Cost Accounting Ratios Uniform Costing PDF

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Uniform Costing

Prepared by Ramnath Natesan Iyer

Uniform costing is defined as “the use by several undertakings of the same costing system, i.e. the same basic costing methods, principles and techniques.” It is not a distinct method of cost accounting like job costing or process costing or contract costing etc. It refers to an arrangement under which several undertakings use the same costing system. Objectives of a uniform costing system (i) (ii) (iii) (iv)

To make available reliable cost data for inter-unit and inter-firm comparison. To help an individual firm/unit to evaluate its performance by comparing its operating cost data with an industry average. To identify the profitability of individual products in an industry. To reinforce confidence among the consumers that the prices of various products are fixed on the basis of reliable cost data.

Scope of a Uniform Costing system Uniform costing system can be adopted by different manufacturing units or branches of an undertaking and different concerns which are members of the same trade/business association and industries which are similar in nature. It is of utmost importance to compare the performance of various units and without the adoption of a uniform costing system a meaningful comparison will not be possible. The members of various trade associations share their experiences as to the operating efficiency which also necessitates the adoption of a uniform costing system. It also facilitates the submission of cost data to various Government agencies including price fixing agencies. Thus, wherever there is a need to compare the performance of various units/firms or to maintain data bank for common use by various units/firms a uniform costing system must be adopted by such units/firms which shall make use of the data. Factors to be covered under a Uniform Costing System There is nothing like a generally accepted scope of a uniform costing system. No costing system can fit into every situation because of various causes explained below. Therefore , there cannot be uniformity in all respects of cost accounting principles, methods and techniques to be used by member units/firms. The level of uniformity depends upon the purpose of installing the uniform costing system. For example, if the purpose is fixation of common prices, uniformity in determining product cost would be sufficient. If the purpose is to compare the operating efficiency of various cost centers the scope

of uniformity would be much wider. Though the exact level of uniformity varies, the installation of any uniform costing system requires uniformity usually in the following areas (i) (ii) (iii) (iv) (v) (vi)

(vii) (viii) (ix) (x) (xi) (xii) (xiii) (xiv) (xv) (xvi) (xvii) (xviii)

Method of costing to be applied Technique of costing (such as standard costing, historical costing ) to be employed Accounting classification including codification Definition of cost centers The cost unit to be adopted Methods of defining the various elements of cost ,i.e. direct material, direct labour, direct expenses, manufacturing overhead, selling overhead, distribution overhead, administrative overhead Method of recovering depreciation Method of allocation/apportionment and absorption of manufacturing overhead Method of applying administrative, selling and distribution overhead Method of accounting of research and development expenses Methods of inventory control, including pricing and valuation of materials Accounting of spoilage, defective work, scrap and wastage The method of valuation of work-in-progress The method of remunerating the workers Accounting of interest on capital, notional rent of owned building Expenses to be excluded from costs The method of recording accounting data e.g. integrated, non-integrated Reports and statements for planning and control

Difficulties in adopting a uniform costing system (i)Difference in size and organizational set up In a small firm several functions are often combined by a single individual while in larger organizations a single function is divided into individual components or elements and an individual is made responsible for performing a single component/element e.g. in a small firm the chief executive looks after all the functions including manufacturing, sales, purchases and manufacturing whereas in a large organization the management is entrusted to a team of specialists drawn from various fields. The spending level of large organizations especially in the area of discretionary costs such as research and development, staff welfare expenses is higher in larger organizations as compared to that of smaller firms (ii) Difference in wage structure Wage structures, pay scales and methods of remuneration are likely to differ among organizations. These differences result in employees cost and overhead (iii)Difference in methods of production and degree of automation

Usually a product can be manufactured by using various methods of production and sometimes even from different raw materials. Obviously cost structures would definitely vary with variation in the methods of production/use of different raw materials. The degree of automation is not likely to be the same for all the units/firms and this also results in variations in the cost structure. (iv)Difference in methods and principles of cost accounting Various choices are available for accounting treatment of different cost elements and as different organizations adopt different methods, cost structures differ. Factors for successful implementation of a uniform costing system (i) (ii) (iii) (iv)

There should exist a spirit of mutual trust and co-operation and a policy of give and take among member units/firms. There should be free exchange of information, ideas and technical knowledge among all the members/units. There should be no feeling of jealousy or rivalry among the members. Well managed and larger firms should be ready to share with smaller firms the benefits of research and development and know-how.

Advantages of a uniform costing system (i) (ii) (iii) (iv) (v) (vi) (vii)

(viii) (ix)

It helps members to adopt and develop the best accounting methods and techniques known to the industry. New entrants get a readymade cost accounting system It facilitates inter-firm comparisons and thus helps members to identify the areas of weaknesses. It assists in the standardization of operations and performances in the industry It avoids cut-throat competition and helps to develop general guidelines for price fixation It provides a standard for the preparation of cost sheets and thus facilitates the settlement of claims under cost plus contracts It creates cost-consciousness among the staff of member units It facilitates the pooling of knowledge and resources and smaller units are benefitted from the knowledge acquired by well established and large units through their research and development activities It helps in furnishing realistic cost data to Government agencies and other authorities and thus ensures fair decisions from them It creates customers’ confidence that prices fixed by the industry are based on correct cost data

Limitations of Uniform costing (i)

(ii) (iii) (iv)

If the differences among the member units are so wide that either these cannot be eliminated or cannot be overcome, the scope of uniform costing gets so much reduced that no significant benefit can be derived from the same. For smaller units, the benefits may not be commensurate with the cost of installing and operating the system. If due to lack of mutual trust and confidence, members tend to withhold some information on grounds of privacy or secrecy, the system loses its usefulness Uniform costing may create monopolistic conditions

Uniform Cost Manual For the successful implementation and effective management of a uniform costing system the central coordinating organization issues the uniform cost manual containing the uniform cost accounting plan agreed to by the members. The uniform cost manual serves as a formal evidence of the plan agreed upon and used as a guide book for installing and operating the uniform costing system. If members belong to the same industry and are similar in size a single manual would serve the purpose. However, if members belong to different industries or there is great disparity in sizes, it is appropriate to issue separate manuals, one for each category of members. A good manual brings out the objectives and benefits of operating a uniform costing syste and lays down the plan is such details that it can be used as a reference book in solving all problems in installation and execution of the system. The following are the main and sub-headings for a typical uniform cost manual . 1. Introduction Statement of objectives and the purpose of the system Scope of the system Advantages to be derived from the system Educating the management, executives and cost accountants to appreciate the system The extent of co-operation desired for effective operation of the system 2. Organization Organization for developing and operating the system: stages in which the system is to be introduced Management of the central coordinating organization 3. Accounting System General accounting principles

Accounting terminology Account headings Code structure Accounting period Method of reconciliation between financial and cost accounts 4. Cost Accounting system Cost unit Classification of cost centers Methods of cost accounting Labour accounting Items to be excluded from cost Allocation, apportionment, re-apportionment and absorption of manufacturing overhead Accounting of administrative overhead Accounting of selling and distribution overhead Accounting of research and development expenses Method of book-keeping 5. Presentation of information Forms and contents of reports and statements Periodicity of reports Cost statement Cost and other financial ratios Supplementary information 6. Miscellaneous

Inter-Firm Comparison

Inter-firm comparison is the technique of identifying the strengths and weaknesses of a firm by comparing the performance, efficiencies, costs and profits of various firms in a particular industry. Though budgetary control and standard costing systems are useful and effective tools for planning and control, yet, they often fail to throw light on areas of potential improvements and potential weaknesses. Inter-firm comparison makes up for these shortcomings of any control system operating within the organization. Procedure involved in inter-firm comparison 1. A central coordinating organization collates, analyses and interprets data collected from various participating organizations 2. The management of various participating organizations is provided with information which enables them to determine the efficiency being achieved by comparing the performance of participating firms. 3. Weaknesses are highlighted by bringing out the possible causes of variation in results among various firms. 4. Financial and cost ratios are used extensively. Purpose of inter-firm comparison The purpose of inter-firm comparison is improvement in efficiency. Management of businesses are sometimes vexed with questions such as whether the profit is adequate, how efficient is marketing and how efficient is production. Inter-firm comparison attempts to provide answers to these questions. By comparing its own return on capital employed with the industry average and also with the figures of other participating firms the management of a firm gets an idea whether the profit earned by the firm is adequate. If the profit is inadequate a comparison of other supplementary ratios provides an insight into the weaknesses and enables the management to take appropriate action for removing them. Similarly, the management of a firm objectively evaluates its own performance in different areas of operation (e.g. sales, production) by comparing various financial and cost ratios of the firm with those of other participating firms. Thus, the purpose of inter-firm comparison is to provide a device which assists the management of a firm in evaluating the performance and also in identifying the weaknesses and the strengths so that appropriate actions can be taken to improve its performance. Management ratios that may be used for inter-firm comparison 1. Return on Assets (%)= Operating Profit/operating Assets X 100 2. Profit margin to Sales(%)= Operating Profit/Sales X 100

3. Turnover of assets (times per year)= Sales/ Assets This ratio may be further analysed as under (a) General asset utilization ratios (times per year) (i) Sales per Fixed Assets . This can be further analysed as under Fixed Asset utilization ratio (Sales per rupee of the asset (I)Sales/Building (II) Sales/Plant and Machinery (III) Sales/other Assets (ii) Sales per Current Assets This ratio can be further analysed as follows(Sales per rupee of the asset) (I) Cost of Sales /Materials stock (II) Cost of Sales/Work-in-progress (III) Cost of Sales/Finished Goods (IV) Cost of Sales/Debtors 4. Operating costs as a percentage of Sales This can be further analysed into each operating cost as a % of Sales such as (I) Production cost (II) Administration cost (III) Direct Material cost (IV) Direct Labour cost (V) Other production cost 5. Value added (I) Per Rupee of sale (II) Per Rupee of operating asset (III) Per employee

Advantages of inter-firm comparison 1.Weakness are revealed and this leads to remedial action 2. The general trend of sales, profit or cost of production in the industry is revealed 3.It provides a stimulus for self -evaluation 4.The central organization selects and reports only the selected key ratios.This saves management time and helps each firm to concentrate only on weak spots 5. Specialized knowledge and experience of the central organization are at the disposal of the participating firms. Statistics, knowledge and experience possessed by the central organizationare used for a correct interpretation of the results. 6. Participating firms provide data on a voluntary basis using standard definitions and therefore, the data so provided are better comparable than figures in published annual accounts

7.It provides signals of sickness of an individual firm and the industry in general. Thus it helps to draw Government attention towards the impending sickness of the industry. Limitations of inter-firm comparison Ratios lose their significance if participating firms widely differ in size, method of production etc. Under such situations ratios are likely to be misused as the ratios without understanding what they reflect would lead to misleading results....