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CHAPTER -1

INTRODUCTION
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WHAT IS COST ANALYSIS?

Cost analysis (also called economic evaluation, cost allocation, efficiency assessment, cost-benefit analysis, or cost-effectiveness analysis by different
authors) is currently a somewhat controversial set of methods in program evaluation. One reason for the controversy is that these terms cover a wide
range of methods, but are often used interchangeably.

Cost Management is one of the primary functions of Project Managers. When integrated with the scope/quality of the project and time management,
these three functions form the core of Project Management. The cost management function maintains its important focus at every stage throughout the
life cycle of a project. In listing the reasons for the success of a project, the management of cost is the most important as all project aspects affect this
function. What counts for the owner is the “bottom line.”

The initial Cost Management Task Group was chaired by Mr. D.W. Haeney, Stelco Inc., (a member of the PMI Southern Ontario Chapter) in 1983. Mr.
P.G. Georgas, Stelco Inc., (also a member of the PMI Southern Ontario Chapter) is now chairing the Cost Management function of Project 121, Body of
Knowledge assisted by G.V. Vallance, Stelco Inc. The preliminary report of the Cost Management Function Committee was completed for presentation
at the PMI October 1985 Denver Workshop. The workshop reviewed and critiqued this preliminary report and instituted several modifications. The time
phase or the chronological progression of process and activities throughout the project life cycle was eliminated from the function chart. The result was
that some processes were combined. The resulting two dimensional modified workshop chart still did not meet the requirements of being fully integrated
with other Project management functions. A matrix system was suggested and this final report incorporates the matrix approach and the interface with
other Project Management functions.

This report is the final submission of the 1985 Cost Management Function Committee. The report includes all of the ideas and work from the initial
report (August 1985), the modifications recommended at the workshop, the matrix chart, technical references and all of Mr. Wideman's suggestions.

It is understood that the matrix and function charts, technical reference and glossary of terms will be used to establish a data library for education
purposes (accreditation and certification) for all PMI members and students. There still remains a great deal of thinking, discussion and writing before
the Cost Management function of the PMI Body of Knowledge is complete. This report is only a beginning and future groups will enlarge and refine the
existing information.
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Cost Management Function

The Cost Management function (WBS-1) includes the processes that are required to maintain financial control of projects (economic evaluation which
initiates the project, estimating, organizing, controlling, analyzing, reporting, forecasting and taking the necessary corrective action. The Function chart
(Figure 1), the Function Impact Matrix chart (Figure 2) and glossary of terms are attached to this report. The initial Function chart was developed using
the guidelines of March, 1985 for presentation at the Denver workshop. The resulting Function chart (Figure 1) incorporated the workshop data and
subsequent suggestions by Mr. Wideman. One major conclusion of the workshop was the addition of the matrix format to the Body of Knowledge. The
Function Impact Matrix chart (Figure 2) for Cost Management illustrates the complexities of interfacing with other project management functions. Both
charts encompass the total project cost management concepts from initiation to completion during the total project life cycle.

Cost Function Chart

The process levels used in the Cost Function chart (Figure 1) are as follows:

1. Cost Estimating

2. Cost Budgeting

3. Cost Control

4. Cost Applications

Each of the process levels (WBS-2) were expanded into activity levels (WBS-3). An additional level (WBS-4) lists the techniques that are associated with
some of of the activities.

Cost Estimating
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Cost estimating is the process of assembling and predicting costs of a project over its life cycle. It encompasses the three phases included in the initial
function chart; namely, economic evaluation, project investment cost and cost forecasting.

The economic evaluation is the initial planning phase to determine whether a project is economically and technically feasible and whether sufficient
funding can be obtained to implement the project. It involves the assessment of “order of magnitude” estimates, project profitability, financing and
acceptance.

The project investment cost is the prediction of future cost even though all the parameters are not fully defined at times during the project's life. It is
during this process that order of magnitude, budget and definitive estimates are produced.

Cost forecasting is the process of developing the future trends along with the assessment of probabilities, uncertainties and inflation that could occur
during the project.

The combination of these three processes assist in predicting the future financial outcome for a successful project.

Cost Budgeting

The cost budgeting process is one of establishing budgets, standards and a monitoring system by which the investment cost of the project can be
measured and managed. This process is the planning phase once project approval is obtained. It includes all the accounting functions required to
establish procedures and systems to monitor the project.

Cost Controls

Although the control functions appears in all of the Project Management function charts, the activities associated with each are not universal and hence
the term Cost Control is used to differentiate from the other functions. The process of cost control is the gathering, accumulating, analyzing, monitoring,
reporting and managing the costs on an ongoing basis.

Cost Applications
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This is the process level associated with special applications of cost techniques that are not included in the other cost processes. It also includes associated
topics that affect cost management such as computer applications, value analysis, etc.

Cost Function Impact Matrix Chart

The Function Impact Matrix chart (Figure 2) illustrates the interaction and integration of the processes of the Cost Management function with the other
project management functions. The traditional core project management functions (Scope, Quality, Time and Cost) are dynamically linked with the
other “softer” components (Human Resources, Communications and Contracts/Procurement) and the operational functions (Planning & Controlling,
Integration & Coordination, Systems/Processes, Probability/Risk and Applications). The resulting matrix chart provides a mosaic of the interfaces and
demonstrates the complexities of the Cost Management Function.

At the most basic level, cost allocation is simply part of good program budgeting and accounting practices, which allow managers to determine the true
cost of providing a given unit of service (Kettner, Moroney, & Martin, 1990). At the most ambitious level, well-publicized cost-benefit studies of early
intervention programs have claimed to show substantial long-term social gains for participants and cost savings for the public (Berreuta-Clement,
Schweinhart, Barnett, et al., 1984). Because these studies have been widely cited and credited with convincing legislators to increase their support for
early childhood programs, some practitioners advocate making more use of cost-benefit analysis in evaluating social programs (Barnett, 1988, 1993).
Others have cautioned that good cost-benefit or cost-effectiveness studies are complex, require very sophisticated technical skills and training in
methodology and in principles of economics, and should not be undertaken lightly (White, 1988). Whatever position you take in this controversy, it is a
good idea for program evaluators to have some understanding of the concepts involved, because the cost and effort involved in producing change is a
concern in most impact evaluations (Rossi & Freeman, 1993).

COST ANALYSIS IS OF THREE IN EVALUATION:

1. Cost Allocation
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live in rural areas? Are any client characteristics commonly related to important outcomes such as birth weight of the baby? Deciding how to collect
enough client and service data to give useful information, without overburdening staff with unnecessary paperwork requirements, requires a lot of
planning. Larger agencies often hire experts to design data systems, which are called MIS or management-and-information- systems.

If you are working for an existing agency, your ability to separate out unit costs for services or outcomes may depend on the systems that are already in
place for budgeting, accounting, and collecting service data. However, if you are in a position to influence these functions, or need to supplement an
existing system, there are a number of texts that discuss the pros and cons of different ways of budgeting, accounting, and designing MIS or
management-and-information-systems (see Kettner, Moroney & Martin, 1990).

COST - EFFECTIVENESS ANALYSIS :

Most often, cost-effectiveness and cost-benefit studies are conducted at a level that involves more than just a local program (such as an individual State
Strengthening project). Sometimes they also involve following up over a long period of time, to look at the long-term impact of interventions. They are
often used by policy analysts and legislators to make broad policy decisions, so they might look at a large federal program, or compare several smaller
pilot programs that take different approaches to solving the same social problem. People often use the terms interchangeably, but there are important
differences between them.

Cost - Effectiveness analysis assumes that a certain benefit or outcome is desired, and that there are several alternative ways to achieve it. The basic
question asked is, "Which of these alternatives is the cheapest or most efficient way to get this benefit?" By definition, cost-effectiveness analysis is
comparative, while cost-benefit analysis usually considers only one program at a time. Another important difference is that while cost-benefit analysis
always compares the monetary costs and benefits of a program, cost-effectiveness studies often compare programs on the basis of some other common
scale for measuring outcomes (eg., number of students who graduate from high school, infant mortality rate, test scores that meet a certain level, reports
of

child abuse). They address whether the unit cost is greater for one program or approach than another, which is often much easier to do, and more
informative, than assigning a dollar value to the outcome (White, 19

COST - BENEFIT ANALYSIS :

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The basic questions asked in a cost-benefit analysis are, "Do the economic benefits of providing this service outweigh the economic costs" and "Is it
worth doing at all"? One important tool of cost-benefit analysis is the benefit-to-costs ratio, which is the total monetary cost of the benefits or outcomes
divided by the total monetary costs of obtaining them. Another tool for comparison in cost-benefit analysis is the net rate of return, which is basically
total costs minus the total value of benefits.

The idea behind cost-benefit analysis is simple: if all inputs and outcomes of a proposed alternative can be reduced to a common unit of impact (namely
dollars), they can be aggregated and compared. If people would be willing to pay dollars to have something, presumably it is a benefit; if they would pay
to avoid it, it is a cost. In practice, however, assigning monetary values to inputs and outcomes in social programs is rarely so simple, and it is not always
appropriate to do so (Weimer & Vining, 1992; Thompson, 1982; Zeckhauser, 1975).

"Suppose the drop-out rate in an inner-city high school is 50%. Prevention Program A enrolls 20 students, costs $20,000, and 15 of the 20 students (75%)
graduate. Thus Program A resulted in 5 additional graduates at a cost of $20,000, or one additional graduate for every $4,000. Prevention Program B
enrolls 20 students, costs $15,000, and 12 of the 20 students (60%) graduate. Thus Program B resulted in 2 additional graduates at a cost of $15,000, or
one additional graduate for every $7,500 spent. Although Program B is cheaper ($15,000 compared to $20,000), Program A is more COST-EFFECTIVE
($4,000/each additional graduate, compared to $7,500/additional graduate). A COST-BENEFIT ANALYSIS in this situation, instead of comparing unit
costs, would require estimating the dollar value of high school graduation

OBJECTIVES OF STUDY

Cost analysis can be used at several levels. At the most basic level, cost allocation is simply part of good program budgeting and accounting practices ,
which allow managers to determine the true cost of providing a given unit of service. it deals with cost allocation , cost effectiveness and cost benefit.

Five Tiers :

Tier 1 – Program definition

Tier 2 – Accountability

Tier 3 – Understanding & refining

Tier – 4 Progam towards objective

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Tier 5 – Program impact

COST ANALYSIS METHODOLOGY :

PRIMARY DATA COLLECTION :-

 All the data collection process has been carried out through the constitutions with the staff members concerned in the department of finance in the
organization.

 Direct interactions with the manager, The accountants and the related staff concern helped me in gathering of the required data.

 Took the help of the management from the other departments and the guidance from the internal guide.

SECONDATY DATA COLLECTION :-

 Certain assumptions have been made in regard to the future projects of the company.

 The data have been prepared in the consultation with the various personals of the organization indirectly.

 The changes in capital due to expected better management have been taken in the account while calculating the related capital structures.

 The results of the capital structures forecasts have been analyzed to give suggestions for improvement of the performance of the Organization.

OBJECTIVES AND SCOPE OF COST ACCOUNTING

Objectives of Cost Accounting are as follows:

1) To Ascertain the Cost : To ascertain the cost of product or a services reveled and enable measurement of profit by proper valuation of inventory.

2) To Analyse Costs : To analysis costs or to classify the expenses under different heads of accounts viz. material, labour, expenses etc.
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3) To Allocate and Apportion the Costs : To allocate or charge the direct expenses or specific costs such as Raw Material, Labour to particular product,
contract or process and to distribute common expenses to each product, contract or process on a suitable basis.

4) Cost Reporting : Cost Reporting or presentation includes :

a) What to report i.e. what is the nature of information to be presented?

b) Whom to Report i.e. to whom the report is to be addressed.

c) When to Report i.e. when the report is to be presented i.e. Daily weekly monthly yearly etc.

d) How to Report i.e. in what format the report is to be presented.

5) To Assist the Management : Cost Accounting assist the management in:

a) Indicating to the management any inefficiencies and extent of various forms of waste of Raw Material, Time, Expenses etc.

b) Fixing of selling price.

c) Providing information to enable management to take decision of various types.

d) Controlling Inventory of Raw Material, goods in process, finished goods, spares and consumables etc.

6) Cost Control : Cost Accounting assist the management in cost control. Cost control includes the following stages.

a) Setting up of targets of cast and production for each period.

b) Measuring the actual figures of performance relating to cost, production etc. for the period concerned.

c) The figures of actual performance are to be compared with the targets to find out the variation.

d) Analysing the variance, whether favourable or adverse.

e) Immediate action has to be taken in case of adverse variation.

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7) Optimum Product Mix : Advise the management in deciding optimum product mix merits and demerits of alterative courses of action viz. make of buy
decisions, introduction or Automation mechanization, rationalization, system of production etc.

8) Future Policies : Advise management on future policies regarding Expansion, growth, capital investment, etc.

Scope of Cost Accountancy

The scope of Cost Accountancy is very wide and includes the following:-

(a) Cost Ascertainment: The main objective of Cost Accounting is to find out the Cost of product/services rendered with reasonable degree of accuracy.

(b) Cost Accounting: It is the process of Accounting for Cost which begins with recording of expenditure and ends with preparation of statistical data.

(c) Cost Control: It is the process of regulating the action so as to keep the element of cost within the set parameters

. (d) Cost Reports: This is the ultimate function of Cost Accounting. These reports are primarily prepared for use by the management at different levels.
Cost reports helps in planning and control, performance appraisal and managerial decision making.

(e) Cost Audit: Cost Audit is the verification of correctness of Cost Accounts and check on the adherence to the Cost Accounting plan. Its purpose is not
only to ensure the arithmetic accuracy of cost records but also to see the principles and rules have been applied correctly. To appreciate fully the
objectives and scope of Cost Accounting, it would be useful to examine the position of Cost Accounting in the broader field of general accounting and
other sciences. i.e Financial Accounting, Management Accounting, Engineering and Service Industry.

IMPORTANCE AND ADVANTAGES OF COST ACCOUNTING

The importance and advantages of cost accounting are presented below:

1. Helps in controlling cost: Cost accounting helps in controlling cost by applying some techniques such as standard costing and budgetary control.

2. Provides necessary cost information: It provides necessary cost information to the management for planning, implements and controlling.

3. Ascertains the total per unit cost of production: It ascertains the total and per unit cost of production of goods and services that helps to fix the selling
prices as well.
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4. Introduces cost reduction programs: It helps to introduce and implement different cost reduction programs.

5. Discloses the profitable and non profitable activities: It discloses the profitable and non profitable activities that enable management to decide to
eliminate or control unprofitable activities and expand or develop the profitable activities.

6. Provides information for the comparison of cost: It provides reliable data and information which enable the comparison of cost between periods,
volume of output, determent and processes.

7. Checks the accuracy of financial accounts: It helps checking the accuracy of financial accounts. This is done by preparing cost reconciliation statement.

8. Helps investing and financial institutions: It is also advantageous to investment and financial institutions since it discloses the profitability and
financial position in which they intend to invest.

Elements of Cost

➢ Direct and indirect material

➢ Direct and Indirect Labour

➢ Direct and Indirect expenses

Classifications of Costs

➢ On the basis of elements - Direct Material, labour, expenses and Overheads

➢ On the basis of functions - Production expenses, Office expenses, Selling expenses and Distribution expenses

➢ On the basis of behaviour - Variable expenses, fixed expenses and semi variable expenses

➢ On the basis of Controllability - Controllable and Uncontrollable

➢ On the basis of time - Historical cost and Predetermined Cost

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Direct Material

Direct material cost is which cost can be conveniently identified and allocated to Cost units

Example: Material specially purchased from a particulate job, order or process

Indirect Material

Indirect material cost cannot be conveniently allocated but can be apportioned of Absorbed by units or cost centers

Example: Lubricating oil, fuel, cotton, waste etc,

Labour Cost:

Labour cost is the cost of remuneration (Wages, salaries bonus etc.,) paid or payable to the employees of an undertaking.

Direct Labour

Direct labour is that labor which can be conveniently identified with and allocated to cost units. It is the among of labour which directly engaged or
productive jobs or process

Example: Wages paid to a machine operator.

Indirect labour cost

It is the cost of labour or directly engaged in the production operators and engaged to assists or help the production operation

Example: Wages of store keepers, Inspectors etc.

Expenses

The cost other than the material cost and labour cost are called expenses.
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Direct Expenses

Direct expenses are those expenses which can be directly identified with and allocated to cost units Example: Hire of a special plants and machinery
required for a particular job.

Indirect Expenses

Indirect expenses are those expenses which are common to jobs or process and cannot be directly identified with a particular job or process.

Factory Overheads

Factory overheads are those expenses which are incurred in connection with manufacturing operation but which cannot be identified and allocated to
cost units or job or process.

Example: Power, factory rent salary of works manager

Office Expenses

Office expenses are those expenses which are incurred in formulating policies, planning and controlling the functions, directing and motivating the
personnel of an organization for the attainment of the objectives.

Example: Office salaries, administration expenses, rent, repairs, depreciation of office building. Selling expenses

Selling expenses are those expenses which are incurred to promote sales and to retain customers. That is the costs, which are incurred to create and
stimulate demand for the products are known as selling expenses.

Example: Advertisement expenses, Salesman salaries, commission Bad debts.

Distribution expenses

Distribution expenses are those expenses which are incurred to distribute the goods which are manufactured by the concern.

Example: Delivery van expenses, Carriage outwards packing expenses etc.,

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Fixed Cost

Fixed cost is the cost which is constant within the installed capacity, irrespective of volume of outputs. Fixed cost is the cost which is unaffected by the
volume of output.

Example: Rent of building, factory, managers salary, insurance, administration expenses.

Variable cost

Variable cost is the cost which will vary according to the volume of unit production.

Semi – Variable cost or semi-fixed cost

Semi fixed cost is one which is partly fixed and partly variable it is also known as semi variable cost. Example: Telephone expenses, Electricity expenses.

Controllable cost

Controllable cost is the cost which can be controlled by the action of the executive of a concern. Controllable cost is the cost is the cost which may be
directly regulated by the top level management. Example: Variable cost is an example for controllable cost.

Uncontrollable cost

Uncontrollable cost is the cost which cannot be controlled by the action of the executive of a concern. Example: Fixed expenses like salary, rent etc.,

Normal cost

Normal cost is the cost which is normality incurred at a given level of output which is normality attained.

Abnormal cost

Abnormal cost is the cost which is not normality incurred at a given level of output which is normality attained.

Historical cost
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Historical costs are those costs which are competed or ascertained after they have been incurred. The cost which is calculated after the completion of the
job or process is known as historical cost.

Predetermined costs

Predetermined costs are those cost which are computed in advance of production. The cost which is estimated before the production is attained
predetermined costs are also known as standard cost.

Marginal cost

Marginal cost is the variable cost which is includes direct material; direct labour, direct expenses.

Advantages of Cost Accounting

The advantages are grouped into four categories. They are.

1.To the Management

➢ In fixing price

➢ In fixing profit

➢ In fixing sales

➢ In selecting a sales mix

➢ In selecting an alternative production pattern

➢ In determining the future course of action

➢ In fixing remuneration to workers

2.To the employees

➢ fixing a sound wage policy

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➢ In fixing a suitable bonus plan

➢ In distinguish between efficient and inefficient workers

➢ In fixing appropriate incentive scheme in employees

3.To the government

➢ In facilitating the assessment of excise duty

➢ In facilitating the assessment of income tax

➢ In facilitating the formulation of policies regarding industry

5. To the public
➢ With control over costs, the prices are fair
➢ With control over wastage, the quality is better
➢ Cause overall growth of industries and employment
Limitation of Cost Accounting
➢ Not applicable to small business concern
➢ Expenses involved in installing a costing system is disproportionate to the benefits received from it
➢ It is only based on estimation Methods of costing
Job costing
The costing adopted to concerns which produce goods according to the specific order of the customer is called job costing.
Example: Printing, Machine tools, Repair shops.
Batch Costing
Batch costing is a method of costing adopted to concerns which produce group of identical or similar product in large units.
Example: Medicines, Ready-made garments, Spare parts.
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Contract costing
Contract costing is adopted by the concern which produce product of construction types. It is just like job costing. But a period is longer the cost.
Process costing
Process costing is adopted by concern which produces production of mass scale with two or more processes.
Operation costing
Operation costing is a method of costing adopted for the concern, producing products with number of process or operations where costs are
collected, accumulated and ascertained for each operation separately.
Example: Engineering, toy making etc.
Single or output Costing
Single or output costing is methods of costing adopted by concern which produce one product with identical and standard units through two or
more processes.
Example: Mines Quarries, Brick works.
Operating costing
The method of costing adapted by concerns which render services is called operating costing Example: Railways, Airways, Road transport
Hospital, Power source etc.,
Techniques (or) type of costing Historical Costing
The determination of cost after the costs have been incurred is called historical costing. Standard Costing
The determination of cost before the costs are incurred for the production is called standard costing.
Absorption costing
The absorption costing is also known as full cost. In absorption costing, different costs incurred for manufacturing a product are charged to the
product.
Marginal costing
Marginal costing is also called variable costing. It helps the management to take decisions on the basis of variable costs and fixed cost.
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Uniform costing
Uniform costing is an adoption of similar costing principle and practices.
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: It is beneficial to workers as well since it emphasizes the efficient utilization of labour and scientific systems of wages payment.