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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)

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 of external factors too. So the only thing left to increase the profit margins is by handling the internal factors. Cost management techniques have gone through a lot of transformation. And it cant 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 the cost drivers in that system. And then suggest a better system on basis of the problem they are facing in the current system. Strategic cost management is deliberate decision-making aimed at aligning 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 ensure long run sustainable profits for the firm. Strategic cost management takes two forms: structural cost management, which employs tools of organizational design, product design and process design to build a cost structure that is coherent with strategy; and executional cost management, 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 managed under different conditions. What is the costing system at the firm that we will be studying and the problems using that costing system? Keeping in mind the nature of their operations and the problems they are facing We also suggested an alternative costing system which according to our understanding would help them in a better manner. We studied the Costing system of Crescent Textile Mills for our project. The objective of our research 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 Mills and what system they prefers the most. b) To understand if using a costing system appears to be expensive and it causes a problem 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 and over-applied overhead.

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 the following: The history and detail of costing systems used in world

Signature

Date 07-01-12

Acknowledgements

We like to thank ALLAH for giving us the strength to complete our assigned task on time. We like to thank our instructor for the course of MANAGERIAL AND COST ACCOUNTING Mr . Ali Shan for not only teaching us the course in an efficient manner but also applying those concepts in a real world environment. Also we are thankful to the management of CRESCENT TEXTILE MILLS Specifically the Accounts Department for not only letting us study there costing system but also helping us in understanding there operations so we can get the knowledge of the problems they face. And Also to Mr . Asad Ullah (owner Crescent Textile Mills ) for facilitating us in the study of his company .

Table of Contents

Chapter 1
Introduction to Costing System: Purpose, Application, Methods Costing System The Five Parts of a Cost Accounting System 6 7 8

Chapter 2 Costing System: Crescent Textile Mills Introduction, Scope, Objective Costing Method Budgeting 14 15 16 18

Chapter 3 Proposed Costing System : Crescent Textile Mills Implementation of ABC costing system Advantages of Activity Based Costing 21 23 26

CHAPTER 4 Environmental Cost Management Issues 29

REFRENCES

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Chapter 1

Introduction To Costing System: Purpose, Application, Methods

Costing System An accounting system established to monitor a company's costs, providing management with information 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 available 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 the company.

The Five Parts of a Cost Accounting System A cost accounting system requires five parts that include: 1. 2. 3. 4. 5. an input measurement basis, an inventory valuation method, a cost accumulation method, a cost flow assumption 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.

Input Measurement Bases: The basis of a cost accounting system begins with the type of costs that flow into and through the 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 allocation methods, (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 least amount 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

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 the inventory 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 10

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 better strategic 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 is also 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 ASSUMPTIONS A 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 flow assumptions 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 12

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 Capability Inventory 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 or service 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 why are 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 15

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 a weaving 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 o o o o o o o o To arrange timely production and maintain quality goods for entire satisfaction of the customers To make Crescent Textile Mills a first choice for the foreign customers by improving its quality and services. To extend exports all over the world through better services. To establish and develop excellent working environment in the departments. Computerization Incline a sense of civic responsibility in the staff members To achieve companys objectives Implementation of ISO-9002 standards 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 a system 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 is allotted to each lot card entered and gets the lot card binded from the binder and keeps these bindings in record room for further reference. When the Job starts to process, the cost of every process (, bleaching, washing, dyeing, printing, mercerizing, finishing) Export fabric cost sheet shows the information about the grey cost, processing cost, freight charges. Rejection Report: Folding department where defects are checked & identified raises processed Lot Card. It contains the following Forms. Finish cloth defect report Lot entry form raised by Grey Fabric warehouse. Lot entry Forms also raised by folding. Processing Cost Sheet Processing 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 a system 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 18

 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 from the 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, cotton cess (20% charges on each bale consumption by Govt.), and preparation of reports presented to 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, long staple, 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 the cost of process under which raw material devour, monthly basis reports issued from spinning unit 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 spindles There are 3 components of the yarn cost, 1. Material Cost 2. Manufacturing Cost 3. 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: 19

It is cost of packing of finished goods. It is calculated as, Packing Cost= total expenses/ total packing The cost of cotton is calculated in the above mentioned way while the cost of polyester is calculate 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 pounds for each count. Grey Cloth Costing: Grey cloth costing is to determine estimated quality wise cloth cost for decision making on company ample basis where needed. It involves the determination of the cost of construction of cloth, blending ratio of yarn used, and processing i.e. (Grey, bleach, dyed, and print), for this purpose, the yarn rate, unit wise summary of expenses, loom wise/cloth wise cloth production and 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 Warp*20 *1.0936

Weft weight = picks*width Weft*20

*1.0936

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 production Where, Total loom pick production= (average pick production*total production) While, Total expenses=salary + energy cost+ depreciation cost + FOH (factory overhead) cost So, 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 of job order costing as by using the proposed costing system the company would be able to monitor and pin point the cost and performance of each activity involved in the job as it is difficult to identify the problem which may effect the cost in the costing system which is being practice by the company.

Overview of Activity Based Costing An activity based costing system is designed to match overhead costs as closely as possible with a company's activities. By doing so, overhead costs can be reasonably associated with products, departments, customers, or other users of activities, which tells managers where overhead costs are being used within a company. This results in much better control over overhead costs. Activity based costing involves a two-step process where overhead costs are first assigned to those activities that generate the overhead costs; the costs are then further allocated to those products, 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, are associated with specific machines. For example, a machine may require ten cents of electricity per minute. If so, this overhead cost can be charged out to those products that are run through the machine, based on the time spent being worked upon it. Other overhead costs are associated with a specific product line, and can reasonably be allocated to the activities performed within that product line. For example, there is typically a supervisor who is assigned to a single product line. If so, the fully burdened salary of this person can be charged to such related activities as production and maintenance scheduling. Still other overhead costs may be grouped by commodity used in the production process. For example, each member of the purchasing staff may be responsible for the procurement of a specific commodity. If so, this overhead 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 to the accumulation, storage, and allocation of overhead costs using many of these activity measures.

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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 the company 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 resource consumption by each activity. Step 4: Select cost drivers This step is similar for a traditional ABC implementation. Cost drivers are used to trace the cost of activities to products based on their consumption rate. Thus, operating cost drivers can trace operating 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 Sales revenue 14,759.257 Gross profit 1,364.616 Operating expenses 884.955 Other operating 179.043 income Finance cost 527.172 Profit before tax 131.532 Taxation 99.465 Net profit after tax 32.067 Activity Categories and Activities Activity Categories 2010 10,863.386c 1,456.742 731.247 184.767 566.793 343.469 118.821 224.648 %Change 35.86 -6.32 21.02 -3.10 -6.99 -61.70 -16.29 -85.72

Activities 24

Customer Management

Production Planning and Preparation Production Management Product Distribution Enterprise Management

Contact Customers Prepare Quotes Invoice and Collect Money Manufacturing process Plan Production Purchase Materials Materials Manage Production Store Final Product Ship Final Product Develop Employees Manage Business

To determine the operating cost, the companys income statement was analyzed to identify operating 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 Depreciation Other Operating Expenses Total Operating Cost

xxx xxx xxx xxx

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

Activities Contact Customers Invoice and Collect Money Plan Production Purchase Materials Receive and Handle Materials Manage Production Store Final Product Ship Final Product Develop Employees Manage Business Total Operating Cost

OperatingCost Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx

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Lets add two more activities to our example: procurement and material handling. The costs of these two activities are not caused bynor do they correlate withmachine hours. Rather, we will assume that both of these activities are related to the physical weight of the direct material used 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 the manufacturing overhead that will be allocated via machine hours, and instead plans to allocate the 30 million to the products based on the weight of the materials used. The company expects that during the year it will procure and handle 3,000,000 bulks of material. Under activity based costing, the company will assign approximately Rs 9 (30 million divided by 3,000,000 bulks) per bulk product weight to each unit manufactured. The end result is that the large/big products will not only have more direct material cost, they will also be assigned more factory overhead than the lighter parts. By assigning some manufacturing overhead to a product based on the products weight, the remaining manufacturing overhead assigned via machine hours will be reduced. These points are illustrated in the following table:

Mfg overhead costs assigned to setups Number of setups Mfg overhead cost per setup Mfg O/H costs caused by handling Bulks of material in products Mfg O/H costs caused by producing the items: Total manufacturing overhead costs Less: Cost traced to machine setups Less: Costs traced to procurement/handling Mfg costs to be allocated on machine hours Machine hours (MH) Mfg overhead costs allocated per MH Mfg Overhead Cost Allocations

ABC Costing 20 million 400 40,000

Without ABC Costing 0 Not applicable 0 0 Not applicable

30 million 3,000,000

180,000,000 200,000 300,000 135,000,000 100,000 1350

180,000,000 0 0 135,000,000 100,000 1800

Rs 40000 setup cost per 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 get the true costs associated with business activities at each of its revenue and cost centres. These companies have profit centres like business and marketing department etc. These centres have both revenue as well as cost centres. They are therefore viable centres, which generate most of the 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 better examine their business activities that are indirectly associated with their service delivery like information systems, customer support, electricity, security, marketing, transport services and maintenance. It will thus make it easier for them to be accurate in assigning costs. They will be in a better position to assign cost for the operations of their cost centres since these centres do not bring any revenue. It will also help the managers to identify inefficient product, department and activity and therefore allocate more resources on profitable product, department and activity. ABC will also help to control the cost at individual level and on departmental level and to find unnecessary costs. The only problem is ABC has been found to be a very high-cost accounting technology. Installing an ABC system is technically complex, requiring talented personnel and a considerable amount of time. Though its been argued that ABC has lost ground to 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 in practice full costing tends to use past cost and to restrict its consideration of future cost to outlay cost. It also provides a long - run relevant cost which gives information that relate only to the 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 a review 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 to compare this cost to the profit margins earned on sales of products that are sold through it. You can then determine if the distribution channel should be reconfigured or eliminated in order to improve overall levels of profitability. How do product costs vary by plant? An ABC analysis will itemize the costs of each plant, and correctly allocate these costs to the activities conducted within them, which allows a company to determine which plants are more efficient than others. Should we make or buy an item? An ABC analysis includes all activity costs associated with a manufactured item, which yields a comprehensive view of all costs associated 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 costs should be in potential acquisition targets. If the targets have higher costs than the benchmark levels, then the acquiring company knows that it can strip out costs from the acquisition candidate by improving its processes, which may justify the cost of the acquisition.

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What does each activity cost? An ABC analysis can reveal the cost of each activity within an organization. The system is really designed to trace the costs of only the most significant activities, but its design can be altered to itemize the costs of many more activities. This information can then be used to determine which activities are so expensive that they will be the main focus of management attention, or which can be profitably 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 be charged. However, the actual price charged may be much higher, since this may be driven by the ability of the market to absorb a higher price, rather than the underlying cost of a product. What products should we sell? An ABC analysis can be combined with product prices to yield a list of margins for each product sold. When sorted by market, product line, or customer, it is then easy to see which products have low or negative returns, or which yield such low margin volume that they are not worth keeping. Which customers do we want? An ABC analysis can itemize the costs that are specific 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 margins on products sold to customers, this reveals which customers are the most profitable after all 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 and social needs of the community in perspective. Therefore, Crescent is committed to full filling all kinds of ethical, Security, Health and safety and Environmental standards. Their aim is to conserve the environmental water and energy, promote reuse & recycling, and ensure waste minimization and proper treatment of waste generated. Crescent has a major investment in waste water treatment. They are able to do so by implementing ETP & following the 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 Crescent business. In an effort to reduce the burden on the environment; Crescent has made a major investment 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 and then fed into an evaporator. The caustic soda which is re-concentrated up to the necessary concentration 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 the emission of pollutants in waste water; but also provides cost savings in chemical and water recovery; 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 to handle variations in water quality and flow. Based on a purely physical process, the DAF system utilizes the property of micro bubble adherence to suspended solids, which increases the tendency 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-exerciseproblem-solutions http://www.productpilot.com/en/suppliers/crescent-textile-mills-ltd/products/en http://www.aptma.org.pk/viewdetail.asp?uid=crescenttex

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