cma final project group 2 section 2

8/3/2019 Cma Final Project Group 2 Section 2

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.University of Engineering and Technology

Costing System Analysis & Proposal

Crescent Textile Mills, Faisalabad

Submitted to: Sir Ali Shan

Prepared by:

Iqra Saeed (91)

Rai Zaman (61)

Asjad Ahmad (65)

Zunairah J. Khan (77)


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Abstract

Cost management is a labor some task for companies. Cutting down the cost means having

bigger profit margins. The pricing strategy of products of a company depends on a lot ofexternal factors too. So the only thing left to increase the profit margins is by handling theinternal factors. Cost management techniques have gone through a lot of transformation. And itcant be said that which system is the best one.

For our semester project we had to study the costing system of a manufacturing firm. Find thecost drivers in that system. And then suggest a better system on basis of the problem they arefacing in the current system. Strategic cost management is deliberate decision-making aimed ataligning the firm's cost structure with its strategy and optimizing the enactment of the strategy.Alignment and optimization must comprehend the full value chain and all stakeholders to ensurelong run sustainable profits for the firm. Strategic cost management takes two forms: structuralcost management, which employs tools of organizational design, product design and process

design to build a cost structure that is coherent with strategy; and executional costmanagement, which employs various measurement and analysis tools (e.g., variance analysis,analysis of cost drivers) to evaluate cost performance.

In this report we discussed in detail the concept of what a costing system is. How it is managedunder different conditions. What is the costing system at the firm that we will be studying andthe problems using that costing system? Keeping in mind the nature of their operations and theproblems they are facing We also suggested an alternative costing system which according toour understanding would help them in a better manner.

We studied the Costing system of Crescent Textile Mills for our project. The objective of ourresearch was to try to address among many others following questions to Crescent Textile Mills

regarding activity costing system being used:

a) To understand the available costing strategies and systems of Crescent Textile Millsand what system they prefers the most.

b) To understand if using a costing system appears to be expensive and it causes aproblem in manufacturing, then how Crescent Textile Mills overcome the problem.

c) To know which method Crescent Textile Mills is using for disposing of under-applied andover-applied overhead.


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Attestation

We understand the nature of plagiarism, and I am aware of the Universitys policy on this

I certify that this project reports original work by me during my University project except for thefollowing:

The history and detail of costing systems used in world

Signature Date 07-01-12


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Acknowledgements

We like to thank ALLAH for giving us the strength to complete our assigned task on time. Welike to thank our instructor for the course of MANAGERIAL AND COST ACCOUNTING Mr . AliShan for not only teaching us the course in an efficient manner but also applying thoseconcepts in a real world environment. Also we are thankful to the management of CRESCENTTEXTILE MILLS Specifically the Accounts Departmentfor not only letting us study there costingsystem but also helping us in understanding there operations so we can get the knowledge ofthe problems they face. And Also to Mr . Asad Ullah (owner Crescent Textile Mills ) forfacilitating us in the study of his company .


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Table of Contents

Chapter 1

Introduction to Costing System: Purpose, Application, Methods 6

Costing System 7

The Five Parts of a Cost Accounting System 8

Chapter 2

Costing System: Crescent Textile Mills 14

Introduction, Scope, Objective 15

Costing Method 16

Budgeting 18

Chapter 3

Proposed Costing System : Crescent Textile Mills 21

Implementation of ABC costing system 23

Advantages of Activity Based Costing 26

CHAPTER 4

Environmental Cost Management Issues 29

REFRENCES 31


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Chapter 1

Introduction To Costing System:

Purpose, Application, Methods


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Costing System

An accounting system established to monitor a company's costs, providing management withinformation on operations and performance.

What is the main purpose of costing system

Costing systems are components of a broader accounting system used by a given company or

organization. The main function of the costing system is to keep a focused eye on expenditures

made by the company. While the data that is collected and generated by the costing system is

also integrated into the overall accounting system, the costing approach allows for easy

extraction of the data for reports to upper management.

The information that typically is gathered by a costing system allows owners and managers to

quickly identify the current status of two key factors that are relevant to the success of the

company. Operational costs are often the foundation of the data collected by a costing system.

Here, management is able to get a snapshot of all expenditures that are directly connected with

the general operation of the organization, especially in terms of production costs.

A second important bloc of information that is retrieved with the use of a costing system is

performance cost. Here, management is able to view any and all expenditures that are related

to helping the company remains profitable, less the direct cost of operations. Expenses

associated with marketing, public relations, and sales efforts are examples of the type of

expenditures that are captured in the performance cost module.

A costing system is not intended to replace an accounting system. Instead, the systems actually

work within the broad framework of general accounting systems to extract specific data for quick

and easy analysis. By making use of a costing system, it is possible to quickly identify

expenditures that were intended to benefit the company, but are failing to do so in a significant

way. This makes it possible for owners and managers to make the necessary adjustments to

the companys working strategy and thus exercise a more responsible use of availab le

resources.

From this perspective, it can be said that regular use of a costing system can help to minimize

waste and also make it possible to direct available resources in more productive directions

rather than continuing to spend money on items that are accomplishing little or nothing for thecompany.


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The Five Parts of a Cost Accounting System

A cost accounting system requires five parts that include:

1. an input measurement basis,

2. an inventory valuation method,

3. a cost accumulation method,

4. a cost flow assumption

5. a capability of recording inventory cost flows at certain intervals.

These five parts and the alternatives under each part. Note that many possible cost accounting

systems can be designed from the various combinations of the available alternatives, although

not all of the alternatives are compatible. Selecting one part from each category provides a

basis for developing an operational definition of a specific cost accounting system.


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Input Measurement Bases:

The basis of a cost accounting system begins with the type of costs that flow into and throughthe inventory accounts. There are three alternatives including: pure historical costing, normal

historical costing and standard costing.

Pure Historical Costing:

In a pure historical cost system, only historical costs flow through the inventory accounts.

Historical costs refers to the costs that have been recorded. The term actual costs is sometimes

used instead, but the term "actual" seems to imply that there is one true cost associated with a

particular output. But determining the cost of a product, or service requires many cost

allocations, e.g., allocating the cost of fixed assets to time periods, and allocating indirect

manufacturing costs, or overhead to products. Since there are many alternative allocationmethods, (e.g., straight line or accelerated depreciation) the calculated cost of a unit of product

or service simply represents an attempt to approximate the true cost.

Normal Historical Costing:

Normal historical costing uses historical costs for direct material and direct labor, but overhead

is charged, or applied to the inventory using a predetermined overhead rate per activity

measure. Typical activity measures include direct labor hours, or direct labor costs. The amount

of factory overhead charged to the inventory is determined by multiplying the predetermined

rate by the actual quantity of the activity measure. The difference between the applied overhead

costs and the actual overhead costs represents an overhead variance.

Standard Costing:

In a standard cost system, all manufacturing costs are applied, or charged to the inventory using

standard or predetermined prices, and quantities.

Four Inventory Valuation Methods:The four inventory valuation methods that appear in Exhibit 2-1 are arranged in the order of the

amount of cost that is traced to the inventory. The throughput method involves tracing the leastamount of cost to the inventory, while the activity based method includes tracing the greatest

amount of costs to the inventory. In direct (or variable) costing, a greater amount of cost is

traced than in the throughput method, but a lesser amount than in the full absorption method.

Direct costing and full absorption costing are the traditional methods, while the throughput and

activity based methods are relatively new. These inventory valuation methods are very

important because they control the manner in which net income is determined. As we shall see


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is this chapter and subsequent chapters, the amount of net income can vary tremendously for

different inventory valuation methods. The four methods are described below.

The Throughput Method:

The throughput method was developed to complement a concept referred to as the theory of

constraints. In this method only direct material costs are charged to the inventory. All other costs

are expensed during the period. Sales, less direct material costs is referred to as throughput

which reflects how the method got its name. The throughput method does not provide proper

matching (as defined by GAAP) because all manufacturing cost, other than direct material are

expensed when incurred rather than capitalized in the inventory. Therefore, the throughput

method is not acceptable for external reporting although advocates argue that it provides many

advantages for internal reporting.

The Direct or Variable Method:

In the direct (or variable) method, only the variable manufacturing costs are capitalized, or

charged to the inventory. This method provides some advantages and some disadvantages for

internal reporting. However, it does not provide proper matching because the current fixed costs

associated with producing the inventory are charged to expense regardless of whether or not

the output is sold during the period. For this reason direct costing is not generally acceptable for

external reporting.

The Full Absorption Method:

Full absorption costing (also referred to as full costing and absorption costing) is a traditional

method where all manufacturing costs are capitalized in the inventory, i.e., charged to theinventory and become assets. This means that these costs do not become expenses until the

inventory is sold. In this way, matching is more closely approximated. All selling and

administrative costs are charged to expense. Technically, full absorption costing is required for

external reporting, although many companies apparently use something less than a pure full

absorption costing system. The full absorption method is also frequently used for internal

reporting. The second major section of this chapter compares the income statements for full

absorption costing with those used for direct costing because they are by far the dominant

methods.

The Activity Based Method:

Activity based costing is a relatively new type of procedure that can be used as an inventory

valuation method. The technique was developed to provide more accurate product costs. This

improved accuracy is accomplished by tracing costs to products through activities. In other

words, costs are traced to activities (activity costing) and then these costs are traced, in a

second stage, to the products that use the activities. Another way to express the idea is to say

that activities consume resources and products consume activities. Essentially, an attempt is

made to treat all costs as variable, recognizing that all costs vary with something, whether it is


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production volume or some non-production volume related phenomenon. Both manufacturing

costs and selling and administrative costs are traced to products in an ABC system. Note that

treating selling and administrative costs in this way is not acceptable for external reporting.

In traditional full absorption costing and direct (or variable) costing systems, indirect

manufacturing costs are allocated to products on the basis of a production volume related

measurement such as direct labor hours. Thus, the fundamental differences between traditional

systems and activity based systems are: 1) how the indirect costs are assigned (ABC uses both

production volume and non-production volume related bases) and 2) which costs are assigned

to products (in ABC systems, an attempt is made to assign all costs to products including

engineering, marketing, distribution and administrative costs, although some facility related

costs may not be assigned).

At the present time, most of the companies that use the activity based method have developed

stand alone, micro-computer based systems separate from the company's mainframe cost

accounting system used for external reporting.4 The idea is to develop more accurate product

costs than the traditional cost accounting system provides so that management can make betterstrategic decisions such as product introduction, pricing, mix and discontinuance. In these

systems, ABC is not used as an inventory valuation method. Activity based costs are not

charged to the inventory accounts. However, it is used to determine product costs once per

year, or more frequently when changes are made in the production process.

Four Cost Accumulation Methods:Cost accumulation refers to the manner in which costs are collected and identified with specific

customers, jobs, batches, orders, departments and processes. The center of attention for cost

accumulation can be individual customers, batches of products that may involve several

customers, the products produced within individual segments during a period, or the products

produced by the entire plant during a period. The companys cost accumulation method, or

methods are influenced by the type of production operation (See the Product-Process Matrix

below and the Hayes & Wheelwright summaries for more information), and the extent to which

detailed cost accounting information is needed by management.

Job Order:

In job order costing, costs are accumulated by jobs, orders, contracts, or lots. The key is that the

work is done to the customer's specifications. As a result, each job tends to be different. For

example, job order costing is used for construction projects, government contracts, shipbuilding,automobile repair, job printing, textbooks, toys, wood furniture, office machines, caskets,

machine tools, and luggage. Accumulating the cost of professional services (e.g., lawyers,

doctors and CPA's) also fall into this category.

Process:


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In process costing, costs are accumulated by departments, operations, or processes. The work

performed on each unit is standardized, or uniform where a continuous mass production or

assembly operation is involved. For example, process costing is used by companies that

produce appliances, alcoholic beverages, tires, sugar, breakfast cereals, leather, paint, coal,

textiles, lumber, candy, coke, plastics, rubber, cigarettes, shoes, typewriters, cement, gasoline,

steel, baby foods, flour, glass, men's suits, pharmaceuticals and automobiles. Process costing isalso used in meat packing and for public utility services such as water, gas and electricity.

Back Flush:

Back flush costing is a simplified cost accumulation method that is sometimes used by

companies that adopt just-in-time (JIT) production systems. However, JIT is not just a

technique, or collection of techniques. Just-in-time is a very broad philosophy, that emphasizes

simplification and continuously reducing waste in all areas of business activity. JIT systems

were developed in Japan and depend on the communitarian concepts of teamwork and

continuous improvement. In fact, many of the assumptions, attitudes and practices of

communitarian capitalism are included in the JIT philosophy.

One of the many goals of JIT systems is zero ending inventory. In a backflush cost system,

manufacturing costs are accumulated in fewer inventory accounts than when using the job order

or process cost methods. In fact, in extreme backflush systems, most of the accounting records

are eliminated. The production facilities are also arranged in self contained manufacturing cells

that are dedicated to the production of a single, or similar products. In this way more of the

manufacturing costs become direct product costs and fewer cost allocations are necessary.

Thus, more accurate costing is obtained in spite of the fact that the cost accumulation method is

simplified.

FOUR COST FLOW ASSUMPTIONSA cost flow assumption refers to how costs flow through the inventory accounts, not the flow of

work or products on a production line. This distinction is important because the flow of costs is

not always the same as the flow of work. The various types of cost flow assumptions include:

specific identification (e.g., by job), first in, first out, last in, first out and weighted average.

Costs flow through the inventory accounts by the job in a job order cost system which

represents an example of specific identification. The requirements of the various jobs

determines the timing of the cost flows. Simple jobs tend to move through the system faster

than more complex jobs. The first-in, first-out (FIFO) and weighted average cost flowassumptions are used in process costing. Since costs are accumulated by the process or

department in a process cost environment, a cost flow assumption is needed to determine the

treatment of the beginning inventory. When FIFO is used, it is assumed that the units of product

in the beginning inventory are finished first and transferred to the next department before any of

the units that are started during the period. The group of units in the beginning inventory

maintain their separate identity and prior period costs. However, when the weighted average


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cost flow assumption is used, the beginning inventory units lose their separate identity because

they are lumped together with the units of product started during the period. Process costing

tends to be fairly challenging, therefore you may find these introductory concepts to be

confusing.

Although last-in, first-out (LIFO) is frequently used for tax reporting purposes, it is not normally

used in the accounting records.

.

Recording Interval CapabilityInventory records can be maintained on a perpetual or a periodic basis. Conceptually, the

perpetual inventory method provides a company with the capability of maintaining continuous

records of the quantities of inventory and the costs flowing through the inventory accounts. The

periodic method, on the other hand, requires counting the quantity of inventory before inventory

records can be updated. In the past, manufacturers tended to keep perpetual inventories, while

retailers used the periodic method. However, today a variety of modern point of sale devices

and dedicated microcomputer software are readily available to provide any company with

perpetual inventory capability.

Objectives

The basic objective to study the costing system is to get an in depth and real life view of the

applications of cost accounting in the manufacturing sector. Also to find a better solution for the

manufacturing unit which helps it betters then the previous existing system. The costing system

is use to accumulate the costs of goods or services. The information on the cost of a product orservice is used by managers to set the prices of the product, control operations, and develop

financial statements. Also, the cost system improves control by providing information on the

costs incurred by each department or manufacturing process.


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Chapter 2

Costing System

Crescent Textile Mills


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Introduction

The company we will be choosing for this research would be Crescent Textile Mills. Crescent

Textile Mills Ltd is a Faisalabad based textile unit. The company was listed at stock exchange in

1951. The Crescent Textile Mill Ltd is engaged in the business of textile manufacturing of

spinning, weaving, dyeing, bleaching, printing, made ups and otherwise dealing in yarn and

fabrics. The Crescent Textile Mills started as a weaving unit with 500 semi auto looms. Now the

present picture of The Crescent Textile Mills is that it is the one of the largest textile units in

Pakistan.

The electricity consumed by The Crescent Textile Mills is produced by its own power

station located within the boundary of The Crescent Textile Mills Ltd. All spinning, weaving,

towel, processing and garment units are 1.1 Background and Context:

Nishat Group is one of the most affluent and diversified group in South East Asia. It has

fixed/current assets of over Rs300bn and it ranks amongst the top five business houses of

Pakistan. The group has spread its operations in key sectors like textile, cement and financial

services. Under its umbrella come Adamjee and Security General, Nishat Mills, DG Khan

cement, MCB bank, Phoenix Aviation and many more. It has a strong market share in each of

the sector it operates in and is led by a highly experienced and professional management.

The project demanded a complete analysis of the costing system of our target firm, i.e. Nishat

Mill LTD. To work upon this task, we had to plan a visit to understand the in depth working of all

the departments in the mill. We studied the cost relationship of the products being manufactured

by the firm.

Scope and Objective

Our basic objective was to understand the costing system being used in the target firm and whyare they using this costing system.

Overview

This chapter describe in detail the costing system being used by Crescent Textile Mills and the

cost drivers that are affecting the cost in production of garments, the product range of the firm

being produced in fabric processing department. Also the suggestions for competitive strategy


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cost leadership/ differentiation is given in the last chapters keeping the environmental cost

management issues in mind.

Company Profile

Crescent Textile Mills is a Faisalabad based textile unit. The company was listed at stock

exchange in 1951. Crescent Textile Mills is engaged in the business of textile manufacturing of

spinning, weaving, dyeing, bleaching, printing, made ups and otherwise dealing in yarn and

fabrics.

Flagship of large crescent group, CTMs main area of business is in textile. As a composite unit

having ISO-9002 certification on 1997, which is engaged in spinning, weaving, processing and

is one of the largest exporters of cotton yarn in Pakistan. The pioneer of Crescent Textile Mills

was Mian Muhammad Shafi, who belonged to Chinyot. Crescent Textile Mills started as aweaving unit with 500 semi auto looms. Now the present picture of Crescent Textile Mills is that

it is the one of the largest textile units in Pakistan.

Now Crescent Textile Mills has seven independent complete units of spinning, 184 weaving

sulzer looms, one separate unit of towel & one complete unit of garments. Crescent Textile Mills

has one of the largest textile-processing units with a capacity of 2.5 million meters fabric

monthly.

The electricity consumed by Crescent Textile Mills is produced by its own power station located

within the boundary of Crescent Textile Mills. All spinning, weaving, towel, processing and

garment units are located within the same boundary.

The total no of employees are more than 5000 from which 2000 employees are staff and on

permanent basis. Factory runs complete 24 hrs a day and employees work in three-day and

night shifts of 8 hours.

Crescent Textile Mills was established in 1951 as a private limited company. Crescent Textile

Mills was converted into a public limited company in 1958. The crescent group effectively

controls the company. In the context of Pakistan, Crescent Textile Mills stands out for the

composite nature of its activities. Superior quality standards with ISO 9002 certificate

management is committed to expand into the higher value added areas of industry.

Crescent Textile Mills is playing a vital role in the development of Pakistan specially by earning

a huge foreign exchange through exports. Crescent Textile Mills sells more than 80% of its

products to the foreign market. In 1992-93 & 1994, the Crescent Textile Mills was awarded the

President of Pakistan Trophy for export, given to the largest exporter from Pakistan in any

category.


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Firms Target

The target of the Crescent Textile Mills is To produce superior quality products to face

competition in the international market and to train the staff at the world-class level to enhance

the maximum shareholders value

CORPORATE OBJECTIVES

Following are some main objectives of Crescent Textile Mills:

o To arrange timely production and maintain quality goods for entire satisfaction of the

customers

o To make Crescent Textile Mills a first choice for the foreign customers by improving its

quality and services.

o To extend exports all over the world through better services.

o To establish and develop excellent working environment in the departments.

o Computerization

o Incline a sense of civic responsibility in the staff members

o To achieve companys objectives

o Implementation of ISO-9002 standards

o To provide the employees a friendly atmosphere to increase their commitment and

loyalty towards their organization.

COSTING METHODS

Costing sections currently execute the following activities,

Job order costing

Made-ups job order costing

Budgeting at company level

Stock valuation on monthly bases and reconciliation of stock

Yarn Costing

Grey Cloth Costing


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Job Order Costing:

The job order costing is made for the, Processing

Made-up

Processing Job Order Costing;

In Processing Job Order Costing the profit/loss of each order is calculated through asystem and to compare it with Export Dept. Estimation Sheet. Its process is as follows,

Grey issue to processing (daily basis reports) Processing lot card (shows the process in which fabric goes through) Export fabric cost sheet

Processed cloth job card Posting the information into computerized job order costing system

The all provided information is verified and fed into the system and the entry number isallotted to each lot card entered and gets the lot card binded from the binder and keeps thesebindings in record room for further reference. When the Job starts to process, the cost of everyprocess (, bleaching, washing, dyeing, printing, mercerizing, finishing)

Export fabric cost sheet shows the information about the grey cost, processing cost, freightcharges.

Rejection Report:

Folding department where defects are checked & identified raises processed Lot Card. Itcontains the following Forms.

Finish cloth defect report Lot entry form raised by Grey Fabric warehouse. Lot entry Forms also raised by folding. Processing Cost SheetProcessing Gain / Loss & rejection statement is raised on daily bases. make rejection report

which are more than 5% and submit it VPF and CEO on monthly basis.

Made-ups job order cost sheet:

In Processing Job Order Costing the profit/loss of each order is calculated through asystem and to compare it with Mkt. Dept. Estimation Sheet. Its processes is as follows,

Receipts of lot card from home textile Checking of fabric and accessories detail Processed fabric cost Fabric consumption is prepared Per meter rate is applied to total fabric consumed. Stitching charge & FOH calculated for the order Made-ups estimation of marketing


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Data entry, comparisons, summaries and profit/loss of the orders

Budgeting:

Budgeting is an evaluation of input (budget provide) and output (budget consumed) from

all divisions for the allocation of resources for the future operations. All production reports fromthe concerning units as spinning units, weaving unit, processing, home tex, Crescent Hattar,and power generation, profit and loss account report from the account section, stock reports,and stock position reports of raw martial, working in progress, finished goods, fabric,processing, and towel from the stock management section, local/export sale reports, cottoncess (20% charges on each bale consumption by Govt.), and preparation of reports presentedto Govt.

The documentation of this report consists on the detailed information about production,sources of production (looms, spindles etc), status of raw material (cotton, short staple, longstaple, yarn etc.), production and consumption of finished goods, sales and stocks of cloth,workers strength, and payment of cess.

Yarn costing:

Yarn costing involves the calculation of the raw material price, blending ratio and thecost of process under which raw material devour, monthly basis reports issued from spinningunit on the basis of which the cost is calculated.Parameters of the costing of yarn are as follows,

Cotton rate per mounds Cotton yield/recovery %age (82% for cotton) OPS/PPS (ounce per spindle/production per spindle) Unit wise summary of expenses Spindle Cost (per shift spindle cost) Daily spindle worked statements Packing Material items Expenses of Combing section

OPS/PPS (ounce per spindle/production per spindle) is calculated as,OPS=Total production*16 ounce*2.20461lbs/total spindlesThere are 3 components of the yarn cost,

1. Material Cost2. Manufacturing Cost3. Packing Cost

Material Cost:

It is cost of processing of yarn. It is calculated as,Material Cost= rate per mounds/37.324 kg /2.20461lbs / yield %age

Manufacturing Cost:

It is cost of convergence of raw material into finished goods. It is calculated as,M. Cost= spindle cost*16 ounce/OPS

Packing Cost:


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It is cost of packing of finished goods. It is calculated as,

Packing Cost= total expenses/ total packingThe cost of cotton is calculated in the above mentioned way while the cost of polyester iscalculate as,PC= rates per Kg/2.2 lbs /yield% age

While summing up the costs of both cotton and polyester, we calculate cost of yarn in poundsfor each count.

Grey Cloth Costing:

Grey cloth costing is to determine estimated quality wise cloth cost for decision makingon company ample basis where needed. It involves the determination of the cost of constructionof cloth, blending ratio of yarn used, and processing i.e. (Grey, bleach, dyed, and print), for thispurpose, the yarn rate, unit wise summary of expenses, loom wise/cloth wise cloth productionand yarn sizing repot month wise.There are 2 components of Grey cloth costing.

Material Cost

Conversion Cost

Material Cost:

Material cost of cloth is calculated as,

Warp weight= ends*width *1.0936

Warp*20

Weft weight = picks*width *1.0936

Weft*20

Weight per count= weft weight +warp weight/ 40mtr

Conversion Cost:

Cost per pick per meter is called the conversion cost. It is calculated as,CC=total expenses/ total loom pick productionWhere,Total loom pick production= (average pick production*total production)While,

Total expenses=salary + energy cost+ depreciation cost + FOH (factory overhead) costSo,Grey cloth cost= material cost + conversion cost


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Chapter 3

Proposed Costing System

Crescent Textile Mills


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Suggested Costing System

We suggested that Crescent Textile Mills should use activity base costing system instead ofjob order costing as by using the proposed costing system the company would be able tomonitor and pin point the cost and performance of each activity involved in the job as it isdifficult to identify the problem which may effect the cost in the costing system which is beingpractice by the company.

Overview of Activity Based Costing

An activity based costing system is designed to match overhead costs as closely as possiblewith a company's activities. By doing so, overhead costs can be reasonably associated withproducts, departments, customers, or other users of activities, which tells managers whereoverhead costs are being used within a company. This results in much better control overoverhead costs.

Activity based costing involves a two-step process where overhead costs are first assigned tothose activities that generate the overhead costs; the costs are then further allocated to thoseproducts, customers, and so forth that use the activities.

Cost Allocation Examples

There are several ways to allocate overhead costs. Some overhead costs, such as utilities, areassociated with specific machines. For example, a machine may require ten cents of electricityper minute. If so, this overhead cost can be charged out to those products that are run throughthe machine, based on the time spent being worked upon it. Other overhead costs areassociated with a specific product line, and can reasonably be allocated to the activitiesperformed within that product line. For example, there is typically a supervisor who is assignedto a single product line. If so, the fully burdened salary of this person can be charged to suchrelated activities as production and maintenance scheduling. Still other overhead costs may begrouped by commodity used in the production process. For example, each member of thepurchasing staff may be responsible for the procurement of a specific commodity. If so, thisoverhead cost can be distributed to individual products based on their usage of the commodity.Clearly, there are many valid ways to allocate overhead costs to various activities, and from

there to users of those costs. An activity based costing system creates a structured approach tothe accumulation, storage, and allocation of overhead costs using many of these activitymeasures.


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Implementation of ABC costing system:

Step 1: Review the companys financial information

Nearly all of the needed financial information can be obtained from the companys income

statement and balance sheet.

Step 2: Identify main activities

Identify the main activities describing the manufacturing and business processes of thecompany that consume operating resources or are responsible for capital investments.

Step 3: Determine operating cost for each activity

Calculate the operating cost for each activity. Costs should mirror overhead resourceconsumption by each activity.

Step 4: Select cost drivers

This step is similar for a traditional ABC implementation. Cost drivers are used to trace the costof activities to products based on their consumption rate. Thus, operating cost drivers can traceoperating costs and capital cost drivers can trace capital charges to the products.

Step 5: Calculate product cost

Operating costs and capital costs are traced to the products.

The Companys income statement and balance sheet were obtained.

Summary of Financial Results is as below:

Particulars 2011 2010 %ChangeSales revenue 14,759.257 10,863.386c 35.86Gross profit 1,364.616 1,456.742 -6.32Operating expenses 884.955 731.247 21.02

Other operatingincome

179.043 184.767 -3.10

Finance cost 527.172 566.793 -6.99Profit before tax 131.532 343.469 -61.70Taxation 99.465 118.821 -16.29Net profit after tax 32.067 224.648 -85.72Activity Categories and Activities

Activity Categories Activities


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Customer Management Contact CustomersPrepare QuotesInvoice and Collect Money

Production Planningand Preparation

Manufacturing processPlan ProductionPurchase Materials

ProductionManagement

MaterialsManage Production

Product Distribution Store Final ProductShip Final Product

Enterprise Management Develop EmployeesManage Business

To determine the operating cost, the companys income statement was analyzed to identifyoperating expenses.In this example, the cost of goods sold item represents direct expenses, such as materials,supplies, and direct labor that can be traced directly to the products.

SG&A Expenses xxxDepreciation xxxOther Operating Expenses xxxTotal Operating Cost xxx

Based on the data given in the income statement the companys total operating cost wasdetermined to be Rs.13, 394.643 million during the year 2011 and was traced to the activitiesusing Job Order Costing. Note that the sum of the cost of all activities is equal to the totaloperating cost.

Activities OperatingCost

Contact Customers XxxInvoice and Collect Money Xxx

XxxPlan Production XxxPurchase Materials XxxReceive and Handle Materials XxxManage Production XxxStore Final Product XxxShip Final Product XxxDevelop Employees XxxManage Business XxxTotal Operating Cost Xxx


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Lets add two more activities to our example: procurement and material handling. The costs ofthese two activities are not caused bynor do they correlate withmachine hours. Rather, wewill assume that both of these activities are related to the physical weight of the direct materialused in making the product.

The company determines that 30 million of its annual manufacturing overhead is associated

with procurement and material handling. As a result, the company removes 30 million from themanufacturing overhead that will be allocated via machine hours, and instead plans to allocatethe 30 million to the products based on the weight of the materials used. The company expectsthat during the year it will procure and handle 3,000,000 bulks of material. Under activity basedcosting, the company will assign approximately Rs 9 (30 million divided by 3,000,000 bulks) perbulk product weight to each unit manufactured. The end result is that the large/big products willnot only have more direct material cost, they will also be assigned more factory overhead thanthe lighter parts. By assigning some manufacturing overhead to a product based on theproducts weight, the remaining manufacturing overhead assigned via machine hours will bereduced. These points are illustrated in the following table:

ABC Costing Without ABC CostingMfg overhead costs assignedto setups

20 million 0

Number of setups 400 Not applicableMfg overhead cost persetup

40,000 0

Mfg O/H costs caused byhandling

30 million 0

Bulks of material in products 3,000,000 Not applicable

Mfg O/H costs caused byproducing the items:Total manufacturing overheadcosts

180,000,000 180,000,000

Less: Cost traced tomachine setups

200,000 0

Less: Costs traced toprocurement/handling

300,000 0

Mfg costs to be allocated onmachine hours

135,000,000 135,000,000

Machine hours (MH) 100,000 100,000Mfg overhead costs

allocated per MH

1350 1800

Mfg Overhead CostAllocations

Rs 40000 setup costper batch +Rs 9 per bulk +Rs 1350 per MH

1800


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The use of ABC will allow the managers of the textile companies to better understand and getthe true costs associated with business activities at each of its revenue and cost centres. Thesecompanies have profit centres like business and marketing department etc. These centres haveboth revenue as well as cost centres. They are therefore viable centres, which generate most ofthe revenues. An effective activity based costing system will help increase the revenue

generation of these centres. Activity based costing will also enable the managers to betterexamine their business activities that are indirectly associated with their service delivery likeinformation systems, customer support, electricity, security, marketing, transport services andmaintenance. It will thus make it easier for them to be accurate in assigning costs. They will bein a better position to assign cost for the operations of their cost centres since these centres donot bring any revenue. It will also help the managers to identify inefficient product, departmentand activity and therefore allocate more resources on profitable product, department andactivity. ABC will also help to control the cost at individual level and on departmental level and tofind unnecessary costs. The only problem is ABC has been found to be a very high-costaccounting technology. Installing an ABC system is technically complex, requiring talentedpersonnel and a considerable amount of time. Though its been argued that ABC has lost groundto alternative metrics, such as Kaplan's Balanced Scorecard and economic value added its still

widely in used. Finally it will be unwise for these companies to use full costing, because inpractice full costing tends to use past cost and to restrict its consideration of future cost tooutlay cost. It also provides a long - run relevant cost which gives information that relate only tothe narrow circumstance of the moment.

Advantages of Activity Based Costing:

There are many questions that an ABC system can answer, such as the following:

How do we increase shareholder value? When an ABC analysis is combined with areview of investment costs for various tactical or strategic options, we can determine the

return on investment to be expected for each of the investment options. How much does a distribution channel cost? An ABC system can accumulate all of

the costs associated with a particular distribution method, which allows managers tocompare this cost to the profit margins earned on sales of products that are sold throughit. You can then determine if the distribution channel should be reconfigured oreliminated in order to improve overall levels of profitability.

How do product costs vary by plant? An ABC analysis will itemize the costs of eachplant, and correctly allocate these costs to the activities conducted within them, whichallows a company to determine which plants are more efficient than others.

Should we make or buy an item? An ABC analysis includes all activity costsassociated with a manufactured item, which yields a comprehensive view of all costsassociated with it, and which can then be more easily compared to the cost of a similar

item that is purchased. What acquisition is a good one? By using internal ABC analyses to determine the

cost of various activities, a company can create a benchmark for what these costsshould be in potential acquisition targets. If the targets have higher costs than thebenchmark levels, then the acquiring company knows that it can strip out costs from theacquisition candidate by improving its processes, which may justify the cost of theacquisition.


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What does each activity cost? An ABC analysis can reveal the cost of each activitywithin an organization. The system is really designed to trace the costs of only the mostsignificant activities, but its design can be altered to itemize the costs of many moreactivities. This information can then be used to determine which activities are soexpensive that they will be the main focus of management attention, or which can beprofitably combined with other activities through processing centering. This is a primary

cost-reduction activity. What price should we charge? An ABC analysis reveals all of the costs associated

with a product, and so is useful for determining the minimum price that should becharged. However, the actual price charged may be much higher, since this may bedriven by the ability of the market to absorb a higher price, rather than the underlyingcost of a product.

What products should we sell? An ABC analysis can be combined with product pricesto yield a list of margins for each product sold. When sorted by market, product line, orcustomer, it is then easy to see which products have low or negative returns, or whichyield such low margin volume that they are not worth keeping.

Which customers do we want? An ABC analysis can itemize the costs that arespecific to each customer, such as special customer service or packaging issues, as well

as increased levels of warranty claims or product returns. When added to the marginson products sold to customers, this reveals which customers are the most profitable afterall costs are considered.


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CHAPTER 4

Environmental Cost Management Issues


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Environmental Cost Management Issues

For any companys success, it is important to keep the economic, environmental andsocial needs of the community in perspective. Therefore, Crescent is committed to full filling allkinds of ethical, Security, Health and safety and Environmental standards.Their aim is to conserve the environmental water and energy, promote reuse & recycling, andensure waste minimization and proper treatment of waste generated. Crescent has a majorinvestment in waste water treatment. They are able to do so by implementing ETP & followingthe Green Policy under the Environmental Management Policy System.For doing so, they use to bear following costs:Cost of controlling discharged content from their manufacturing unit to outside environment(wastage of chemicals used in dyeing cloths, bed sheets, curtains and cushions and poaching)= 200,000 rupees per month.Cost of controlling air pollution = 100,000 rupees per month.

Total Cost of Environmental Management Policy System = 300,000 rupees per month.

Environment management is an area of ever-increasing importance in Crescentbusiness. In an effort to reduce the burden on the environment; Crescent has made a majorinvestment in caustic recovery plants & waste water treatment,.

1. Caustic Recovery Plant:

The washing liquor from the caustifying process is purified with a self-cleaning pre-filter andthen fed into an evaporator. The caustic soda which is re-concentrated up to the necessaryconcentration is available for process reuse. The distillate which is generated by evaporation

can be reused in the washing process because of its perfect purity.The system enables a maximum recovery rate of 85% to be achieved. This not only reduces theemission of pollutants in waste water; but also provides cost savings in chemical and waterrecovery; as well as energy savings through the recovery of hot water.

2 . Waste Water Treatment Plant:

Based on the Dissolved Air Floatation System (DAF).The DAF system has the capability tohandle variations in water quality and flow. Based on a purely physical process, the DAF systemutilizes the property of micro bubble adherence to suspended solids, which increases thetendency of the solids to float. After the solids are suspended to the surface; they are skimmed

into a collecting bin. The size of the bubbles greatly affects the efficacy of the flotation process,with bubbles smaller than 100m considered the most effective.


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REFRENCES

http://www.crescenttextile.com/Finance/Half%20Yearly%20CTML%20Accounts%2031%20Mar%2005.pdf

http://learning.hccs.edu/faculty/thomas.jackson1/acct2302/managerial-accounting-chapter-exercise-

problem-solutions

http://www.productpilot.com/en/suppliers/crescent-textile-mills-ltd/products/en

http://www.aptma.org.pk/viewdetail.asp?uid=crescenttex
http://www.crescenttextile.com/Finance/Half%20Yearly%20CTML%20Accounts%2031%20Mar%2005.pdfhttp://www.crescenttextile.com/Finance/Half%20Yearly%20CTML%20Accounts%2031%20Mar%2005.pdfhttp://learning.hccs.edu/faculty/thomas.jackson1/acct2302/managerial-accounting-chapter-exercise-problem-solutionshttp://learning.hccs.edu/faculty/thomas.jackson1/acct2302/managerial-accounting-chapter-exercise-problem-solutionshttp://learning.hccs.edu/faculty/thomas.jackson1/acct2302/managerial-accounting-chapter-exercise-problem-solutionshttp://www.productpilot.com/en/suppliers/crescent-textile-mills-ltd/products/enhttp://www.productpilot.com/en/suppliers/crescent-textile-mills-ltd/products/enhttp://www.aptma.org.pk/viewdetail.asp?uid=crescenttexhttp://www.aptma.org.pk/viewdetail.asp?uid=crescenttexhttp://www.aptma.org.pk/viewdetail.asp?uid=crescenttexhttp://www.productpilot.com/en/suppliers/crescent-textile-mills-ltd/products/enhttp://learning.hccs.edu/faculty/thomas.jackson1/acct2302/managerial-accounting-chapter-exercise-problem-solutionshttp://learning.hccs.edu/faculty/thomas.jackson1/acct2302/managerial-accounting-chapter-exercise-problem-solutionshttp://www.crescenttextile.com/Finance/Half%20Yearly%20CTML%20Accounts%2031%20Mar%2005.pdf

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