Engineered, discretionary and committed costs

Management Control System,
Meaning & Definition
Costs
Engineered, Discretionary and Committed costs
Approaches
Steps

1. Ajilal
ENGINEERED, DISCRETIONARY
AND COMMITTED COSTS

2. CONTENT
•Introduction
•Engineered Cost
•Discretionary Cost
•Committed costs
•Steps
•Approaches
Ajilal, GIMS

3. INTRODUCTION
Responsibility Centers
Aresponsibilitycenterisanorganizationalsubsystemchargedwitha
well-definedmissionandheadedbyamanageraccountableforthe
performanceofthecenter.
"Responsibilitycentersconstitutetheprimarybuildingblocksfor
managementcontrol."Itisalsothefundamentalunitofanalysisofa
budgetcontrolsystem.
Ajilal, GIMS

4. CONT…
AResponsibilityCenterisanorganizationunitheadedbya
responsiblemanager.
There are four major types of responsibility centers are;
Cost centers
Revenues centers
Profit centers
Investment centers.
Ajilal, GIMS

5. CostCentre
Acostcentreisaresponsibilitycentreinwhichmanagerisheldresponsible
forcontrollingcostinputs.
There are two general types of cost centres
Engineered expense centres
Eiscretionaryexpense centres.
Cont…
Ajilal, GIMS

6. CONT…
Anengineeredcostcentreisacentrewhereanoutputcanbequantitatively
measuredandthereisareasonablygoodunderstandingoftheinput/output
relationship,i.e.thelevelofcoststhatshouldbeincurredtoachievea
specifiedlevelofoutputisknown.
Examplesofengineeredcostcentresinhotelsincludehousekeeping
Ajilal, GIMS

7. DISCRETIONARY EXPENSE CENTRE
ADiscretionaryExpenseCentreisaresponsibilitycentrewhose
budgetaryperformanceisbasedonachievingitsgoalsbyoperating
withinpredeterminedexpenseconstraintssetthroughmanagerial
judgementordiscretion.
Ajilal, GIMS

8. Revenue Centre
Arevenuecentreisaresponsibilitycentrewhosebudgetaryperformance
ismeasuredprimarilybyitsabilitytogenerateaspecifiedlevelof
revenue.
Profit Centre
Inaprofitcentre,thebudgetmeasuresthedifferencebetweenrevenues
andcosts.
Ajilal, GIMS

9. Investment Centre
Aninvestmentcentreisaresponsibilitycentrewhosebudgetary
performanceisbasedonreturnoninvestment.
Engineeredcostcentres,discretionaryexpensecentre,andrevenuecentres
aremoreoftenusedwithFunctionalOrganizationDesignsandwiththe
functionunitsinaMatrixDesign.
Ajilal, GIMS

10. ENGINEERED COSTS
Engineeredcostsareelementsofcostforwhichthe"right"or"proper"
amountofcoststhatshouldbeincurredcanbeestimatedwitha
reasonabledegreeofreliability.
For example : Costs incurred in a factory for direct labor, direct
material, components, supplies, and utilities.
Ajilal, GIMS

11. Characteristics
•Their input can be measure in monetary terms .
•Their output can be measured in physical terms
•The optimal rupee amount of input required to produce one unit of
output can be established.
Ajilal, GIMS

12. DISCRETIONARY COSTS
Discretionarycostsarethoseforwhichnosuchengineeredestimate
isfeasible;theamountofcostsincurreddependsonmanagement's
judgmentabouttheamountthatisappropriateunderthe
circumstances.
Thecostsoftheinputs,orresourcesrequiredtoperformsuch
activitiesarereferredtoasdiscretionarycosts.
Ajilal, GIMS

13. CONT…
Thesecostsarediscretionaryinthesensethat
managementmustchoosethedesiredlevelofthe
activitybasedonintuitionorexperiencebecausethere
isnowell-definedcauseandeffectrelationship
betweencostandbenefits.
Ajilal, GIMS

14. Discretionarycostsareusuallygeneratedbyserviceorsupport
activities.
It is also called Discretionary Expenditure or Managed Cost
Intermsofcostbehavior,discretionarycostsmaybefixed,variableor
mixed.
Cont…
Ajilal, GIMS

15. Discretionarycostsrelatetocompanyactivitiesthatareimportant
butwhoseleveloffundingissubjecttojudgment.
Discretionarycostsaregeneratedbyactivitiesthatvaryintypeand
magnitudefromday-to-dayandwhosebenefitsareoftennot
measurableinmonetaryterms.
Ajilal, GIMS

16. CONT…
Inaddition,performancequalitycanalsovaryaccordingtothetask
andemployeeskilllevelsinvolved.
Discretionarycostactivitiesareusuallyserviceorientedandinclude
employeetravel,repairsandmaintenance,advertising,researchand
development,andemployeetraininganddevelopment.
Ajilal, GIMS

17. COMMITTED COSTS
Committedcostsreferstothecostsassociatedwithestablishingand
maintainingthereadinesstoconductbusiness.Thebenefitsobtainedfrom
theseexpendituresarerepresentedbythecompany'sinfrastructure.
For example, the costs associated with the purchase of a franchise, a patent,
drilling rights and plant and equipment create long term obligations that fall
into the committed cost category.
Thesecostsaremainlyfixedintermsofcostbehaviorandexpiretobecome
expensesintheformofamortizationanddepreciation.
Ajilal, GIMS

18. Controlofcommittedcostsisfirstprovidedduringthecapital
budgetingevaluationprocesswhenexpectedbenefitsare
comparedtotheexpectedcostsofinvestinginplantassetsor
humanresources.
Managersmustdecidewhichactivitiesarenecessarytoattain
companyobjectivesanddeterminewhichassetsareneededto
supportthoseactivities.
Ajilal, GIMS

19. CONT…
Anothermethodofcontrollingcommittedcostsinvolves
comparingactualandexpectedresultsfromplantasset
investments(apostinvestmentaudit).
Companymanagementiscommittedtotheplantasset
investmentsforsometimeperiod,butchangesin
circumstancesmightnecessitatechangesinthelevelof
commitment.
Ajilal, GIMS

20. STEPS TO IDENTIFY
DIFFERENT TYPE OF
COST
1A.Ismanagementabletochangein
theshortruntheamountofacost?
1B.Iftheanswerisno,thenthecost
iscommittedanditslevelcannotbe
avoided
2A.Doesthecostdependonthelevel
ofothervariablesuchassales
volume,headcounts,product
features?
2B.Iftheanswerisyesthenthecost
isengineered
2C.Iftheanswerisno,thenthecost
isadiscretionarycost.

21. APPROACHES TO BUDGETING
Reference to Engineered, Standard & Discretionary Costs
Ajilal, GIMS

22. Thestartingpointinpreparingthebudgetisthecurrentlevelofspending.The
budgeteradjuststheseamountsforanticipatedinflammation,costimplicationsof
thechangesinthejobtobedoneandinsomecasesforanticipatedproductivity
improvements.Insomecompanies,thepreparationofbudgetprecededbyazero
basereview.
Inthecaseofengineeredexpensecentre/standardcostcentre,managementmust
decidewhethertheproposedoperatingbudgetrepresentedthecostofperforming
ataskefficientlyforthecomingperiod.
Ajilal, GIMS

23. CONT…
Inthecaseofdiscretionarycostcentre,whileformulatingthebudget,
managements’principaltaskistodecideonthemagnitudeofthejob
thatshouldbedone,becausebasedonsuchjobexpenses/resourcesare
budgeted.
Ajilal, GIMS

24. Thank You
Ajilal, GIMS