CHAPTER 1: DEVELOPMENTS IN BUSINESS ENVIRONMENT
Accounting is the language of business that communicates the financial
results of an enterprise to various stakeholders viz., investors, regulating
agencies, the management itself etc. by means of various financial
statements. Accounting is the process of identifying, measuring, recording,
classifying, summarising, analyzing, interpreting and communicating the
financial transactions and events. Accounting is classified into Financial
Accounting, Cost Accounting, Management Accounting, Tax Accounting etc.
Management Accounting deals with the application of accounting techniques
for providing information designed to help all levels of the management in
planning and controlling the activities of business enterprise and in decision
making. The objective of this branch of accounting is to provide any and /
or all information that management needs in taking a rational decision
depending on the situation and to evaluate the impact of its decisions and
actions. Management Accounting is not only confined to the areas of cost
accounting but also covers other areas such as capital expenditure decisions,
capital structure decisions, dividend decisions, investment decisions etc. as
well. Management Accounting rules are set within the company with
emphasis on future to accomplish management objectives relating to adding
value to the company. This is the data that could be soft, or estimates, that
must only improve the value of decisions more than the cost of information.
The emphasis of Management Accounting is on timeliness and focuses on
different segments of the organization and need not follow GAAP or any
prescribed format. Management accounting data must only be relevant for
management decisions in Planning, Directing, Motivating and Controlling.

IMPACT OF CHANGING ENVIRONMENT ON COST AND MANAGEMENT
ACCOUNTING
Question:
How has the composition of manufacturing costs changed during recent
years? How has this change affected the design of cost accounting systems?
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Answer:
Traditionally, manufacturing companies classified the manufacturing costs to
be allocated to the products into (a) Direct materials. (b) Direct labour and
(c) Indirect manufacturing costs. In the present day context characterised
by intensive global competition, large scale automation of manufacturing
processes, computerization and real time processing of data, diversification
to suit customer needs, manufacturing costs are classified in to three broad
categories as under:
1. Direct costs: As many total costs relating to cost objects as feasible
are classified into direct costs. The objective is to trace as many costs
as possible into direct and to reduce the amount of costs classified into
indirect because the greater the proportion of direct costs the greater
the accuracy of the cost system.
2. Indirect cost pools: Increase the number of indirect cost pools so
that each of these pools is more homogeneous. In a homogeneous
cost pool, all the costs will have the same cause-and-effect
relationship with the cost allocation base.
Use cost-and-effect criterion for identifying the cost allocation base for each
indirect cost pool.
The change in the classification of manufacturing costs as above has lead to
the development of Activity Based Costing (ABC). ABC refines a costing
system by focusing on individual activities as the fundamental cost objects.
An activity is an event, task or unit of work with a specified purpose, for
example, designing, set up, etc. ABC system calculates the costs of
individual activities and assigns costs to cost objects such as products or
services on the basis of the activities consumed to produce the product or
provide the service.
TOTAL QUALITY MANAGEMENT (TQM):
TQM is a systematic process for identifying and implementing solution and
prioritise opportunities for improvement. TQM seeks to increase customer
satisfaction by finding the factors that limit current performance. The TQM
approach stresses on the need for a customer-oriented approach to
management reporting, eliminating some or more of traditional reporting
practices. The emphasis of TQM is to design and build quality in the
product, rather than allow defectives and then inspect and rectify them. The
focus is on the causes rather than the symptoms of poor quality. While
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doing this, modern management accounting practices are put to use. It is
often viewed as a technique suitable for manufacturing processes but this is
an important tool to increase efficiency in service sector also.
Quality: It is a measure of goodness to understand how a product meets its
specifications. When the expression "quality" is used, we usually think
terms of an excellent product or service that fulfills or exceeds our
expectations. These expectations are based on the intended use and the
selling price. When a product surpasses our expectations we consider that
quality.
Costs of performing checks to ensure quality specifications are called quality
costs. These are of 4 types
a. Prevention costs,
b. Appraisal costs,
c. Internal failure costs and
d. External failure costs.
Question:
Classify the following items under appropriate categories of quality costs viz.
Prevention Costs, appraisal Cost, Internal Failure Costs and External Failure
costs:
a. Rework
b. Disposal of scrap
c. Warranty Repairs
d. Revenue loss
e. Repair to manufacturing equipment
f. Discount on defective sale
g. Raw material inspection
h. Finished product inspection
i. Establishment of quality circles
j. Packaging inspection
Answer:
Prevention Costs : g, i Appraisal Costs : h, j
Internal Failure : a, b, e External Failure Costs : c, d, f.
CIMA defines ‘Total Quality Management’ as “Integrated and
comprehensive system of planning and controlling all business functions so
that products or services are produced which meet or exceed customer
expectations. TQM is a philosophy of business behaviour, embracing
principles such as employee involvement, continuous improvement at all
levels and customer focus, as well as being a collection of related techniques
aimed at improving quality such as full documentation of activities, clear
goal-setting and performance measurement from the customer perspective.”
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TQM is composed of three important parameters:
Total: Organization wide
Quality: With its usual Definitions, with all its complexities.
Management: The system of managing with steps like Plan, Organised,
Control, Lead, Staff, etc.

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