.

Occasionally, it is used to identify specific securities. This method of identification allows investors to reduce or offset capital gains by picking a specific lot of securities to be used as the basis for a sale.

Obviously, this inventory method takes more work upfront than the alternatives. It might not be a reasonable use of time for a seller of t-shirts or candles. But it could be very useful to a seller of a wide variety of merchandise who wants a steady stream of information on what products or styles are in demand, what’s not selling, and what needs restocking.

In addition, it has practical uses in accounting. It makes it easy to calculate the ending inventory cost. That figure tells the company the total annual expenses associated with all unsold goods in its inventory. It also provides a highly accurate figure for the cost of goods sold.

Advantages

  • The first and most important advantage of using the Specific identification method is that it helps the business keep track of every item of the inventory used in the company from the time such inventory comes into the business till the time it goes out of business.
  • With the use of the specific identification, method cost is assigned to every item used in the company individually. In the LIFO inventory and FIFO methods, the cost is assigned to the inventory by grouping them based on specified criteria. It ensures a high degree of accuracy in the valuation of closing stock at the end of a particular period and the valuation of the cost of goods sold during the period.

Disadvantages

  • As it tracks every item of the inventory used in the company from the time such inventory comes into the business until the time it goes out of business is kept, it requires lots of effort and time from the person responsible for such tracking.
  • If the companies use the Specific identification method, then under those situations, the company’s net income can be manipulated easily by the company’s management.
  • As the company has a vast number of transactions, it is difficult to identify the purchased products, so this method is rarely used. It is restricted to businesses dealing with high-value items.

Example

Take a retailer for example. Retailers order tons of inventory from wholesalers and manufacturers on a regular basis. Palates of goods can be delivered on a daily basis. Let’s assume an electronics retailer ordered 10 computers. Each computer is slightly different and can be identified by the serial number. The receiving department can unpack the shipment, scan each computer into the system, and assign the total invoice cost to the individual goods.

This system is extremely accurate because each piece of inventory can be tracked separately. There are no estimates involved which make the inventory and cost of goods sold numbers more accurate on the financial statements as well.

Even though this system is extremely accurate, few companies actually use it. There are two main problems with the specific identification method. The first main problem is that the system takes a lot of time and effort. Each piece of inventory must be separately scanned and entered into the system. The second reason is that most goods can’t be separately identifiable. A huge palette of homogenous goods is most like indistinguishable.

Most companies use FIFO or LIFO inventory valuation methods.

Management Notes

Departments involved in Labour Cost Control

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(1) Personnel Department:

This department in a large organisation is responsible for recruitment, training discharge, transfer etc. and maintaining their records.

The main functions are:

(i) Receiving requisition for labour from various departments

(ii) Selection and Recruitment

(iii) Information to the concerned departments like requisioning department and pay roll department.

(2) Engineering and Work Study Department:

This department helps in labour cost control through following functions:

(i) Preparing production plans and specifications for each job,

(ii) Initiating and supervising research and experimental work

(iii) Maintaining efficient and safe working conditions

(iv) Performing work-studies e.g., Time study, Motion study etc.

(v) Analyzing jobs and job evaluation and studies

(vi) Performance appraisals and labour Productivity

(vii) Fixing Piece rate.

(3) Time Keeping Department:

Its functions are maintenance of attendance records of employees and job time booking.

(4) Payroll Department:

This department has to perform following functions:

(i) To maintain record of job classification and wage rate of each and every employee,

(ii) To verify and to summarize the time of each worker as shown on daily time cards,

(iii) To calculate wages earned by each and every worker

(iv) To prepare payroll of every department,

(v) To calculate total amount of wages and deductions for each employee

(vi) To disburse wages

(vii) To devise a suitable internal check preparing and paying out wages.

(5) Cost Accounting Department:

This department is concerned with:

(i) Documentation of Wages Accounting

(ii) Analysis of total labour cost and

(iii) Treatment of idle time, Overtime, Leave Pay etc.

Management Notes

Labour Cost, Introduction, Meaning, Objectives, Elements, and Types

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Labour is one of the most important factors of production along with land, capital, and organization. In cost accounting, labour cost represents the human effort employed in converting raw materials into finished goods. It is the second major element of cost after material cost and plays a vital role in determining productivity, efficiency, and profitability of an organization.

Efficient control of labour cost helps in reducing overall production cost, improving quality, and increasing competitiveness. Since labour involves both monetary and human considerations, proper planning, recording, and control of labour cost are essential for effective cost management.

Meaning of Labour Cost

Labour cost refers to the total remuneration paid or payable to workers for their services rendered in the production and related activities of an organization. It includes not only wages and salaries but also all benefits and allowances paid to employees in return for their work.

Labour cost covers payments made to workers engaged in manufacturing, administration, and selling activities. It may include basic wages, overtime wages, bonuses, incentives, allowances, employer’s contribution to provident fund, gratuity, and other fringe benefits.

In cost accounting, labour cost is classified into direct labour cost and indirect labour cost, depending on whether the labour can be directly identified with a specific product or not.

Objectives of Labour Cost Control

  • To Reduce Cost of Production

One of the primary objectives of labour cost control is to reduce the overall cost of production. Efficient utilization of labour minimizes idle time, overtime, and unnecessary payments. By improving work methods, proper supervision, and effective wage systems, labour cost per unit can be reduced, leading to increased profitability and competitive pricing in the market.

  • To Ensure Optimum Utilization of Labour

Labour cost control aims to ensure optimum utilization of available workforce. Proper job allocation, work scheduling, and avoidance of underemployment or overstaffing help in achieving maximum output from minimum labour effort. This prevents wastage of labour time and enhances productivity.

  • To Minimize Idle Time and Overtime

Another important objective is to reduce idle time and excessive overtime. Idle time leads to payment without corresponding output, while overtime increases labour cost due to higher wage rates. Effective planning, timely availability of materials, and proper maintenance of machinery help in controlling idle time and overtime.

  • To Improve Labour Productivity and Efficiency

Labour cost control seeks to increase productivity and efficiency of workers. Training, performance evaluation, incentive schemes, and proper working conditions motivate workers to improve their performance. Higher productivity results in lower labour cost per unit and better utilization of resources.

  • To Establish Fair and Efficient Wage System

An important objective of labour cost control is to establish a fair, equitable, and efficient wage system. Proper wage structures ensure that workers are adequately compensated for their efforts, reducing labour turnover and industrial disputes. Fair wages also motivate employees to work efficiently.

  • To Prevent Fraud and Manipulation

Labour cost control aims to prevent frauds and malpractices such as bogus workers, false time recording, and inflated wage payments. Effective time-keeping, time-booking, and payroll systems ensure accuracy and transparency in wage payments.

  • To Facilitate Accurate Costing and Decision Making

Proper control of labour cost provides accurate labour cost data for product costing, budgeting, and managerial decision-making. Correct allocation of labour cost helps management in pricing, cost comparison, and performance evaluation.

  • To Maintain Industrial Harmony

Labour cost control also aims to maintain industrial harmony by ensuring timely and fair wage payments, good working conditions, and transparent policies. Harmonious labour relations reduce disputes, strikes, and absenteeism, contributing to smooth operations and stable production.

Elements of Labour Cost

Labour cost consists of all payments made to employees for their services rendered to an organization. It includes not only wages and salaries but also various allowances and benefits provided to workers. The main elements of labour cost are explained below:

  • Wages and Salaries

Wages and salaries form the basic element of labour cost. Wages are generally paid to factory and hourly-rated workers, while salaries are paid to office staff and supervisory employees. This includes basic pay for normal working hours and forms the largest portion of total labour cost.

  • Overtime Wages

Overtime wages are paid when workers work beyond normal working hours. These wages are usually paid at a higher rate than normal wages. Overtime increases labour cost and is generally treated as direct or indirect labour cost depending on the nature and reason for overtime.

  • Bonus and Incentives

Bonus and incentive payments are made to motivate workers to improve productivity and efficiency. These may be paid based on performance, output, profits, or statutory requirements. Incentives help increase production but also add to labour cost.

  • Allowances

Allowances are additional payments made to workers over and above basic wages. These include dearness allowance, house rent allowance, conveyance allowance, and special allowances. Allowances compensate employees for increased cost of living or special working conditions.

  • Employer’s Contribution to Statutory Funds

Labour cost includes the employer’s contribution to statutory funds such as provident fund, employee state insurance, gratuity, and pension schemes. These are compulsory payments made as per labour laws and form an important element of labour cost.

  • Fringe Benefits and Perquisites

Fringe benefits and perquisites include non-monetary benefits such as medical facilities, subsidized meals, housing, transport, leave travel concession, and recreational facilities. These benefits improve employee welfare but also increase labour cost.

  • Leave Wages

Leave wages are payments made to employees for paid leave, including casual leave, sick leave, earned leave, and holidays. Although no work is performed during leave, wages paid for such periods are included in labour cost.

  • Training and Welfare Expenses

Expenses incurred on training, safety, and employee welfare are also treated as part of labour cost. These costs help improve skill levels, efficiency, and safety but increase overall labour expenditure.

Types of Labour Cost

1. Direct Labour Cost

Direct labour cost refers to wages paid to workers who are directly involved in manufacturing products or providing services. These workers contribute directly to the production process, such as machine operators, assembly line workers, and artisans. Since direct labour costs can be traced to specific products, they are classified as prime costs. Direct labour costs fluctuate with production levels, making them variable costs. Controlling direct labour costs is essential for ensuring profitability, as higher efficiency can reduce production costs and enhance competitiveness.

2. Indirect Labour Cost

Indirect labour cost includes wages paid to employees who do not directly participate in the manufacturing or service process but support it. Examples include supervisors, maintenance staff, security personnel, and storekeepers. These costs cannot be traced to a single product but are essential for smooth operations. Indirect labour costs are treated as overheads and are allocated to products based on predetermined rates. While they do not vary significantly with production volume, optimizing indirect labour costs can enhance operational efficiency and reduce unnecessary expenses.

3. Fixed Labour Cost

Fixed labour costs remain constant regardless of production levels. These include salaries of permanent employees, contractual staff wages, and long-term benefit payments such as pensions. Fixed labour costs are crucial for maintaining stable workforce availability and operational continuity. Even during periods of low production, businesses must pay fixed labour costs, affecting overall financial planning. Companies strategically manage fixed labour costs by balancing permanent and temporary employees. Effective workforce planning ensures that fixed costs do not become a financial burden during slow production periods.

4. Variable Labour Cost

Variable labour costs fluctuate with production levels and include wages paid to hourly workers, overtime payments, and performance-based incentives. These costs increase when production rises and decrease when demand declines. Variable labour costs allow businesses to adjust workforce expenses based on operational needs, providing financial flexibility. For example, industries with seasonal demand rely on contract labour to manage workload variations. While variable labour costs can help reduce financial strain during downturns, ensuring proper productivity and quality control is essential when relying on a flexible workforce.

5. Semi-Variable Labour Cost

Semi-variable labour costs contain both fixed and variable components. For example, supervisors’ salaries may remain fixed up to a certain level of production but may include overtime pay when production increases. Another example is part-time workers whose wages depend on hours worked. Semi-variable costs provide workforce stability while allowing flexibility in managing labour expenses. Businesses must carefully analyze semi-variable labour costs to optimize resource utilization and control unnecessary expenses. Effective cost management ensures that labour remains efficient, productive, and cost-effective in fluctuating production environments.

6. Productive Labour

Labour that contributes directly to production output is known as productive labour. It usually forms part of direct labour cost.

7. Unproductive Labour

Labour that does not contribute directly to production, such as idle time or standby labour, is called unproductive labour and is generally treated as indirect labour cost.

Management Notes

Challenges in installing effective cost accounting system

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The implementation of a cost accounting system is an important step for a growing small business. Implementation begins with identification of the correct costing system for the business, moves on to deployment of the system and finishes with post-deployment support to train employees on how to use the system effectively. Best practices in cost-system implementation focus on all three parts of the implementation process.

(i) Management Apathy:

If management is not really convinced of the advantages of the costing system or if it has somehow been made to accept the system against its will, it will merely tolerate it and not encourage it properly. This will lead others also to withhold their cooperation and, therefore, the system may never operate effectively. The reports may all be correct and prompt but probably no one will look at them.

(ii) Hostility from Line Staff:

Line staff people often believe that firstly they know how to run their business and, therefore, they do not need anyone to tell them what information they need and, secondly, that they cannot waste their time in “form filling”. They may also be afraid that proper information will expose some of their mistakes or that the new system will make them less useful than before in the eyes of the management. There is a tendency to resent anything new unless it is patently to one’s advantage.

(iii) Structure of Authority:

The cost accounting system may be based on formal authority structure whereas in reality the structure may be quite different. If, for example, trade union leaders have a great deal of influence on the various decisions, the system may run into difficulties it is not likely that the organisation chart will show the authority of the union leaders.

(iv) Changed Circumstances:

Business often undergoes rapid changes the market may change and the production process may change; management ideas change also. If the costing system is not adapted to the changed circumstances, it will cease to be effective. For example, if a cotton textile mill is converted into a mill producing man-made fibres, the Cost Accounting system must also be suitably changed.

(v) Indifference:

Often a part of the system breaks down; if it is not quickly set right, it will affect the whole system. For example, if issues of material are not properly watched and kept under control, the whole materials control system may break down. Also there may be delay in the flow of information and report may be delayed. If this is not corrected the whole decision-making and control system may be vitiated. The same will be the result if there are serious errors in report. It is, therefore, necessary that someone should watch the actual operation of the system continuously and carefully.

(vi) Low Status of Cost Accountant:

The cost accountant will often have to collect and furnish information which may not be liked by someone. If the cost accountant occupies a very junior position, he may not be able to do his work without fear or favour and, therefore, the information supplied by him may not lead to the correct decision. It is essential that the cost accountant should be a high ranking official, having direct access to the top management. He must also be assisted by a properly trained and adequate staff.

(vii) Lack of Clarity about Priorities and Objectives:

If the Cost Accounting staff is not clear about the end uses to which costing information will be put, they may not go about their task in the correct manner; they may even send the wrong sort of or inadequate information. Because of all these difficulties, it is necessary to proceed slowly, taking everyone along. An educative process for all concerned is essential to see that the costing system is accepted and operated sincerely.

Management Notes

Important terminologies of Cost Accounting

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Direct Cost

Direct costs can be easily identified as per the expenditure on cost objects. So, for example, if we pick how much expenditure a business has had on purchasing the raw materials inventory, we will be able to directly point out.

Indirect Cost

In the case of indirect costs, the challenge is that we can’t identify the costs as per the cost object. So, for example, if we try to understand how much rent is given for sitting the machinery in a place, we won’t be able to do it because the rent is paid for the entire space, not for a particular place.

The essential difference between direct costs and indirect costs is that only direct costs can be traced to specific cost objects. A cost object is something for which a cost is compiled, such as a product, service, customer, project, or activity. These costs are usually only classified as direct or indirect costs if they are for production activities, not for administrative activities (which are considered period costs).

Prime Cost

Prime costs are a firm’s expenses directly related to the materials and labor used in production. It refers to a manufactured product’s costs, which are calculated to ensure the best profit margin for a company. The prime cost calculates the direct costs of raw materials and labor that are involved in the production of a good. Direct costs do not include indirect expenses, such as advertising and administrative costs.

Prime cost = Direct raw materials + Direct labour

Production Cost

Production costs refer to all of the direct and indirect costs businesses face from manufacturing a product or providing a service. Production costs can include a variety of expenses, such as labor, raw materials, consumable manufacturing supplies, and general overhead.

Direct Labor Costs

Direct labor consists of the fully burdened cost of all labor directly involved in the production of goods. This usually means those people working on production lines or in work cells. Other types of production labor are recorded within the category of factory overhead costs.

Direct Material Costs

Direct materials consists of those materials consumed as part of the production process, including the cost of normal scrap that occurs as part of the process.

Factory Overhead Costs

Factory overhead consists of those costs required to maintain the production function, but which are not directly consumed on individual units. Examples are utilities, insurance, materials management salaries, production salaries, maintenance wages, and quality assurance wages.

Administration Cost

Administrative expenses refer to the costs incurred by a company or organization that include, but are not limited to, the salaries and benefits of the administrative workers within the company or organization, as well as rent and managerial compensation. Also known as General and Administrative expenses, the costs are categorized separately from Sales & Marketing and Research costs.

  1. Administrative Expenses
  • Managerial team
  • IT team
  • Executive compensation
  • Rent of equipment and buildings
  1. Non-Administrative Expenses
  • Manufacturers
  • Developers
  • Engineers
  • Sales Team

Selling and Distribution Cost

The term ‘distribution‘ is widely used in relation to the whole operation of getting goods into the hands of the consumer, and thus covers the two functions of sales promotion and delivery. The expression ‘distribution costs’, however, may be considered as relating only to delivery.

Selling Costs: The cost incurred in promoting sales and retaining customers. Selling expenses are those expenses which are incurred to promote sales and service to customers. Thus, selling overhead includes Salesmen’s Salaries, Commission, Travelling expenses, Cost of advertisement, Posters, Cost of price list and catalogue, Debt collection charges, Bad debts, Free gift, Showrooms expenses, After-sale service, Legal expenses for recovering debt, etc.

Distribution Costs: The cost of the process which begins with making the packed product available for dispatch and ends with making the reconditioned returned empty package available for re-uses. Distribution expenses, on the other hand, are those which are incurred for warehousing and storage, packing for goods sent and making the goods available for delivery to customers. So, in broader sense of the item, distributions expenses include- Cost of storing, Cost of warehousing, Cost of packing, Cost of delivery, and Cost of preparation of challan.

Fixed Cost

In accounting and economics, fixed costs, also known as indirect costs or overhead costs, are business expenses that are not dependent on the level of goods or services produced by the business. They tend to be recurring, such as interest or rents being paid per month. These costs also tend to be capital costs. This is in contrast to variable costs, which are volume-related (and are paid per quantity produced) and unknown at the beginning of the accounting year. Fixed costs have an effect on the nature of certain variable costs.

For example, a retailer must pay rent and utility bills irrespective of sales. As another example, for a bakery the monthly rent and phone line are fixed costs, irrespective of how much bread is produced and sold; on the other hand, the wages are variable costs, as more workers would need to be hired for the production to increase. For any factory, the fix cost should be all the money paid on capitals and land. Such fixed costs as buying machines and land cannot be not changed no matter how much they produce or even not produce. Raw materials are one of the variable costs, depending on the quantity produced.

Fixed cost is considered an entry barrier for new entrepreneurs. In marketing, it is necessary to know how costs divide between variable and fixed costs. This distinction is crucial in forecasting the earnings generated by various changes in unit sales and thus the financial impact of proposed marketing campaigns. In a survey of nearly 200 senior marketing managers, 60 percent responded that they found the “variable and fixed costs” metric very useful. These costs affect each other and are both extremely important to entrepreneurs.

Variable Cost

A variable cost is a cost that varies in relation to either production volume or the amount of services provided. If no production or services are provided, then there should be no variable costs. If production or services are increasing, then variable costs should also increase.

Types of Variable Costs

Direct materials are considered a variable cost. Direct labor may not be a variable cost if labor is not added to or subtracted from the production process as production volumes change. Most types of overhead are not considered a variable cost.

Semi-variable Cost

In such mixed cost, the fixed part will occur irrespective of the production level; even in the case of zero production activities, a fixed cost will still occur. However, the variable part of such costs is dependent on the level of production work carried by the entity and increases in proportion to the production levels. That means that semi-variable costs can be calculated by adding the fixed costs and the variable costs (based on the level of production).

Period Cost

Period costs are costs that cannot be capitalized on a company’s balance sheet. In other words, they are expensed in the period incurred and appear on the income statement. Period costs are also called period expenses.

Product Cost

Product cost refers to the costs incurred to create a product. These costs include direct labor, direct materials, consumable production supplies, and factory overhead. Product cost can also be considered the cost of the labor required to deliver a service to a customer. In the latter case, product cost should include all costs related to a service, such as compensation, payroll taxes, and employee benefits.

Product cost appears in the financial statements, since it includes the manufacturing overhead that is required by both GAAP and IFRS. However, managers may modify product cost to strip out the overhead component when making short-term production and sale-price decisions. Managers may also prefer to focus on the impact of a product on a bottleneck operation, which means that their main focus is on the direct materials cost of a product and the time it spends in the bottleneck operation.

Product Cost Calculation

The cost of a product on a unit basis is typically derived by compiling the costs associated with a batch of units that were produced as a group, and dividing by the number of units manufactured. The calculation is:

Product unit cost = (Total direct labor + Total direct materials + Consumable supplies + Total allocated overhead) ÷ Total number of units

Explicit Cost

Explicit cost is valuable if you’re trying to create long-term strategic goals for a company or simply assessing its profitability. Learning how this metric varies from implicit costs can help you understand, determine and establish the total economic cost. Explicit costs can be easily determined and invaluable for decision-making in a business or department.

Important

Calculating profit: Once a company pays all its explicit costs, the profit is the remaining monetary value on the general ledger.

Performing long-term strategic planning: Explicit cost helps calculate a company’s profitability. It’s a key metric for long-term strategic planning because it allows a business to predict its profits for a specific period.

Implicit Cost

In economics, an implicit cost, also called an imputed cost, implied cost, or notional cost, is the opportunity cost equal to what a firm must give up in order to use a factor of production for which it already owns and thus does not pay rent. It is the opposite of an explicit cost, which is borne directly. In other words, an implicit cost is any cost that results from using an asset instead of renting it out, selling it, or using it differently. The term also applies to foregone income from choosing not to work.

Implicit costs also represent the divergence between economic profit (total revenues minus total costs, where total costs are the sum of implicit and explicit costs) and accounting profit (total revenues minus only explicit costs). Since economic profit includes these extra opportunity costs, it will always be less than or equal to accounting profit.

Although implicit costs are non-monetary costs that usually do not appear in a company’s accounting records or financial statements, they are nonetheless an important factor that must be considered in bottom-line profitability. Implicit costs distinguish between two measures of business profits accounting profits versus economic profits.

  • Accounting profits are a company’s profits as shown in its accounting records and financial statements (such as its income statement). However, accounting profits, which are calculated as total revenues minus total expenses, only reflect actual cash expenses that a company pays out – its explicit costs.
  • Economic profits take into consideration both explicit and implicit costs. Therefore, while a company may show a positive net accounting profit, it may actually be a losing economic enterprise when its implicit costs are factored into the profitability equation

Historical Cost

Historical cost is the price paid for an asset when it was purchased. Historical cost is a fundamental basis in accounting, as it is often used in the reporting for fixed assets. It is also used to determine the basis of potential gains and losses on the disposal of fixed assets.

Historical Cost Adjustments

According to the accounting standards, historical costs require some adjustment as time passes. Depreciation expense is recorded for longer-term assets, thereby reducing their recorded value over their estimated useful lives. Also, if the value of an asset declines below its depreciation-adjusted cost, one must take an impairment charge to bring the recorded cost of the asset down to its net realizable value. Both concepts are intended to give a conservative view of the recorded cost of an asset.

Other Types of Costs

Historical cost differs from a variety of other costs that can be assigned to an asset, such as its replacement cost (what you would pay to purchase the same asset now) or its inflation-adjusted cost (the original purchase price with cumulative upward adjustments for inflation since the purchase date).

Historical cost is still a central concept for recording assets, though fair value is replacing it for some types of assets, such as marketable investments. The ongoing replacement of historical cost by a measure of fair value is based on the argument that historical cost presents an excessively conservative picture of an organization.

Current Cost

Current cost is the cost that would be required to replace an asset in the current period. This derivation would include the cost of manufacturing a product with the work methods, materials, and specifications currently in use. The concept is used to generate financial statements that are comparable across multiple reporting periods.

Future or Predetermined Cost

A futures contract is a legal agreement to buy or sell a particular commodity asset, or security at a predetermined price at a specified time in the future. Futures contracts are standardized for quality and quantity to facilitate trading on a futures exchange.

The buyer of a futures contract is taking on the obligation to buy and receive the underlying asset when the futures contract expires. The seller of the futures contract is taking on the obligation to provide and deliver the underlying asset at the expiration date.

These costs are computed in advance of the actual spending. And it usually includes all specifications with regards to the cost in question. In manufacturing firms, they are estimated for raw materials, labor and Overheads. When the actual costs are included during the period, the actual is compared with the predetermined to get the variance. A favorable variance means the actual cost is lower while an unfavorable variance implies that the actual cost was higher.

The term is also used in standard costing. In this situation, the standard cost is said to be the predetermined cost which is then compared with the actual cost. Variance is used to understand the cost item. So that adjustments can be made.

Using predetermined cost improves management efficiency. It also reduces the cost of production. Furthermore, it serves as a key performance indicator. A manager spending above the predetermined cost may imply that he or she is not performing well in terms of managing the entity’s finance.

Opportunity Cost

The opportunity cost of a particular activity is the value or benefit given up by engaging in that activity, relative to engaging in an alternative activity. More simply, it means if you chose one activity (for example, an investment) you are giving up the opportunity to do a different option. The optimal activity is the one that, net of its opportunity cost, provides the greater return compared to any other activities, net of their opportunity costs. For example, if you buy a car and use it exclusively to transport yourself, you cannot rent it out, whereas if you rent it out you cannot use it to transport yourself. If your cost of transporting yourself without the car is more than what you get for renting out the car, the optimal choice is to use the car yourself.

Formula and Calculation of Opportunity Cost

Opportunity Cost = FO−CO

Where:

FO=Return on best forgone option

CO=Return on chosen option

Management Notes

Precautions for installing effective cost accounting system

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A cost accounting system is used by manufacturers to record production activities using a perpetual inventory system. In other words, it’s an accounting system designed for manufacturers that tracks the flow of inventory continually through the various stages of production.

Precautions

The Technical Details

Technical operations of the concern and whether production is more important than selling or vice versa should be kept in mind. Obviously more attention must be paid to the more significant factor.

Objects:

What are the objects which the management wants to achieve and what sort of information does it need for the achievement of its objectives? Information about costs meant for fixing prices would be quite different from that intended to reveal efficiencies or inefficiencies in operations or that required to make decisions on a rational basis.

The Product

The nature of product should be considered to decide type of cost system. For example, if materials used are insignificant, an elaborate system of materials control will not be necessary.

Type of Materials

The type of materials available and the timing of their supplies together with the storage problem, should also be taken into consideration.

Factors

Factors that are or are not amenable to control should be considered. Attention has to be paid to controllable factors. For instance, if a particular method of packing is prescribed by law, it is no use trying to think of an alternative.

Type of Labour

The type of labour which is required and the methods of their remuneration should also be kept in mind.

Management

The character of management itself and the decision-making process should also be taken into account. Modern managements usually need detailed information. The information flows will have to be designed with reference to the sources and end uses of the information. For example, if decisions are taken by a person who refuses to divulge any information, the system must keep this in view.

Business Peculiarities

Any peculiarities of the business, that there may be, must be kept in view. For instance, if purchases of particular item are to be made only from one particular source or firm, the costing system need not build an adequate purchase procedure; it should concentrate on the proper use of the concerned item.

Use of Financial Books

The possibility of using financial books and procedures should also be kept in mind. As stated above, cost accounting is to be treated as an investment and, therefore, all existing useful procedures, books and records should be used. For example financial accounts need adequate record of purchases and wages. With a little change, these can be made to serve the needs of Cost Accounting also. As far as possible, cost records and financial books should be well coordinated, even fully integrated.

Choice of Unit

The choice of the unit regarding which costs have to be obtained should also be considered. For example, in case of steel, costs are ascertained per tonne of steel and in case of cotton textiles, the unit is kg. of yarn or cloth. In case of motor transport the cost will be found per bus-kilometre or passenger-kilometre or sometimes tonne-mile. These are known as units of cost and it is necessary to choose a proper unit neither too big nor too small.

Full Discussion

Above all, the system should be designed after a full and frank discussion with all those who will be involved.

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