UNIT – 4: - Cost Control Teaching Hours

Cost control and Cost Reduction-Control over wastages, Scrap, Spoilage and
defectives– Methods of cost reduction.

What is cost control?

Cost control refers to the process of monitoring and managing expenses within an
organization to maintain financial stability and achieve profitability. This process involves
identifying and analyzing various cost factors, such as operational expenses, production
costs, and overheads, and implementing measures to reduce or optimize them.
It aims to strike a balance between minimizing costs without compromising the
quality of products or services. By effectively controlling costs, businesses can enhance their
competitiveness, improve operational efficiency, and generate higher profits, ultimately
leading to long-term growth and success.
Cost Control - Definition
CIMA, London has defined cost control as “the regulation by executive action of the
cost of operating an undertaking particularly where action is guided by cost accounting”
Characteristics of Cost Control
1) The cost control mechanism cannot be applied unless the reported costs are produced
and submitted in time.
2) For successful monitoring, it is important to have an adequate and suitable delegation
of authority.
3) In the case of an effective control system, deciding centers of responsibility is
essential.
4) A key aspect of an efficient cost control system is that expenses are relevant and are
manageable.

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Explain the Cost Control Techniques
There are several methods of cost control techniques that organizations can use to manage
their expenses. Some of these techniques include:
1. Budgeting
Creating a budget can help organizations to plan their expenses and ensure that they are in
line with their revenue.
2. Standard costing
This technique involves setting a standard cost for a product or service and comparing the
actual cost against this standard to identify variances
3. Activity-based costing
This technique involves identifying the activities that drive costs and allocating those costs to
products or services based on the resources used.
4. Inventory management
Managing inventory levels can help organizations to reduce waste and avoid stockouts.
5. Process improvement
Analyzing and improving business processes can help organizations to reduce waste and
increase efficiency.
6. Outsourcing
Outsourcing non-core functions can help organizations to reduce costs and focus on their core
competencies.
7. Negotiation Negotiating with suppliers and vendors can help organizations to reduce costs
and improve their bottom line.
Process of Cost Control (or) Steps in Cost Control
Handling business expenses is definitely not a “set it and forget it” consideration. Rather,
think of it as a continuous, cyclical process that involves the following steps:
1. Resource Planning
Cost control starts by implementing project controls; predicting the upcoming
costs of a project, whether it’s for equipment, materials, staff, or even just time spent.
The resource planning step occurs before the actual work begins.
Companies often use the work-breakdown structure to examine each subtask in
the schedule and decide on what skills or equipment are necessary for each. Historical
financial data for comparable projects and feedback from team members are important
points to consider for this task.

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2. Estimating Cost
Next approximate the overall cost of resources needed for the work. Cost
estimation is a complicated matter that depends on your current budget and how much
information you have available. We’ll talk more about cost estimation later.
3. Budgeting
Once the work is underway, the next step is allocating the budget to each task.
Cost budgeting is a combination of applying the estimated costs to project scheduling.
Every activity in the workflow gets its own specific amount of the budget here.
4. Cost Monitoring
Finally, project management needs to cover handling changes in the budget. Cost
control measures the variance of the actual costs from the predetermined baseline cost
and takes action whenever necessary. This step also requires you to check the actual
results of those actions.
Definition of Cost Reduction
“Cost reduction” is a continuous process of critical cost examination, analysis and
challenge of standards. In this each aspect of businesses such as products, process,
procedures, methods, organization, personnel etc., are critically examined and reviewed
with a view of improving efficiency and effectiveness and reducing the costs.
Major elements of Cost Reduction
 Savings in per unit cost.
 No compromise with the quality of the product.
 Savings are non-volatile in nature
Features of cost reduction:
1. Reduction in Unit Costs:
The aim of cost reduction is to bring down the cost per unit of a commodity or
service. Unit cost may come down if the prices of input factors also come down. But, in
that case, the reduction will not be real and permanent. Sooner or later, the prices of
inputs will rise owing to limited supply for natural causes.
2. Reduction to be Permanent:
Reduction In unit cost should not only be real but permanent also. A temporary
reduction in the unit cost has no significance if, in the near future, cost per unit goes up
for whatever reason.

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3. Use Value to be Unaffected:
Any article, produced with the available scarce resources has not only exchange
value but use value also. Its value in exchange is dependent upon market forces.
However its value in use depends entirely upon its quality.
Techniques of Cost Reduction
1. Just-In-Time (JIT) System
The main aim of JIT is to produce the required items, at the required quality and
quantity, at the precise time they are required. JIT purchasing requires for the items where too
much carrying costs associated with holding high inventory levels. Purchasing system
reduces the investment in inventories because of frequent order of small quantities.
2. Target Costing
Target costing refers to the design of product, and the processes used to produce it, so
that ultimately the product can be manufactured at a cost that will enable the firm to make
profit when the product is sold at an estimated market-driven price. This estimated price is
called target price.
3. Activity Based Management (ABM)
Activity based management is the use of activity based costing to improve operations
and to eliminate non-value added cost. The main goal of ABM is to identify and eliminate
non-value added activities and costs.
4. Life Cycle Costing
Life cycle costing estimates and accumulates costs over a product's entire life cycle in
order to determine whether the profits earned during the manufacturing phase will cover the
costs incurred during the pre-and-post manufacturing stage.
5. Kaizen Costing
Kaizen costing is the process of cost reduction during the manufacturing phase of an
existing product. The Japanese word 'Kaizen' refers to continual and gradual improvement
through small activities, rather than large or radical improvement through innovation or large
investment technology.
6. Business Process-re-engineering
Re-engineering is a complete redesign of process with an emphasis on finding creative
new ways to accomplish an objective. The aim of business process re-engineering is to
improve the key business process in an organization by focusing on simplification, cost
reduction, improved quality and enhanced customer satisfaction.

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7. Total Quality Management (TQM)
Under the TQM approach, all business functions are involved in a process of
continuous quality Improvement.
8. Value chain
Value chain analysis is a means of achieving higher customer satisfaction and
managing costs more effectively. The value chain is the linked set of value creating activities
all the way from basic raw materials' sources, component suppliers, to the ultimate end-use
product or service delivered to the customer.
9. Bench Marketing
Bench marketing is a continual search for the most effective method of accomplishing
a task by comparing the existing methods and performance levels with those of other
organizations or other sub-units within the same organization.
10. Management Audits
Management audits, also known as performance audits, can be used to facilitate cost
reduction in both profit and non-profit organizations. Management audits are intended to help
management to do a better job by identifying waste and inefficiency and recommending a
corrective action.
Distinguish between Cost control and Cost Reduction
BASIS FOR
COST CONTROL COST REDUCTION
COMPARISON
Meaning A technique used for maintaining A technique used to economize the unit
the costs as per the set standards is cost without lowering the quality of the
known as Cost Control. product is known as Cost Reduction.
Savings in Total Cost Cost Per Unit
Retention of Quality Not Guaranteed Guaranteed
Nature Temporary Permanent
Emphasis on Past and Present Cost Present and Future Cost
Ends when The pre-determined target is No end
achieved.
Type of Function Preventive Corrective

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Important Terminology used in Cost Control and Cost Reduction
1. Waste:
Waste is defined as discarded substances having no values. In many industries, some
waste is inevitable. Such waste may arise due to the inherent nature of materials, chemical
reaction, evaporation, drying, sublimation of goods etc. Waste can also be in the form of
smoke, gas, slag or dust which arises in the course of a manufacturing process.
Waste may be invisible or visible. The former type of waste (i.e., waste due to drying,
evaporation etc.) is invisible whereas the latter type of waste (i.e., gas, smoke, slag etc.) is
visible. Waste has practically no measureable value. Rather in some industries, the waste
instead of realizing any value creates a problem for its disposal incurring further costs. The
waste may be normal and abnormal from the point of view of treatment in costing.
2. Normal Waste
It is the loss which is unavoidable on account of inherent nature of material. Some
materials such as liquid materials lose their weight due to evaporation. Similarly, there are
some materials (i.e. coal) which are wasted due to loading and unloading. Materials may be
wasted due to breaking the bulk into smaller parts.
Normal waste is unavoidable and as such may be reduced to some extent if there is
strict control but cannot be totally eliminated. Such loss can be estimated in advance on the
basis of past experience or chemical data. As waste has practically no value, its treatment in
costing is relatively simple. The normal process loss is recorded only in terms of quantity.
Thus, the cost of normal waste is recovered from the good output because it is a principle of
costing that all normal expenses which are necessarily to be incurred should be included in
the cost of production.
3. Abnormal Waste:
Any loss caused by unexpected or abnormal conditions such as sub-standard
materials, carelessness, accident etc. or loss in excess of the margin anticipated for normal
process loss should be regarded as abnormal waste.
4. Scrap:
Scrap is discarded material having some values. It represents fragments or remnants
of material that are left from certain type of manufacture. It is a material loss but has small
value without further processing. Examples of scrap are available in operations like turning,
boring, punching, sawing, shavings, moulding, etc. from metals on which machine operations
are carried out; saw dust and trimmings in the timber industry; dead heads and bottom ends in
foundries; and cuttings, pieces and splits in leather industry.
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There are three types of scrap, namely:
(a) Legitimate scrap,

(b) Administrative scrap,

(c) Defective scrap.

1. Legitimate scrap,
Legitimate scrap arises due to the nature of operation like turning, boring, punching

etc. as discussed above. This type of scrap can be pre-determined and efforts should be made

that it should not be more than the pre-determined quantity.

2. Administrative scrap
Administrative scrap arises due to administrative action, such as, a change in the

method of production.

3. Defective scrap
Defective scrap arises because of use of inferior quality of material or bad

workmanship or defective machines. Such type of scrap is abnormal because it arises due to

abnormal reasons.
What is Spoilage?
Spoilage is waste or scrap arising from the production process. The term is most
commonly applied to raw materials that have a short life span, such as food used in the
hospitality industry. Normal spoilage is the standard amount of waste or scrap that is
caused by production, and which is difficult to avoid. Abnormal spoilage exceeds the
normal or expected rate of spoilage. For example, an overcooked meal cannot be served
to a customer, and so is instead classified as abnormal spoilage.
Key characteristics of spoilage
1. Unrecoverable loss: Once a product is classified as spoiled, its value cannot be restored
through repair or rework, making it an unrecoverable loss for the company.
2. Separate accounting treatment: Spoiled products are usually accounted for separately
and not included in the cost of goods sold (COGS). Instead, they are recorded under different
accounts such as “spoilage expense” or “scrap costs”.
3. Incurred during production: Spoilage occurs within the production process and is
considered an inherent part of manufacturing operations.

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What is defective in cost accounting?
Defective products or units are those which do not meet with dimensional or quality
standards and are reworked for rectification of defects by application of material, labour
and/or processing and salvaged to the point of either standard product or substandard product
to be sold as seconds.