Category: Management Notes

Management Notes

Standard Costing introduction

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Standard Costing is a cost accounting method that involves setting predetermined, standard costs for direct materials, direct labor, and manufacturing overhead. It is used to establish a benchmark for comparing actual costs to expected costs and to identify any variances that may occur during production.

Standard costing, costs are recorded in the accounting system at standard rates, and variances are identified and analyzed to understand the reasons for deviations from the standard. This information is then used to adjust future cost estimates and improve cost control.

Standard costing is commonly used in manufacturing industries where products are produced in large quantities and costs can be accurately predicted based on historical data and experience. It is also used in service industries where costs can be assigned to individual products or services.

Process of Standard Costing:

  • Establishing standard costs for direct materials, direct labor, and manufacturing overhead
  • Recording actual costs incurred during production
  • Calculating and analyzing variances between actual and standard costs
  • Investigating and explaining the reasons for variances
  • Adjusting future cost estimates based on the information gathered from the analysis.

Advantages of standard costing:

  • It helps to identify inefficiencies in production processes.
  • It provides a framework for cost control.
  • It enables management to identify areas for improvement.
  • It facilitates the calculation of variances that can be used for performance evaluation.
  • It provides a consistent basis for decision-making.

Disadvantages of Standard Costing:

  • It can be time-consuming and expensive to set up.
  • It may not accurately reflect the actual costs of production.
  • It may not be suitable for businesses that operate in rapidly changing markets.
  • It can lead to a focus on cost reduction at the expense of quality and customer service.
  • It may not take into account non-financial factors that can impact production costs, such as employee morale and motivation.

The main formulas used in standard costing are:

  • Standard Cost per unit = Direct materials standard cost per unit + Direct labor standard cost per unit + Manufacturing overhead standard cost per unit
  • Total Standard cost = Standard cost per unit × Number of units produced
  • Variance = Actual cost – Standard cost
  • Material price variance = (Actual price – Standard price) × Actual quantity
  • Material quantity variance = (Actual quantity – Standard quantity) × Standard price
  • Labor rate variance = (Actual rate – Standard rate) × Actual hours
  • Labor efficiency variance = (Actual hours – Standard hours) × Standard rate
  • Overhead spending variance = (Actual overhead – Budgeted overhead) × Actual activity
  • Overhead efficiency variance = (Actual activity – Standard activity) × Standard overhead rate.

Standard Costing example question with solution

ABC Ltd. produces and sells widgets. The company’s budgeted production for the year is 10,000 units, with a budgeted overhead of $50,000. The budgeted direct materials and direct labor cost per unit are $20 and $10 respectively. The budgeted fixed overhead per unit is $5. The standard overhead rate per direct labor hour is $5.

During the year, ABC Ltd. produced 9,800 units, and incurred actual overhead of $49,500. The actual direct materials cost was $195,000, while actual direct labor cost was $98,000.

Required:

  • Calculate the standard cost per unit for direct materials, direct labor, and overhead.
  • Calculate the total standard cost per unit.
  • Prepare a standard cost card.
  • Calculate the overhead variance and the overhead cost applied.

Solution:

  • Calculation of standard cost per unit:

Direct materials cost per unit = Budgeted direct materials cost per unit = $20

Direct labor cost per unit = Budgeted direct labor cost per unit = $10

Variable overhead cost per unit = Standard overhead rate per direct labor hour * Budgeted direct labor hours per unit = $5 * 1 = $5

Fixed overhead cost per unit = Budgeted fixed overhead cost per unit = $5

Total standard cost per unit = Direct materials cost per unit + Direct labor cost per unit + Variable overhead cost per unit + Fixed overhead cost per unit

= $20 + $10 + $5 + $5 = $40

  • Calculation of total standard cost per unit:

Total standard cost per unit = Standard cost per unit * Budgeted production per year = $40 * 10,000 = $400,000

  • Preparation of standard cost card:

Direct materials: $20 per unit

Direct labor: $10 per unit

Variable overhead: $5 per unit

Fixed overhead: $5 per unit

Total: $40 per unit

  • Calculation of overhead variance and overhead cost applied:

Actual overhead = $49,500

Actual direct labor cost = $98,000

Standard overhead rate per direct labor hour = $5

Budgeted direct labor hours = Budgeted production * Budgeted direct labor hours per unit = 10,000 * 1 = 10,000 hours

Overhead cost applied = Standard overhead rate per direct labor hour * Actual direct labor hours

= $5 * 9,800 = $49,000

Overhead variance = Actual overhead – Overhead cost applied

= $49,500 – $49,000 = $500 (favorable)

The favorable variance suggests that the company’s actual overhead cost was less than the overhead cost applied based on the standard rate.

Setting of Standard

Standard costing is a method of accounting that uses standard costs and variances to evaluate performance and control costs. In standard costing, a standard is set for each cost element, such as direct materials, direct labor, and overhead. The standard represents the expected cost for a unit of product or service, based on historical data or estimates.

Setting standards in standard costing is an important process that allows businesses to control costs and evaluate performance. By setting standards for each cost element, businesses can compare actual costs to expected costs and identify variances. Variances may be favorable (actual costs are lower than expected) or unfavorable (actual costs are higher than expected), and can provide insights into areas where cost control measures may be necessary. By analyzing variances and taking corrective action, businesses can improve their performance and profitability.

Steps in setting standards in Standard Costing:

  • Identify cost elements:

The first step in setting standards is to identify the cost elements that will be included in the standard cost. This typically includes direct materials, direct labor, and overhead.

  • Determine standard quantity and price:

For each cost element, the standard quantity and price are determined. The standard quantity is the amount of a cost element that is required to produce one unit of product or service, while the standard price is the expected cost per unit of the cost element.

  • Establish standard costs:

The standard cost for each cost element is calculated by multiplying the standard quantity by the standard price. For example, if the standard quantity for direct materials is 2 pounds per unit and the standard price is $5 per pound, the standard cost for direct materials is $10 per unit.

  • Review and update standards:

Standards should be reviewed and updated regularly to ensure they remain accurate and relevant. This includes considering changes in market conditions, technology, and production processes that may affect costs.

Applications of Standard Costing:

  • Budgeting and Forecasting:

Standard costing is integral to the budgeting process, providing a basis for estimating future costs. It helps management forecast the costs of materials, labor, and overheads, which allows for better financial planning and resource allocation. By using standard costs, companies can predict profitability and set realistic financial goals for the upcoming periods.

  • Cost Control:

One of the primary applications of standard costing is in cost control. By comparing actual costs with standard costs, management can identify variances and investigate their causes. Favorable variances indicate cost savings, while unfavorable variances signal inefficiencies or wastage. This helps managers take corrective actions to maintain cost efficiency.

  • Performance Evaluation:

Standard costing helps in evaluating the performance of departments, cost centers, and employees. Managers can assess whether workers and departments are operating efficiently by comparing actual performance with standards. Variances provide insight into areas where performance may need improvement, and they can also be used to reward or penalize employees based on their contributions to cost management.

  • Inventory Valuation:

Standard costs are often used to value inventories in the balance sheet. This simplifies the process of determining the cost of goods sold (COGS) and ending inventory, as actual costs do not need to be tracked continuously. Inventory is recorded at standard cost, and any variances are recognized separately, improving financial reporting efficiency.

  • Pricing Decisions:

Standard costing helps in setting competitive yet profitable prices. By having a clear understanding of the standard cost of producing goods or delivering services, businesses can make informed pricing decisions that cover costs while maintaining profitability. Standard costs provide a baseline for determining the minimum price at which a product should be sold.

  • Variance Analysis:

One of the most significant applications of standard costing is variance analysis. Variances between actual and standard costs are analyzed to understand deviations in material usage, labor efficiency, and overheads. This analysis helps management pinpoint problem areas and make informed decisions to improve efficiency and reduce costs.

  • Motivation and Benchmarking:

Standard costs serve as benchmarks that motivate employees and departments to achieve cost efficiency. When realistic and attainable, standard costs create targets that guide operational activities. Employees strive to meet or beat these standards, driving productivity and cost-saving initiatives across the organization.

Management Notes

Labour Variance

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Direct labour variances arise when actual labour costs are different from standard labour costs. In analysis of labour costs, the emphasis is on labour rates and labour hours.

Labour variances constitute the following:

Labour Cost Variance:

Labour cost variance denotes the difference between the actual direct wages paid and the standard direct wages specified for the output achieved.

This variance is calculated by using the following formula:

Labour cost variance = (AH x AR) – (SH x SR)

Where:

AH = Actual hours

AR = Actual rate 

SH = Standard hours

SR = Standard rate

Labour Efficiency Variance:

The calculation of labour efficiency or usage variance follows the same pattern as the computa­tion of materials usage variance. Labour efficiency variance occurs when labour operations are more efficient or less efficient than standard performance. If actual direct labour hours required to complete a job differ from the number of standard hours specified, a labour efficiency variance results; it is the difference between actual hours expended and standard labour hours specified multiplied by the stand­ard labour rate per hour.

Labour efficiency variance is computed by applying the following formula:

Labour efficiency variance = (Actual hours – Standard hours for the actual output) x Std. rate per hour.

Assume the following data:

Standard labour hour per unit = 5 hr

Standard labour rate per hour = Rs 30

Units completed = 1,000

Labour cost recorded = 5,050 hrs @ Rs 35

Labour efficiency variance = (5,050-5,000) x Rs 30 = Rs 1,500 (unfavourable) It may be noted that the standard labour hour rate and not the actual rate is used in computing labour efficiency variance. If quantity variances are calculated, changes in prices/rates are excluded, and when price variances are calculated, standard quantities are ignored.

(i) Labour Mix Variance:

Labour mix variance is computed in the same manner as materials mix variance. Manufacturing or completing a job requires different types or grades of workers and production will be complete if labour is mixed according to standard proportion. Standard labour mix may not be adhered to under some circumstances and substitution will have to be made. There may be changes in the wage rates of some workers; there may be a need to use more skilled or expensive types of labour, e.g., employ­ment of men instead of women; sometimes workers and operators may be absent.

These lead to the emergence of a labour mix variance which is calculated by using the following formula:

Labour mix variance = (Actual labour mix – Revised standard labour mix in terms of actual total hours) x Standard rate per hour

(ii) Labour Yield Variance:

The final product cost contains not only material cost but also labour cost. Therefore, gain or loss (higher or lower output than the standard output) should take into account labour yield variance also. A lower output simply means that final output does not correspond with the production units that should have been produced from the hours expended on the inputs.

It can be computed by ap­plying the following formula:

Labour yield variance = (Actual output – Standard output based on actual hours) x Av. Std. Labour Rate per unit of output.

Or

Labour yield variance = (Actual loss – Standard loss on actual hours) x Average standard labour rate per unit of output

Labour yield variance is also known as labour efficiency sub-variance which is computed in terms of inputs, i.e., standard labour hours and revised labour hours mix (in terms of actual hours).

Labour efficiency sub-variance is computed by using the following formula:

Labour efficiency sub-variance = (Revised standard mix – standard mix) x Standard rate

Labour Rate Variance:

Labour rate variance is computed in the same manner as materials price variance. When actual direct labour hour rates differ from standard rates, the result is a labour rate variance. It is that portion of the direct wages variance which is due to the difference between actual rate paid and standard rate of pay specified.

The formula for its calculation is:

Labour rate variance = (Actual rate – Standard rate) x Actual hours

Using data from the example given above, the labour rate variance is Rs 25,250, i.e.,

Labour rate variance = (35 – 30) x 5050 hours = 5 x 5050 = Rs 25,250 (unfavourable)

The number of actual hours worked is used in place of the number of the standard hours speci­fied because the objective is to know the cost difference due to change in labour hour rates, and not hours worked. Favourable rate variances arise whenever actual rates are less than standard rates; unfavourable variances occur when actual rates exceed standard rates.

Idle Time Variance:

Idle time variance occurs when workers are not able to do the work due to some reason during the hours for which they are paid. Idle time can be divided according to causes responsible for creat­ing idle time, e.g., idle time due to breakdown, lack of materials or power failures. Idle time variance will be equivalent to the standard labour cost of the hours during which no work has been done but for which workers have been paid for unproductive time.

Management Notes

Material Variances, Material Price Variance, Material Usage Variance, Material Mix and Yield Variance

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Material variances refer to the differences between the standard cost of materials and the actual cost of materials used in production. These variances help management identify whether material costs are being controlled effectively and determine the reasons for deviations from standards.

A material variance may be:

  • Favourable (F): Actual cost is less than standard cost.
  • Adverse or Unfavourable (A): Actual cost is more than standard cost.

Material variance analysis is an important part of standard costing because materials generally constitute a significant portion of production costs.

Material Cost Variance (MCV)

Material Cost Variance (MCV) is the difference between the standard cost of materials that should have been incurred for actual production and the actual cost of materials consumed during production.

It measures the overall effect of differences in:

  • Material prices, and
  • Material quantities used.

Material Cost Variance is one of the most important variances in standard costing because it helps management determine whether material costs are being controlled effectively.

Definition

Material Cost Variance is the difference between:

Standard Cost of Materials – Actual Cost of Materials

This can be computed by using the following formula:

Where:

  • SQ = Standard Quantity
  • SP = Standard Price
  • AQ = Actual Quantity
  • AP = Actual Price

Alternative Formula

MCV = Material Price Variance + Material Usage Variance

or

MCV = MPV + MUV

Interpretation of MCV

Favourable Variance (F)

When:

Standard Cost > Actual Cost

This means the company spent less than expected.

Adverse or Unfavourable Variance (A)

When:

Actual Cost > Standard Cost

This means the company spent more than expected.

Example 1

Standard Data

  • Standard Quantity = 100 kg
  • Standard Price = ₹20 per kg

Standard Cost:

100 × 20 = ₹2,000

Actual Data

  • Actual Quantity = 110 kg
  • Actual Price = ₹22 per kg

Actual Cost:

110 × 22 = ₹2,420

Material Cost Variance

MCV = ₹2,000 − ₹2,420

Thus, the company incurred an Adverse Material Cost Variance of ₹420.

Example 2

Standard Data

  • Standard Quantity = 500 kg
  • Standard Price = ₹15 per kg

Standard Cost:

500 × 15 = ₹7,500

Actual Data

  • Actual Quantity = 480 kg
  • Actual Price = ₹14 per kg

Actual Cost:

480 × 14 = ₹6,720

Material Cost Variance

MCV = ₹7,500 − ₹6,720

Thus, the company earned a Favourable Material Cost Variance of ₹780.

Material Usage Variance

The material quantity or usage variance results when actual quantities of raw materials used in production differ from standard quantities that should have been used to produce the output achieved. It is that portion of the direct materials cost variance which is due to the difference between the actual quantity used and standard quantity specified.

As a formula, this variance is shown as:

Materials quantity variance = (Actual Quantity – Standard Quantity) x Standard Price

A material usage variance is favourable when the total actual quantity of direct materials used is less than the total standard quantity allowed for the actual output.

Causes of Favourable Material Cost Variance

  • Purchase of materials at lower prices.
  • Efficient use of materials.
  • Reduction in material wastage.
  • Bulk purchase discounts.
  • Better purchasing policies.
  • Improved production methods.
  • Efficient supervision.
  • Use of substitute materials at lower costs.

Causes of Adverse Material Cost Variance

  • Increase in market prices.
  • Excessive material consumption.
  • Poor quality materials.
  • Inefficient labour.
  • Machine breakdowns.
  • Production defects.
  • Failure to obtain discounts.
  • Material theft or wastage.

Importance of Material Cost Variance

  • Helps control material costs.
  • Measures purchasing efficiency.
  • Evaluates production efficiency.
  • Identifies wastage and losses.
  • Improves resource utilization.
  • Assists managerial decision-making.
  • Facilitates cost reduction.
  • Strengthens budgetary control.
  • Improves profitability.
  • Supports performance evaluation.

Material Mix Variance

Material Mix Variance (MMV) is the portion of Material Usage Variance that arises because the actual proportion of materials used differs from the standard proportion or mix.

It is applicable when two or more materials are mixed together to produce a finished product. If the actual combination of materials differs from the standard combination, a material mix variance occurs.

Material Mix Variance helps management determine whether changes in the composition of materials have increased or reduced production costs.

Definition

Material Mix Variance is the difference between:

The cost of the Revised Standard Mix and the cost of the Actual Mix at standard prices.

Formula

MMV = ∑SP(RSQ−AQ)

Where:

  • SP = Standard Price
  • RSQ = Revised Standard Quantity
  • AQ = Actual Quantity

Alternative Formula

MMV = Revised Standard Cost − Actual Mix Cost at Standard Prices

Calculation of Revised Standard Quantity (RSQ)

RSQ = (Total Actual Quantity / Total Standard Quantity) × Standard Quantity of each material

Interpretation

Favourable Variance (F)

When the actual mix is cheaper or more economical than the standard mix.

Adverse Variance (A)

When the actual mix is more expensive than the standard mix.

Example

Standard Mix

Material Quantity Price per kg Cost
A 60 kg ₹10 ₹600
B 40 kg ₹20 ₹800
Total 100 kg ₹1,400

Actual Mix

Material Quantity
A 50 kg
B 50 kg
Total 100 kg

Step 1: Calculate Revised Standard Quantity

Since the total actual quantity is equal to the total standard quantity, the Revised Standard Quantity is:

Material RSQ
A 60 kg
B 40 kg

Step 2: Calculate Material Mix Variance

Material A

MMV = 10(60 − 50)

Material B

MMV = 20(40−50)

Total Material Mix Variance

MMV = ₹100(F) − ₹200(A)

Therefore, the Material Mix Variance is ₹100 Adverse.

Another Illustration

Standard Mix

Material Quantity Price
X 80 kg ₹5
Y 20 kg ₹15

Actual Mix

Material Quantity
X 70 kg
Y 30 kg

Calculation

For X:

5(80−70) = ₹50(F)

For Y:

15(20−30) = ₹150(A)

Total:

MMV=₹50(F)−₹150(A)

Causes of Material Mix Variance

1. Shortage of Materials

Certain materials may not be available, forcing the company to use substitutes.

2. Price Changes

A company may change the mix to reduce material costs.

3. Poor Quality Materials

Inferior materials may require additional quantities of other materials.

4. Change in Production Methods

Production techniques may require a different material combination.

5. Purchasing Decisions

The purchase department may buy alternative materials.

6. Technical Reasons

Engineers may recommend changes in material composition.

7. Human Errors

Incorrect mixing of materials may create variances.

8. Change in Product Specifications

Customer requirements may lead to changes in the standard mix.

Relationship with Material Usage Variance

MUV = MMV + MYV

Where:

  • MMV = Material Mix Variance
  • MYV = Material Yield Variance

Importance of Material Mix Variance

  • Helps control material composition.
  • Measures efficiency in mixing materials.
  • Identifies uneconomical material substitutions.
  • Assists in cost reduction.
  • Improves production planning.
  • Helps evaluate purchasing decisions.
  • Improves resource utilization.
  • Supports managerial decision-making.
  • Increases profitability.
  • Strengthens cost control.

Advantages of Material Mix Variance Analysis

  • Detects inefficient material combinations.
  • Improves quality control.
  • Reduces material costs.
  • Facilitates performance evaluation.
  • Improves production efficiency.
  • Helps in variance investigation.
  • Encourages economical use of materials.
  • Enhances profitability.

Limitations of Material Mix Variance

  • Applicable only where multiple materials are mixed.
  • Requires detailed records.
  • Time-consuming calculations.
  • Depends on accurate standards.
  • Ignores external market conditions.
  • Difficult in highly customized production.

Materials Yield Variance

Materials yield variance explains the remaining portion of the total materials quantity variance. It is that portion of materials usage variance which is due to the difference between the actual yield obtained and standard yield specified (in terms of actual inputs). In other words, yield variance occurs when the output of the final product does not correspond with the output that could have been obtained by using the actual inputs. In some industries like sugar, chemicals, steel, etc. actual yield may differ from expected yield based on actual input resulting into yield variance.

The total of materials mix variance and materials yield variance equals materials quantity or usage variance. When there is no materials mix variance, the materials yield variance equals the total materials quantity variance. Accordingly, mix and yield variances explain distinct parts of the total materials usage variance and are additive.

The formula for computing yield variance is as follows:

Yield Variance = (Actual yield – Standard Yield specified) x Standard cost per unit

Materials Price Variance

A materials price variance occurs when raw materials are purchased at a price different from standard price. It is that portion of the direct materials which is due to the difference between actual price paid and standard price specified and cost variance multiplied by the actual quantity. Expressed as a formula,

Materials price variance = (Actual price – Standard price) x Actual quantity

Materials price variance is un-favourable when the actual price paid exceeds the predetermined standard price. It is advisable that materials price variance should be calculated for materials purchased rather than materials used. Purchase of materials is an earlier event than the use of materials.

Therefore, a variance based on quantity purchased is basically an earlier report than a variance based on quantity actually used. This is quite beneficial from the viewpoint of performance measurement and corrective action. An early report will help the management in measuring the performance so that poor performance can be corrected or good performance can be expanded at an early date.

Recognizing material price variances at the time of purchase lets the firm carry all units of the same materials at one price—the standard cost of the material, even if the firm did not purchase all units of the materials at the same price. Using one price for the same materials facilities management control and simplifies accounting work.

If a direct materials price variance is not recorded until the materials are issued to production, the direct materials are carried on the books at their actual purchase prices. Deviations of actual purchase prices from the standard price may not be known until the direct materials are issued to production.

Management Notes

Responsibility Accounting, Functions, Process, Challenges, Responsibility Centers

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Responsibility Accounting is a management control system that assigns accountability for financial results to specific individuals or departments within an organization. Each unit or manager is responsible for the budgetary performance of their area, enabling precise tracking of revenues, costs, and overall financial outcomes. This system helps in evaluating performance by comparing actual results with budgeted figures, identifying variances, and taking corrective actions. Responsibility accounting fosters decentralized decision-making, enhances accountability, and motivates managers to optimize their areas’ financial performance. By clearly defining financial responsibilities, it ensures better control over resources and aligns departmental activities with the organization’s overall objectives, promoting efficiency and effectiveness in achieving financial goals.

Functions of Responsibility Accounting:

  • Cost Control:

Responsibility accounting aids in controlling costs by assigning specific financial responsibilities to managers, ensuring that expenditures are kept within budgeted limits. Managers are accountable for the costs incurred in their respective departments, promoting efficient resource use.

  • Performance Evaluation:

It allows for the evaluation of managerial performance based on financial outcomes. By comparing actual results with budgeted figures, organizations can assess how well managers are controlling costs and generating revenues.

  • Budget Preparation:

Responsibility accounting facilitates detailed and accurate budget preparation. Each manager is involved in creating budgets for their department, ensuring that the overall organizational budget is comprehensive and realistic.

  • Decentralized Decision-Making:

It promotes decentralized decision-making by empowering managers to make financial decisions within their areas of responsibility. This leads to quicker and more effective responses to operational challenges and opportunities.

  • Variance Analysis:

The system provides tools for variance analysis, identifying deviations between actual and budgeted performance. Understanding these variances helps in diagnosing problems, understanding their causes, and taking corrective actions.

  • Goal Alignment:

Responsibility accounting ensures that departmental goals align with the overall organizational objectives. By setting specific financial targets for each responsibility center, it promotes coherence and unity in pursuing the company’s strategic goals.

  • Motivation and Accountability:

It enhances motivation and accountability among managers and employees. Knowing they are responsible for their department’s financial performance encourages managers to work more efficiently and make prudent financial decisions, driving overall organizational success.

Process of Responsibility Accounting:

  1. Defining Responsibility Centers

  • Types of Responsibility Centers:

Identify and establish different types of responsibility centers such as cost centers, revenue centers, profit centers, and investment centers. Each center will have specific financial responsibilities.

  • Assigning Managers:

Designate managers to each responsibility center, ensuring they are accountable for the financial performance of their respective areas.

  1. Setting Financial Targets and Budgets

  • Budget Preparation:

Involve managers in the preparation of budgets for their respective centers. This ensures realistic and achievable targets.

  • SMART Objectives:

Ensure that financial targets are Specific, Measurable, Achievable, Relevant, and Time-bound (SMART).

  1. Tracking and Recording Financial Data

  • Data Collection:

Implement systems for collecting accurate and timely financial data. This includes recording revenues, costs, and other relevant financial transactions.

  • Accounting Systems:

Use robust accounting software to facilitate precise tracking and recording of financial data.

  1. Performance Measurement

  • Variance Analysis:

Regularly compare actual financial performance against the budgeted targets. Identify variances, both favorable and unfavorable, and analyze the reasons behind these differences.

  • Key Performance Indicators (KPIs):

Establish KPIs for each responsibility center to measure financial and operational performance effectively.

  1. Reporting and Communication

  • Regular Reports:

Generate periodic financial reports for each responsibility center. These reports should detail actual performance, variances, and insights into financial activities.

  • Communication Channels:

Ensure clear and open communication channels for discussing performance reports, variances, and necessary corrective actions.

  1. Analyzing and Taking Corrective Actions

  • Variance Analysis:

Perform detailed analysis to understand the causes of significant variances between actual and budgeted performance.

  • Corrective Measures:

Implement corrective actions to address unfavorable variances. This might include cost-cutting measures, process improvements, or revenue enhancement strategies.

  1. Reviewing and Revising Budgets

  • Continuous Review:

Regularly review and update budgets based on actual performance and changing conditions. Adjust financial plans to reflect new information, opportunities, or threats.

  • Feedback Loop:

Establish a feedback loop where insights from performance analysis inform future budget preparations and strategic planning.

  1. Enhancing Accountability and Motivation

  • Performance Appraisal:

Use the information gathered from responsibility accounting to conduct performance appraisals for managers. Reward and recognize managers who meet or exceed financial targets.

  • Training and Development:

Provide training and support to managers to help them understand their financial responsibilities and improve their budgeting and financial management skills.

Challenges of Responsibility Accounting:

  • Accurate Performance Measurement:

Measuring performance accurately can be difficult, especially when indirect costs and revenues need to be allocated to specific departments. Misallocation can lead to unfair evaluations and misguided decisions.

  • Goal Congruence:

Ensuring that departmental goals align with the overall organizational objectives can be challenging. Managers may focus on optimizing their own areas at the expense of the company’s broader goals.

  • Complexity in Implementation:

Setting up a responsibility accounting system can be complex and time-consuming. It requires detailed planning, consistent data collection, and robust financial systems to track and report performance effectively.

  • Resistance to Change:

Managers and employees may resist the implementation of responsibility accounting due to fear of increased scrutiny or accountability. Overcoming this resistance requires effective change management and communication.

  • Maintaining Flexibility:

While responsibility accounting promotes control, it can sometimes lead to rigidity. Managers may become overly focused on meeting budget targets, potentially stifling innovation and flexibility in responding to unexpected opportunities or challenges.

  • Quality of Data:

The effectiveness of responsibility accounting relies heavily on the accuracy and timeliness of financial data. Poor data quality can lead to incorrect performance assessments and misguided decisions.

  • Interdepartmental Conflicts:

Responsibility accounting can sometimes lead to conflicts between departments, especially when resources are limited, or when the success of one department depends on the performance of another. These conflicts can disrupt overall organizational harmony and performance.

Responsibility Centers:

Responsibility centers are segments or units within an organization where managers are held accountable for their performance. These centers are designed to monitor performance, control costs, and ensure that goals are met in alignment with the overall business strategy. There are four main types of responsibility centers, each with specific objectives and measures of performance.

  • Cost Center

A cost center is responsible for controlling and minimizing costs, but it does not generate revenues directly. The performance of a cost center is measured based on the ability to manage expenses within budgeted limits. For example, a production department or an administrative unit may be classified as a cost center. Managers in cost centers are accountable for controlling costs and improving efficiency without concern for revenue generation.

  • Revenue Center

A revenue center is responsible for generating revenues but does not directly manage costs. The primary performance measure for a revenue center is the ability to achieve sales targets. For instance, a sales department or a retail outlet is a revenue center. Managers in revenue centers focus on increasing sales, expanding the customer base, and driving revenue growth, but they are not directly responsible for managing costs associated with the production of goods or services.

  • Profit Center

A profit center is responsible for both revenue generation and cost control, aiming to maximize profitability. It is accountable for managing both income and expenses. The performance of a profit center is typically measured based on the profit it generates, i.e., revenue minus expenses. Examples of profit centers include a branch of a retail business or a product line within a company. Profit center managers are expected to make decisions that impact both the cost and revenue sides of the business to enhance profitability.

  • Investment Center

An investment center goes a step further by being responsible for revenue, costs, and investment decisions. Managers in an investment center are accountable for generating profits as well as making decisions that affect the capital invested in the business. The performance of an investment center is often evaluated based on Return on Investment (ROI) or Economic Value Added (EVA). A division or a subsidiary of a corporation is often an investment center, where managers are responsible not only for managing revenues and costs but also for making strategic decisions regarding capital allocation.

Management Notes

Activity based Accounting

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Activity-based costing (ABC) is a methodology for more precisely allocating overhead costs by assigning them to activities. Once costs are assigned to activities, the costs can be assigned to the cost objects that use those activities. The system can be employed for the targeted reduction of overhead costs. ABC works best in complex environments, where there are many machines and products, and tangled processes that are not easy to sort out. Conversely, it is of less use in a streamlined environment where production processes are abbreviated.

The Activity Based Costing Process Flow

Activity-based costing is best explained by walking through its various steps. They are:

  1. Identify costs. The first step in ABC is to identify those costs that we want to allocate. This is the most critical step in the entire process, since we do not want to waste time with an excessively broad project scope. For example, if we want to determine the full cost of a distribution channel, we will identify advertising and warehousing costs related to that channel, but will ignore research costs, since they are related to products, not channels.
  2. Load secondary cost pools. Create cost pools for those costs incurred to provide services to other parts of the company, rather than directly supporting a company’s products or services. The contents of secondary cost pools typically include computer services and administrative salaries, and similar costs. These costs are later allocated to other cost pools that more directly relate to products and services. There may be several of these secondary cost pools, depending upon the nature of the costs and how they will be allocated.
  3. Load primary cost pools. Create a set of cost pools for those costs more closely aligned with the production of goods or services. It is very common to have separate cost pools for each product line, since costs tend to occur at this level. Such costs can include research and development, advertising, procurement, and distribution. Similarly, you might consider creating cost pools for each distribution channel, or for each facility. If production batches are of greatly varying lengths, then consider creating cost pools at the batch level, so that you can adequately assign costs based on batch size.
  4. Measure activity drivers. Use a data collection system to collect information about the activity drivers that are used to allocate the costs in secondary cost pools to primary cost pools, as well as to allocate the costs in primary cost pools to cost objects. It can be expensive to accumulate activity driver information, so use activity drivers for which information is already being collected, where possible.
  5. Allocate costs in secondary pools to primary pools. Use activity drivers to apportion the costs in the secondary cost pools to the primary cost pools.
  6. Charge costs to cost objects. Use an activity driver to allocate the contents of each primary cost pool to cost objects. There will be a separate activity driver for each cost pool. To allocate the costs, divide the total cost in each cost pool by the total amount of activity in the activity driver, to establish the cost per unit of activity. Then allocate the cost per unit to the cost objects, based on their use of the activity driver.
  7. Formulate reports. Convert the results of the ABC system into reports for management consumption. For example, if the system was originally designed to accumulate overhead information by geographical sales region, then report on revenues earned in each region, all direct costs, and the overhead derived from the ABC system. This gives management a full cost view of the results generated by each region.
  8. Act on the information. The most common management reaction to an ABC report is to reduce the quantity of activity drivers used by each cost object. Doing so should reduce the amount of overhead cost being used.

We have now arrived at a complete ABC allocation of overhead costs to those cost objects that deserve to be charged with overhead costs. By doing so, managers can see which activity drivers need to be reduced in order to shrink a corresponding amount of overhead cost. For example, if the cost of a single purchase order is $100, managers can focus on letting the production system automatically place purchase orders, or on using procurement cards as a way to avoid purchase orders. Either solution results in fewer purchase orders and therefore lower purchasing department costs.

Uses of Activity Based Costing

The fundamental advantage of using an ABC system is to more precisely determine how overhead is used. Once you have an ABC system, you can obtain better information about the following issues:

  • Activity costs. ABC is designed to track the cost of activities, so you can use it to see if activity costs are in line with industry standards. If not, ABC is an excellent feedback tool for measuring the ongoing cost of specific services as management focuses on cost reduction.
  • Customer profitability. Though most of the costs incurred for individual customers are simply product costs, there is also an overhead component, such as unusually high customer service levels, product return handling, and cooperative marketing agreements. An ABC system can sort through these additional overhead costs and help you determine which customers are actually earning you a reasonable profit. This analysis may result in some unprofitable customers being turned away, or more emphasis being placed on those customers who are earning the company its largest profits.
  • Distribution cost. The typical company uses a variety of distribution channels to sell its products, such as retail, Internet, distributors, and mail order catalogs. Most of the structural cost of maintaining a distribution channel is overhead, so if you can make a reasonable determination of which distribution channels are using overhead, you can make decisions to alter how distribution channels are used, or even to drop unprofitable channels.
  • Make or buy. ABC provides a comprehensive view of every cost associated with the in-house manufacture of a product, so that you can see precisely which costs will be eliminated if an item is outsourced, versus which costs will remain.
  • Margins. With proper overhead allocation from an ABC system, you can determine the margins of various products, product lines, and entire subsidiaries. This can be quite useful for determining where to position company resources to earn the largest margins.
  • Minimum price. Product pricing is really based on the price that the market will bear, but the marketing manager should know what the cost of the product is, in order to avoid selling a product that will lose a company money on every sale. ABC is very good for determining which overhead costs should be included in this minimum cost, depending upon the circumstances under which products are being sold.
  • Production facility cost. It is usually quite easy to segregate overhead costs at the plant-wide level, so you can compare the costs of production between different facilities.

Clearly, there are many valuable uses for the information provided by an ABC system. However, this information will only be available if you design the system to provide the specific set of data needed for each decision. If you install a generic ABC system and then use it for the above decisions, you may find that it does not provide the information that you need. Ultimately, the design of the system is determined by a cost-benefit analysis of which decisions you want it to assist with, and whether the cost of the system is worth the benefit of the resulting information.

Problems with Activity Based Costing

Many companies initiate ABC projects with the best of intentions, only to see a very high proportion of the projects either fail or eventually lapse into disuse. There are several reasons for these issues, which are:

  • Cost pool volume. The advantage of an ABC system is the high quality of information that it produces, but this comes at the cost of using a large number of cost pools – and the more cost pools there are, the greater the cost of managing the system. To reduce this cost, run an ongoing analysis of the cost to maintain each cost pool, in comparison to the utility of the resulting information. Doing so should keep the number of cost pools down to manageable proportions.
  • Installation time. ABC systems are notoriously difficult to install, with multi-year installations being the norm when a company attempts to install it across all product lines and facilities. For such comprehensive installations, it is difficult to maintain a high level of management and budgetary support as the months roll by without installation being completed. Success rates are much higher for smaller, more targeted ABC installations.
  • Multi-department data sources. An ABC system may require data input from multiple departments, and each of those departments may have greater priorities than the ABC system. Thus, the larger the number of departments involved in the system, the greater the risk that data inputs will fail over time. This problem can be avoided by designing the system to only need information from the most supportive managers.
  • Project basis. Many ABC projects are authorized on a project basis, so that information is only collected once; the information is useful for a company’s current operational situation, and it gradually declines in usefulness as the operational structure changes over time. Management may not authorize funding for additional ABC projects later on, so ABC tends to be “done” once and then discarded. To mitigate this issue, build as much of the ABC data collection structure into the existing accounting system, so that the cost of these projects is reduced; at a lower cost, it is more likely that additional ABC projects will be authorized in the future.
  • Reporting of unused time. When a company asks its employees to report on the time spent on various activities, they have a strong tendency to make sure that the reported amounts equal 100% of their time. However, there is a large amount of slack time in anyone’s work day that may involve breaks, administrative meetings, playing games on the Internet, and so forth. Employees usually mask these activities by apportioning more time to other activities. These inflated numbers represent misallocations of costs in the ABC system, sometimes by quite substantial amounts.
  • Separate data set. An ABC system rarely can be constructed to pull all of the information it needs directly from the general ledger. Instead, it requires a separate database that pulls in information from several sources, only one of which is existing general ledger accounts. It can be quite difficult to maintain this extra database, since it calls for significant extra staff time for which there may not be an adequate budget. The best work-around is to design the system to require the minimum amount of additional information other than that which is already available in the general ledger.
  • Targeted usage. The benefits of ABC are most apparent when cost accounting information is difficult to discern, due to the presence of multiple product lines, machines being used for the production of many products, numerous machine setups, and so forth – in other words, in complex production environments. If a company does not operate in such an environment, then it may spend a great deal of money on an ABC installation, only to find that the resulting information is not overly valuable.

The broad range of issues noted here should make it clear that ABC tends to follow a bumpy path in many organizations, with a tendency for its usefulness to decline over time. Of the problem mitigation suggestions noted here, the key point is to construct a highly targeted ABC system that produces the most critical information at a reasonable cost. If that system takes root in your company, then consider a gradual expansion, during which you only expand further if there is a clear and demonstrable benefit in doing so. The worst thing you can do is to install a large and comprehensive ABC system, since it is expensive, meets with the most resistance, and is the most likely to fail over the long term.

Management Notes

Make or Buy Decision

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Make or Buy decision is a critical strategic choice that businesses face when considering whether to manufacture a product in-house (make) or purchase it from an external supplier (buy). This decision has significant implications for cost management, quality control, production efficiency, and overall business strategy.

Factors Influencing the Make or Buy Decision:

  1. Cost Analysis:

One of the primary considerations in the make or buy decision is cost. A comprehensive cost analysis involves evaluating both direct and indirect costs associated with manufacturing in-house versus purchasing from a supplier. Key elements are:

  • Direct Costs: These include raw materials, labor, and overhead costs associated with production. Calculating the total cost of producing the item in-house helps determine if it’s more cost-effective than buying.
  • Indirect Costs: These are not directly tied to production but can affect overall costs. Examples include administrative expenses, equipment depreciation, and maintenance costs.

To compare costs effectively, businesses often use the following formula:

Total Cost of Making = Direct Costs + Indirect Costs

If the total cost of making is lower than the purchase price from suppliers, it may be beneficial to produce in-house.

  1. Quality Control:

Quality is another crucial factor in the make or buy decision. Companies must assess whether they can maintain the desired quality standards if they choose to make the product in-house.

  • Quality Assurance: In-house production allows companies to have greater control over quality assurance processes, ensuring that products meet specifications and standards.
  • Supplier Quality: If opting to buy, it’s essential to evaluate the supplier’s reputation and reliability. A supplier with a history of delivering high-quality products can mitigate quality concerns.

  1. Production Capacity:

The current production capacity of the organization plays a significant role in the make or buy decision. Factors to consider:

  • Existing Capacity: If the company has excess capacity, it may make sense to manufacture the product in-house. Conversely, if facilities are at full capacity, outsourcing may be necessary to meet demand.
  • Flexibility: In-house production offers greater flexibility to adapt to changes in demand or production specifications. This adaptability can be crucial in industries with fluctuating market conditions.

  1. Strategic Focus:

Companies should also consider their long-term strategic goals. The make or buy decision should align with the organization’s core competencies and strategic objectives. Considerations are:

  • Core Competency: If the product is central to the company’s core business and aligns with its strengths, making it in-house may be preferable. For example, a tech company may choose to manufacture its components to maintain control over innovation and quality.
  • Non-Core Activities: Conversely, if the product is not central to the company’s operations, outsourcing may allow management to focus on core activities. For example, a restaurant chain might outsource packaging supplies to concentrate on food quality and service.

  1. Supply Chain Considerations:

The reliability and efficiency of the supply chain also influence the decision. Factors to evaluate:

  • Lead Times: Consider the time required to manufacture versus the lead time for purchasing from a supplier. Long lead times may warrant in-house production to meet customer demands promptly.
  • Supplier Dependability: Assessing the supplier’s ability to deliver consistently and on time is crucial. If suppliers are unreliable, in-house production may be the safer option.

Decision-Making Process:

  • Cost-Benefit Analysis:

Conduct a thorough cost-benefit analysis, considering all relevant costs associated with both making and buying.

  • Risk Assessment:

Evaluate the risks associated with each option, including quality risks, supply chain risks, and potential impacts on operational efficiency.

  • Long-Term Implications:

Consider the long-term implications of the decision on the organization’s strategy, market position, and operational capabilities.

  • Stakeholder Involvement:

Engage relevant stakeholders, including production teams, finance, and procurement, to gather insights and perspectives on the decision.

  • Trial Period:

If feasible, consider conducting a trial period to test the viability of either option before making a long-term commitment.

Decision-Making Points

The results of the quantitative analysis may be sufficient to make a determination based on the approach that is more cost-effective. At times, qualitative analysis addresses any concerns a company cannot measure specifically.

Factors that may influence a firm’s decision to buy a part rather than produce it internally include a lack of in-house expertise, small volume requirements, a desire for multiple sourcing and the fact that the item may not be critical to the firm’s strategy. A company may give additional consideration if the firm has the opportunity to work with a company that has previously provided outsourced services successfully and can sustain a long-term relationship.

Similarly, factors that may tilt a firm toward making an item in-house include existing idle production capacity, better quality control or proprietary technology that needs to be protected. A company may also consider concerns regarding the reliability of the supplier, especially if the product in question is critical to normal business operations. The firm should also consider whether the supplier can offer the desired long-term arrangement.

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Objective of Make and Buy Decision:

  • Cost Efficiency:

One of the primary objectives is to achieve cost savings. By comparing the total cost of manufacturing a product in-house versus purchasing it from an external supplier, businesses aim to minimize expenses. The goal is to identify the option that provides the best financial outcome.

  • Quality Control:

Ensuring product quality is essential for maintaining customer satisfaction and brand reputation. Companies often choose to make products in-house to exert greater control over quality assurance processes. This objective focuses on delivering products that meet or exceed quality standards.

  • Resource Optimization:

The make or buy decision seeks to optimize the allocation of resources, including labor, materials, and production facilities. Businesses aim to use their resources efficiently, ensuring that they are directed toward the most profitable and strategic activities.

  • Flexibility and Responsiveness:

In today’s dynamic market, flexibility is crucial. The decision allows companies to assess whether in-house production can provide the agility needed to respond to changes in consumer demand or market conditions more rapidly than relying on external suppliers.

  • Strategic Focus:

Companies often evaluate whether the product is core to their business strategy. If it aligns with their strengths and competitive advantage, the objective is to make the product in-house, allowing the company to focus on its strategic priorities.

  • Supply Chain Reliability:

A key objective is to ensure a reliable supply chain. Businesses evaluate the dependability of suppliers and their ability to deliver products on time. If external suppliers are unreliable, the objective may shift toward in-house production to mitigate risks associated with delays and disruptions.

Management Notes

Fixation of Selling Price

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Fixation of selling price of a product is, no doubt, one of the most significant factors in modern management.

It becomes necessary for various purposes, like, under normal circumstances of the interest; at trade depression, accepting additional order etc.

Under normal conditions, according to Financial Accounting technique, the selling price of the product must cover the total cost plus a certain margin of profit. But, under Marginal Costing technique, the price must equal the marginal cost plus a certain amount which depends on the nature, variety, demand and supply, policy pricing and other related factors.

Needless to mention that, if the selling price of the product is fixed at Marginal Cost, the amount of loss will be the amount of fixed overheads and the amount of loss will be same or lower if the production is suspended or closed down.

That is why selling in all the periods/loss must be higher than Marginal Cost. In this regard we should remember that it would be easier for us if profitability of a product is known while fixation of selling price.

Illustration:

X Ltd. has an average P/V ratio of 50%. The Marginal Cost of a product is estimated at Rs. 30. What will be the amount of selling price?

Solution:

If selling price is Rs. 100, Variable Cost will be Rs. 50 i.e., contribution will be Rs. 50.

Thus, P/V Ratio = C/S = Rs. 50/Rs.100 = ½ or 50%

So, the selling price which have a marginal cost of Rs. 60 should be:

100 /50 x Rs. 30 = Rs. 60

Alternatively

P/V Ratio = S – V/S

or,.

Variable Cost/Sales = 50/100

Selling Price will be = Variable Cost/sales = Rs. 30/50%= Rs. 60

Management Notes

Functions of Management Accounting

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Management accounting involves collecting, analyzing, and reporting information about the operations and finances of a business. These reports are generally directed to the managers of a business, rather than to any external entities, such as shareholders or lenders. The functions of management accounting include:

  • Margin Analysis: Determining the amount of profit or cash flow that a business generates from a specific product, product line, customer, store, or region.
  • Break even Analysis: Calculating the mix of contribution margin and unit volume at which a business exactly breaks even, which is useful for determining price points for products and services.
  • Constraint Analysis: Understanding where the primary bottlenecks are in a company, and how they impact the ability of the business to earn revenues and profits.
  • Target Costing: Assisting in the design of new products by accumulating the costs of new designs, comparing them to target cost levels, and reporting this information to management.
  • Inventory Valuation: Determining the direct costs of cost of goods sold and inventory items, as well as allocating overhead costs to these items.
  • Trend Analysis: Reviewing the trend line of various costs incurred to see if there are any unusual variances from the long-term pattern, and reporting the reasons for these changes to management.
  • Transaction Analysis: After spotting a variance through trend analysis, a person engaged in managerial accounting might dive deeper into the underlying information and examine individual transactions, in order to understand exactly what caused the variance. This information is then aggregated into a report to management.
  • Capital Budgeting Analysis: Examining proposals to acquire fixed assets, both to determine if they are needed, and what the appropriate form of financing may be with which to acquire them.
Management Notes

Installation of Management Accounting System

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  1. Preparation of Organization Manual

The organization manual contains the duties, powers, scope and responsibilities of each executive in an organization. Moreover, it indicates the means and line of communication between the executives. This prevents the overlapping of functions.

  1. Appointment and Training of Employees

Right candidates should be appointed and suitable training should be provided to them. If so, they can perform their work independently very effectively.

  1. Preparation of Various Forms and Reports

The top management can design various forms and decide the contents of reports according to the needs of managerial decision making. The main objective of preparing various forms and reports is avoiding “Bureaucratization”.

  1. Classification and Codification of Accounts

The financial accounting information is classified and codified for effective analysis and interpretation. The accounts are classified on the basis of nature of accounts. The codification accounts facilitate for easy identification of accounts.

  1. Setting up of Cost Centres

There is a need of setting up of cost centre, profit centre, investment centre and budget centre. If so, only relevant information is collected and analysed in relation to each of them.

  1. Integration of Cost and Financial Data

Both cost accounting data and financial accounting data are used in the management accounting. Hence, there is a need of suitable system to integrate both cost accounts and financial accounts. It avoids duplication of data. The integration system should be accurate and reliable.

  1. Introducing Management Accounting Techniques

The needs of one business organization is differing from another. The top management can introduce various management accounting techniques on the needs of organization and practicability.

  1. Setting up of Budgetary Control System

Every organization should prepare the budgets in order to achieve its objectives economically and efficiently. Hence, the management should establish suitable budgetary control system. Moreover, the proposed system should be flexible and accommodate the changes in future.

  1. Using of Operations Research Techniques

Every business is running under fast changing economic, political and social environment. Everyday number of new types of problems may be encountered by the management. The Operations Research Techniques are highly useful to cope with the emerging problems.

  1. Formulating Standard Costing Techniques

The top management can fix the standard for every business activity relating to cost and revenue. If so, the actual performance can be used to measure the deviations from the standard. Thus, standards are fixed at all levels. The standard should be one which can be adopted by a normal employee.

Management Notes

Limitations of Management Accounting

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Management accounting is an important tool of management. Hence, it serves the management in many ways. Even though, the management accounting has some limitations or disadvantages. They are briefly explained below:

Limitations or disadvantages of management accounting

  1. Based on Financial and Cost Records

Both financial and cost accounting information are used in the management accounting system. The accuracy and validity of management account is largely based on the accuracy if financial and cost records maintained. These records determine the Strength and weakness of management accounting.

  1. Personal Bias

The analysis and interpretation of financial statements are fully depending upon the capability of the analyst and interpreter. Hence, personal prejudices and bias of an individual can affect the objectivity and effectiveness of the conclusions and recommendations.

  1. Lack of Knowledge and Understanding of the Related Subjects

Financial accounting, cost accounting, statistics, economics, psychology and sociology are the related subjects of management accounting. The organization can derive more benefits of management accounting if the management accountant has thorough knowledge over related subjects. If not so, the success of management accounting system is questionable.

  1. Provides only Data

Under management accounting system, many alternatives are developed to solve a problem and submitted before the management. Out of the many alternatives available, the management can select any one of alternatives or even discard all of them. Hence, management accounting can only provide data and not prescribe any course of action.

  1. Preference to Intuitive Decision Making

Scientific decisions can be taken with the help of using management accounting techniques. But, majority of the management accountant and top level executives prefer their past experience and intuition in making business decisions. The reason is that an intuitive decision making is very simple and easy.

  1. Management Accounting is only a Tool

The management accountant is using the management accounting system as a tool to give advice and facilitate the management for decision making. The actual decisions, their implementation and follow up action are the prerogative of the management.

  1. Continuity and Participation

The decisions are taken by the management. Their implementation is vested in the hands of management accountant. The continuous efforts of management accountant and full participation of all levels of management are necessary for successful operation of management accounting system.

  1. Broad Based Scope

The scope of management accounting is very wide since it considers both monetary and non-monetary transactions of the business organization. The limited knowledge and experience of the management accountant can lead to prepare the data unreliable and undependable.

  1. Costly Installation

The cost of installation of management accounting system is very high. Hence, a small business organization can not bear the cost of such installation. Moreover, the utility of this system is restricted only to big and complex organizations.

  1. Resistance to Change

The installation of management accounting system brings some changes in the organizational set up and accounting practice. The personnel concerned may resist such changes unless they are getting confidence.

  1. Evolutionary State

Management accounting is a recent development discipline. The utility of management accounting is depend upon the intelligent interpretation of the data available for managerial use. Hence, it is presumed that the management accounting stands in evolutionary stage.

  1. Unquantifiable Variables

Management accounting seeks to interpret and evaluate an objective historical event on record in terms of money. But, in practice, the business organization is facing many problems which cannot be exposed.

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