Installation of Costing System

A costing system is an established set of procedures, rules, cost records, etc., for the purpose of achieving specified objective at minimum cost. It forms the basis for future operations.

All types of concerns can adopt no one single system. Each concern may design and install a system of its own depending upon its requirements.

It may establish the practice and procedure of making cost records. The need for installing a costing system should be justified by a cost-benefit analysis. The benefits expected from the costing system should more than compensate the expenses of installing and operating the system.

When a decision to install a system is taken, it should be so designed as to serve the purpose of the particular concern. It should be useful in accordance with the objectives of costing and be flexible enough to adapt itself to changing conditions.

Basic Consideration or Requisites of a Good Costing System:

1. The costing system should be simple and easy to operate. It must suit to the requirements of the concern.
2. The benefits derived from the system must more than compensate the expenses incurred in the installation and operation of the system in the organization. In short, the system should be highly economical.
3. The system should facilitate closer coordination among the various divisions in the organization.
4. The system should not disturb the existing organizational set up and if necessary, it should be introduced gradually.
5. The employees concerned should be able to understand the system without much difficulty. The purpose of costing records and reports should be clear to all.
6. There should be promptness and regularity in the preparation and presentation of cost reports.

Steps Involved in the Installation:

Before installing a costing system all care should be taken to study and analyze all aspects involved as otherwise, the system will be a misfit and its full advantage may not be derived. Special attention should be taken to collect information about the various aspects of the organization.

The size of the firm, the nature of business, the nature, method, and stages of production, the number of varieties and quantities of each product and such other technical aspects should be examined carefully. The analysis of materials and wage payment systems should be done.

Forms and records of original entry should be so designed as to involve minimum clerical work and cost. There should be facility to exercise proper control over the system and adopt efficient reporting system. The management requirements and the policy adopted by them towards cost control should be kept in view.

Some formal steps such as codification and classification, establishment of cost centers, guidelines for allocation of indirect costs, introduction of formats and periodical reports, and post installation appraisal of costing system should also be taken to operate the system more effectively.

Requisite

1. Co-operation among member units:

There should be co-operation and a policy of give and take amongst the different units in the industry which are to use uniform costing system. Without any reservations, every participating member should be willing to supply the require information to a central body appointed by themselves.

2. Spirit of sharing experience:

The bigger units should be prepared to share their experiences with the smaller concerns so that the latter may be able to improve their performances.

3. No rivalry:

There should be no rivalry or jealousy amongst the participating members.

4. Free exchange of ideas:

Ideas should be freely exchanged amongst the participating members in order to enable them to judge their efficiency with reference to other units.

5. Leveling the key factors:

Certain key factors such as methods of production, size of the organisation, methods and principles of cost accounting peculiar to individual units should tie carefully noted. These key factors will give different costs of different undertakings in the same industry which will make cost comparison difficult. Thus efforts should be made to locate the key factors which create differences. These varying factors should be levelled out by giving a weightage on an equitable basis.

6. Cost manual:

A cost manual which lays down the recommended cost accounting plan should be circulated amongst the participating members by the central body.

7. Adequate information for categorization:

Some sort of categorisation should be made both in respect of long-term and short-term differences in order to make comparison useful. To distinguish such differences, adequate qualitative and quantitative information should be available.

8. Central organization:

There should be a central organisation for the collection, co­ordination and presentation of information. The method of collection and presentation of information should be properly laid down and clearly indicated.

9. Proper explanation of the scheme:

The scheme must be properly explained to all concerned. This is necessary to convince about its utility and make all concerned to work for its success.

Characteristics of an Ideal Costing System:

An ideal system of costing is that which achieves the objectives of a costing system and brings all advantages of costing to the business. Following are the main characteristics which an ideal system of costing should possess or the points which should be taken into consideration before installing a costing system.

(i) Suitability to the Business:

A costing system should be tailor-made, practical and must be devised according to the nature, conditions, requirements and size of the business. Any system which serves the purposes of the business and supplies necessary information for running the business efficiently is an ideal system.

(ii) Simplicity:

The system of costing should be simple and plain so that it may be easily understood even by a person of average intelligence. The facts, figures and other information’s provided by cost accounting must be presented in the right form at the right time to the right person in order to make it more meaningful.

(iii) Flexibility:

The system of costing must be flexible so that it may be changed according to changed conditions and circumstances. The system without such flexibility will be outmoded because of fast changes in business and industry. Thus, the system must have the capacity of expansion or contraction without much change.

(iv) Economical:

A costing system is like other economic goods. It costs money just like economic goods. If the system is too expensive, management may be unwilling to pay as buyers are not willing to pay for the goods if these are expensive as compared to their utility. A costing system should not be expensive and must be adapted according to the financial capacity of the business.

The benefits to be derived from the system must be more than its costs as management will be willing to install the system when it’s perceived expected benefits exceed its perceived expected costs. In short, the system must be economical taking into consideration the requirements of the business. The cost of installing and operating the system should justify the results.

(v) Comparability:

The costing system must be such so that it may provide facts and figures necessary to management for evaluating the performance by comparing it with the past figures, or figures of other concerns or against the industry as a whole or other department of the same concern.

(vi) Capability of Presenting Information at the Desired Time:

The system must provide accurate and timely information so that it may be helpful to management for taking decisions and suitable action for the purpose of cost control.

(vii) Necessary cooperation and participation of executives from various departments of the concern is essential for development of a good system of cost accounting. Moreover, management should have faith in the costing system and should also provide a helping hand for its development and success.

(viii) The system of costing should not sacrifice the utility by introducing meticulous and unnecessary details.

(ix) A carefully phased programme should be prepared by using network analysis for the introduction of the system.

(x) Minimum Changes in the Existing Set Up:

The existing system of delegation and division of authority and responsibility must not be disturbed with the costing system. As far as possible the system must be such so that it may least disturb the existing organisational set up.

(xi) Uniformity of Forms:

All forms and proformas etc necessary to the system should be uniform in size and quality of paper. Higher efficiency can be obtained by using colour of the paper to distinguish different forms. Printed forms should contain instructions as to their use and disposal. Forms should be suitably designed for collection and dissemination of cost data.

(xii) Minimum Clerical Work:

The filling of the forms by foremen and workers should involve as little clerical work as possible as most of workers are not well educated. To ensure reliable statistics, every original entry should be supported by an examiner’s signatures.

(xiii) Efficient System of Material Control:

There should be an efficient system of stores and stock control as materials usually account for a greater proportion of the total cost. A good method of pricing material issued to production should be followed.

(xiv) Adequate Wage Procedure:

There should be a well defined wage procedure for recording the time spent by workers on different jobs, for preparing the wage sheets and for the payment of wages. Thus the introduction of well defined wage system will help to control the cost of labour.

(xv) Departmentalization of Expenses:

A sound plan should be devised for the collection, allocation, apportionment and absorption of overheads in order to ascertain the cost accurately.

(xvi) Reconciliation of Cost Accounts and Financial Accounts:

If possible the Cost accounts and financial accounts should be interlocked into one integral accounting scheme. If this is not possible the systems should be so devised that the two sets of accounts are capable of easy reconciliation.

(xvii) External Factors:

The installation of a costing system mainly depends on internal factors of a firm, but external factors may also affect the structure of the system. For example, cost accounting rules applicable to certain industries as notified by the Central Government require certain cost information to be developed and included in the books of accounts. Therefore, an ideal system of costing should take care of internal as well as external factors.

(xviii) Duties and Responsibilities of the Cost Accountant:

Under a good system of cost accounting the duties and responsibilities of the cost accountant should be clearly defined. The cost accountant should have access to all works and departments.

To conclude, primary criterion for an ideal costing system is: How well it helps in achieving management goals in relation to its cost?

Installation of a Costing System:

The fundamental factors that a Cost Accountant should consider while introducing a system of costing are:

(i) The existing organisation should be disturbed as little as possible.

(ii) There should be a gradual and smooth introduction of the system.

(iii) While over-elaboration of records should be avoided, it would be false economy to prune out essentials and impair efficiency.

Steps for Installation:

1. Objective to be Achieved through the Costing System:

The costing system will be simple if the objective is only to determine cost but it will have to be elaborate if the objective is to have information which will help management in exercising control and taking decisions.

2. Studying the Existing Organisation and Routine:

In this connection the points to be noted are—the nature of the business and of the operations or process carried on, extent of responsibility and authority attached to the various functionaries, the lay-out of the factory with particular reference to the manufacturing departments, the methods of dealing with wastage of materials, the system of time recording and the methods of computing and paying wages, the system of issuing orders for production to the factory and the amount of fixed, semi-variable and variable overheads.

3. Deciding the Structure of Cost Accounts:

What system of cost accounting is suitable and the extent of details required can be decided after a thorough study of the manufacturing process and their ancillary services. The structure of cost accounts should follow the natural production line; the sequence can be simple, analytical or synthetic. The designing of the system should be such that there is a gradual build up of the cost at each significant stage of production as the product proceeds to completion.

4. Determining the Cost Rates:

This entails a thorough study of factory conditions and decisions are to be made about classification of cost into direct and indirect, grouping of indirect costs into production, selling, administration etc., treatment of wastes of all kinds, methods of pricing issues, methods of recovering overheads and calculation of overhead rates. A complete cost accounting code should be drawn up so that expenditure may be quickly classified in the office as to both source and cause.

5. Introducing the System:

No costing system can be expected to function effectively unless co-operation of all the officials could be obtained. Before the system is put into effect, the implications of the system should be explained to all indicating to them the benefits that will accrue to each and to the business as a whole.

However, complete the system is, it should be introduced only by stages and the existing routines and practices should be utilised unless there are good grounds to supersede them. For example, a start could be made with the stores by introducing proper accounts of receipts and issues, opening of bin cards, stores ledgers etc.

6. Organising the Cost Office:

It is always better that the cost office is situated adjacent to the factory so that delay in routing out documents or in clearing up discrepancies and doubts, is avoided. The costing staff must be allowed to have access to the works if they are to perform their duties properly.

The size of staff would depend on the volume of work involved. A costing organisation is not worth its existence if it cannot present figures with speed and accuracy and observe simplicity in the presentation of results.

The duties of cost office fall into the following spheres:

(i) Stores Accounts:

Posting of materials receipts and stores issues in stores ledgers, preparing material abstracts.

(ii) Labour Accounting:

Evaluation of time sheets, job cards etc., preparing labour abstracts. In some cases preparation of actual pay rolls.

(iii) Cost Accounts:

Posting of all cost accounts whether job or process or service accounts.

(iv) Cost Control:

Posting cost control accounts from data supplied from sections (i) to (ii) above.

Preparation of special statistical and other information for management for carrying out special investigation and preparation of periodical trading statements.

7. Relationship of Cost Office to Other Departments:

The cost department should function independently, the cost accountant being made directly responsible to the General Manager or Managing Director. The costing system should be designed to serve management at all levels.

The cost accountant, therefore, should design his whole system of records and reports etc., with this end in view. He must know and understand the problems faced in the process of production, and try to translate them into financial implications so that correct decision may be taken.

8. Authority and Responsibility:

Authority and responsibility should be clearly defined if the costing system is to be successful. There should be no ambiguity, everything should be clear.

To sum up, a cost system should be perfected in a manner that will enable cost of sales to be computed; provide means for valuing inventories; aid in the control and management of a company, measure the efficiency of men, materials and machines, identify wastes collected by cost codes so as to pave the way for cost reduction, make possible inter-firm comparison, provide data for pricing and policy decision and form a basis for the preparation of various analytical report.

Practical Difficulties in Installing a Costing System:

Practical difficulties, apart from technical costing problems which a cost accountant has to face in installing a costing system, are:

1. Lack of Support from Top Management:

In most of the cases, the cost accounting system is introduced without the support of the top management in all the functional areas. Even managing director or chairman often introduces such system without consulting the departmental heads. The departmental managers treat it as an interference in their work by persons involved in a costing system. Thus it creates fear in the mind of the departmental managers as they treat the system as a device to check their activities.

2. Resistance from the Existing Accounting Staff:

Whenever a new system is introduced resistance is natural, as the existing staff may feel that they would lose their importance and may be unsure of their position in the organisation.

3. Non-Cooperation at Other Levels of Organization:

The foremen, supervisors and other staff may also resent the additional paper work which may arise because of introduction of costing system and may not co-operate with other departments in providing the information which is absolutely necessary for the smooth and efficient working of any accounting system.

4. Shortage of Trained Staff:

There may be shortage of cost accountants to handle the work of cost analysis, cost control and cost reduction. The work of costing department cannot be handled without the availability of trained staff.

5. Heavy Cost of Operating the System:

The cost of operating a system may be heavy unless the costing system is properly designed according to the requirements of each case specially. The system may be able to provide information which is required by all levels of management. It may involve additional paper work. Thus, the operation cost of the system will be heavy.

Steps to Overcome Practical Difficulties:

To overcome the above difficulties, following steps are suggested:

1. Support from the Top Management:

Before the installation or operation of a costing system, there must be firm commitment to the system on the part of the top management. This will create cost consciousness and interest in cost improvement among technical, production and top management.

2. Utility of System to Existing Staff:

The existing accounting staff should be impressed about the need to supplement the existing financial accounting system. It will broaden the job of an accountant and will create new opportunities for the accounting staff.

3. Workers’ Confidence for Cooperation:

The various employees must be properly educated regarding the benefits which can be obtained from such a system. Workers’ confidence should be gained in the system to get their co-operation before steps are taken to put the system in practice.

4. Training of Existing Accounting Staff:

The existing staff working in the accounts department must be proper, trained in costing methods and techniques with the help of the Institute of Cost and Works Accountants of India, Calcutta.

5. Cost System According to Specific Requirements of the Concern:

The system should be installed and operated according to the requirements of a specific case, so that it may not entail heavy cost on the concern. It should avoid additional unnecessary work as far as possible. The system, when installed and operated, will provide many benefits to the concern as compared to the cost and prove beneficial to the concern.

6. Proper Supervision:

There should be proper supervision after installation and continuous efforts on the part of the cost accountant to make the system successful and to achieve the desired goal of cost ascertainment, cost presentation and cost control.