UNIT 19 RECENT DEVELOPMENTS

IN ACCOUNTING
Structure
19.0 Objectives
19.1 Introduction
19.2 Scope and Limitation of Conventional Financial Accounting
19.3 Inflation Accounting
19.4 Human Resources Accounting
19.5 Social Accounting
19.6 Environmental Accounting
19.7 International Accounting
19.8 Strategic Cost Management
19.9 Activity Based Costing
19.10 IT Developments in Accounting
19.11 Let Us Sum Up
19.12 Terminal Questions
19.13 Further Readings

19.0 OBJECTIVES
The objectives of this unit are to:
! explain some of the recent developments in financial and management
accounting;
! give an overview on special accounting issues like inflation accounting, human
resources accounting, environmental accounting and international accounting;
! give an overview on activity based costing and cost reduction methods; and
! review developments of information technology that are related to accounting.

19.1 INTRODUCTION
The primary role of accounting is to record financial transaction and summarise the
same in a useful format. Financial accountants prepare three principal financial
statements by summarising huge volume of financial transactions namely Profit and
Loss Account, Balance Sheet and Cash Flow Statement. While these three are
reported in annual reports, they also prepare a number of statements for internal
purpose. Cost Accountants prepare a number of statements mainly for internal
purpose and the primary objective of the exercise is to find out the cost of
production. However, the world of accounting or accountant is fast changing.
Modern accountants are expected to be more intelligent than doing a mere
compiling job. You might have seen that even smaller companies are started using
computer software for accounting. With simplification in tax laws, the role of 99
Cost Volume Profit accountant in tax administration is also diminishing. Accountants are also expected to
Analysis provide more information about the non-conventional information. When machines
dominate industrial world, accountants are asked to provide more information about
material things of the firm. Today, in many firms, knowledge is asset. Since financial
reports stated above are not geared to provide such information, accountants are asked
to provide additional information. There is also lot of concerns about the social
behaviour of corporate sector. Hence many are interested in knowing the firms’ effort
on social responsibility and environment. Special reports are devised to address some
of these issues. In this unit, we will briefly discuss some of these reports and recent
developments. Each item discussed here are full subject on its own and depending on
your interest, you can specialise in one or more of the subjects either taking up some
specific issue and mastering them by reading some specialised books or attending
some courses on these topics. It is to be noted that accountants today, are expected to
be more intelligent since computers replaced conventional accountants in many firms.
Activity 1
1) It is the time for you to interact with some of your friends who are in accounting
profession. Have a general chat with them and note down what they have
observed as recent trends in accounting profession.
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2) Take any annual report of some well known companies and find out how much of
space they spend in providing non-financial information?
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19.2 SCOPE AND LIMITATION OF

CONVENTIONAL FINANCIAL ACCOUNTING
It is interesting to know why companies are suddenly focussing on some of the reports,
which we mentioned in the introduction. Alternatively, what is the wrong with the
conventional accounting reports? Accounting reports such as profit and loss account,
balance sheet and cash flow statements provide wealth of information but the question
is whether it is adequate to know about the current or future performance of the
companies. Secondly, not all stakeholders are interested only in knowing the profit or
income details. Future of companies depends on current strength and such strength is
not reflected in the accounting reports. This is particularly true for new economy or
knowledge based companies, which is seeing phenomenal growth in recent times.
Also, many stakeholders would be interested to corporate social behaviour. Some of
the prominent limitations are listed below:
a) The balance sheet is often based on historical value. It fails to show the true
value of the firm in that context. Suppose a company owns 10 acres land in Delhi
or Mumbai, which was purchased some 40 years back at the rate of Rs. 10000
per acre. Is it right on the part of the company to show the value of the land at
the same price in 2003 when the cost of land is several 100 times more than the
purchase value? The above applies to many industrial machines which are used
in the firm but are efficiently managed beyond their normal life. How to reflect
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true and fair value of such assets?
b) Is human resource of a firm not an asset? Today, every company is proudly Recent Developments in
stating that they have so many engineers, doctors, etc. in their company. If so, Accounting
what is the value of such intangible pool of expertise inside the company?
Conventional accounting treat salaries and wages paid to such employees as an
expense but fails to recognise the value of human resources.
c) Can a company be focussed narrowly and always aiming to maximise profit? Is it
not fair to provide something to society particularly when they spoil natural
resources in their normal operation? Many developed nations are shifting their
high-pollution industries to the third world countries to have a clean air in their
countries. When these countries shift their base to third world nations, it is
legitimate expectation of the citizens of these countries that these companies
spend sufficient amount to control pollution and other side effects.
d) Companies have changed the way in which it is operating business. Many
concepts such as just in time (JIT), Total Quality Management (TQM), Flexible
Manufacturing System, etc. are common today. But only very few companies
have changed their costing system. For instance, salaries and wages of many
manufacturing companies constitute an insignificant portion of the total cost but
our costing system not only report the labour cost but also uses the same as cost
allocation basis in some cases. Is it not desirable to change our costing system to
get some reliable cost data?
e) Traditionally, firms use IT only for accounting purpose and such accounting was
standalone without any linkages to mainstream business operation. Today,
accounting information is extensively used and also IT is extensively used
throughout the organisation. Is it right or economical or efficient to have
standalone IT system for each functional area? Is it not desirable to have an
integrated accounting system or more specifically enterprise wide resource
planning (ERP), which performs not only accounting but several other business
operations in a total integrative manner?
Activity 2
1) We listed few reasons why accounting or accountants need to change from
conventional outlook. Can you apply these ideas into anyone of the companies or
to your own company and list out your findings?
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2) Find out from your IT friend how ERP is different from that of accounting pages
like Tally.
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3) Do you feel that spending money on social and environment is wastage of
corporate resources? What do these firms get in return by spending such amount?
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Cost Volume Profit
Analysis 19.3 INFLATION ACCOUNTING
Inflation rate is the percentage change in the price level from the previous period. The
primary objective of inflation accounting is to correct conventional historical cost
accounts for the understatement of inventory and plant used in production, i.e. the cost
of goods sold and depreciation, in order to prevent erosion of capital during inflation.
That is, inflation accounting is used to provide information that is useful to present and
potential investors and creditors and other users in making decisions (and) in assessing
the amounts, timing, and uncertainty of prospective cash receipts from dividends or
interest and the proceeds from the sale, redemption, or maturities of securities or loans.
Inflation accounting was of interest when many developing economies were suffering
inflation rates of 25% or more. Now that rates are in single figures, the debate on the
need of inflation accounting is subdued. Some of the related objectives are:

a) To show the real profit and loss for the period under consideration as against the
profit or loss on the basis of historical cost;

b) To show the real value of the assets and liabilities instead of historical cost; and

c) To ensure that sufficient funds will be available to replace the various assets
when the replacement becomes due.

This objective is generally achieved by the current cost method, which is also much
more responsive to the general objectives of financial reporting. There are alternative
methods like Current Purchasing Power Method, Constant Dollar Accounting Method,
etc. Under the current cost accounting method, fixed assets, stocks, stocks consumed,
etc. are shown in the financial statements at their value to the business and not at the
depreciated value or original cost. Depreciation for the year is calculated on the
current value of the fixed assets. All these things normally leads to reduction in profit
worked out under this method compared to normal historical based profit. Since the
discussion beyond this input is out of the scope of the subject, interested students are
advised to refer to Statement of Standard Accounting Practice (SSAP) 16.

There are limitations to inflation accounting and the failure to recognize them has led to
unnecessary complexity in some methods. Inflation accounting cannot isolate or
condense into one earnings number all of the effects of inflation on a company. It is
simply an improved system of measurement which brings financial statements into
harmony with current costs and values. Such improved statements provide a
foundation for analysis of a company’s economic earnings and financial position in an
inflationary environment, including any special effects of inflation.

Activity 3

1) What is the purpose of using inflation index in the preparation of accounting?

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2) Suppose a company provides inflation-adjusted accounting. In your opinion, who

gains most by using such accounting statement?

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3) Identify a few old cement or fertiliser companies, which have been established Recent Developments in
some 20 years back. Compare their book value and market value of the company Accounting
or price per share. Do you feel that the book value is not representative of current
market value? If so, do you feel that use of inflation accounting resolve such
inconsistency?
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19.4 HUMAN RESOURCES ACCOUNTING

In the case of manufacturing firms, most of the assets are in physical form. These
could be easily traced and valued. Hence it’s not much difficult to find the value of the
firm. Other than the physical assets, manufacturing firms also have assets like
intangible assets like goodwill, brand value etc. are to a greater extent possible to give
an approximate value. The most important is human capital, the ability of employees to
do the things that ultimately make the company work and succeed, particularly in the
case of software firms, the main asset is human being. Is it possible to value human
being? Can we assign a value every individual in the firm? Should we have to value the
human beings, just because they form the main asset in the IT firms? Yes it is utmost
necessary. As in most software companies though the projects are completed on a
team basis, the skills of each individual and his contribution is utmost important. Further,
its not only important only for IT firms it could also be more helpful if such value is
given to employees in manufacturing firm also, so that human beings get to know what
is the value they are contributing to the organisation and how much are they able to
improve in providing the value addition. Hence human resource accounting became
important. But not every company understands their contribution to the bottom line or
knows how to manage them to drive even better financial results, even though they
account for as much as 80 per cent of the worth of a corporation.
What is needed is measurement of abilities of all employees in a company, at every
level, to produce value from their knowledge and capability. Human Resource
Accounting (HRA) is basically an information system that tells management what
changes are occurring over time to the human resources of the business. HRA also
involves accounting for investment in people and their replacement costs, and also the
economic value of people in an organization. The current accounting system is not able
to provide the actual value of employee capabilities and knowledge. This indirectly
affects future investments of a company, as each year the cost on human resource
development and recruitment increases.
The information generated by HRA systems can be put to use for taking a variety of
managerial decisions like recruitment planning, turnover analysis, personnel
advancement analysis and capital budgeting, which can help companies save a lot of
trouble in the future. In India, there are very few companies like BHEL, Infosys and
Reliance Industries, which have implemented HRA and some are working on it.
Infosys, which started showing human resource as an asset in its balance sheet, has
been reaping high market valuations.
Companies can derive many benefits by going in for HRA. Not only can they measure
the return on capital employed on total organisational assets (including the human
assets), but the resources can also be planned accordingly. Once organisations realise
the actual benefit and take it as a growth process, it will only help them in increasing
their shareholders’ value. When a company is able to assess an individual’s worth, it
helps in increasing its own worth. Basically HRA can be tracked through two 103
Cost Volume Profit methods: cost-based analysis and value-based analysis. The cost-based approach
Analysis focuses on the cost parameters, which may relate to historical cost, replacement cost,
or opportunity cost. The value-based approach suggests that the value of human
resources depends upon their capacity to generate revenue. This approach can be
further sub-divided into two broad categories: non-monetary and monetary.
The disposition of resources can also be examined by allocating relative human asset
values to different job grades. HRA also helps in examining expenditure on personnel
and in re-appraisal of expenditure on services and training. It can also serve as a key
factor in case of mergers and takeover decisions, where the human asset value
becomes a relevant factor. Another very significant role, which HRA can help in
creating, is goodwill for a company. The company can project itself in having best
practices with superior policies in place. Experts believe that this may help the
organisation attract more investments.
Infosys in its balance sheets shows Human Resources value at Rs. 9539.15 cr. as on
March 31, 2002. The HRA section of Infosys Annual Report states the following:

The dichotomy in accounting between human and non-human capital is fundamental. The
latter is recognized as an asset and is therefore recorded in the books and reported in the
financial statements, whereas the former is totally ignored by accountants. The definition
of wealth as a source of income inevitably leads to the recognition of human capital as one
of several forms of wealth such as money, securities and physical capital.
The Lev & Schwartz model has been used by Infosys to compute the value of the human
resources as on March 31, 2002. The evaluation is based on the present value of the future
earnings of the employees and on the following assumptions:
1. Employee compensation includes all direct and indirect benefits earned both in India
and abroad.
2. The incremental earnings based on group/age have been considered.
3. The future earnings have been discounted at 17.17% (previous year – 21.08%), this
rate being the cost of capital for Infosys. Beta has been assumed at 1.41 based on the
average beta for software stocks in US.

While HRA as a concept has been present in India for more than a decade, with
BHEL taking a lead, it is only now that the awareness is being translated into
application. However, in terms of awareness and acceptance, the level is still low as
many companies take little initiative to make the numbers public to shareholders,
despite having the data. And there is a lack of an industry standard. This means that
every company has to evolve its own standard, which can become a tedious process,
considering that most of them are still involved in improving their business. Industry
bodies like Nasscom can help set a standard.
Activity 4
1) What is HRA? How different is it from Human Resource Management.
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2) How wide is the application in the area of human resources valuation in India?
Name few companies that are implementing HR valuation.
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3) What are the benefits of human resource accounting for the companies and also Recent Developments in
for the employees? Accounting

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19.5 SOCIAL ACCOUNTING

Social accountability is about being answerable to the people affected by your actions.
Leading organizations now engage relevant stakeholders, including employees,
suppliers, consumers, regulators, NGOs and communities, in open, consequential
dialogue at all levels of business decision-making and activity. They also volunteer
information to these stakeholders on their social performance, thereby making
themselves accountable to these interest groups. Social and ethical accounting, auditing
and reporting is still relatively new in many developing or third world nations, but is
gaining acceptance internationally as the primary demonstration of social
accountability. A social report is the result of a thorough evaluative process focused on
the social impact of a business on all its various stakeholders.
Social accounting and audit is a framework which allows an organisation to build on
existing documentation and reporting and develop a process whereby it can account
for its social performance, report on that performance and draw up an action plan to
improve on that performance, and through which it can understand its impact on the
community and be accountable to its key stakeholders. The social accounting process
should be driven by a rigorous methodology that involves the collection, analysis and
interpretation of quantitative and qualitative data. The accounting systems should be
standardized to facilitate verification by a third party. A social report represents the
disclosure of the company’s social performance in the same way that the annual report
discloses financial performance.
Social accounting is not just a public relation exercise but a strategic intervention that,
in addition to disclosing social performance, serves to steer the company in a
transformation process. This strategic effect is achieved by adhering to the principle of
full disclosure. Both negative and positive performances are declared in the final
report. Consequently the corporation is compelled to perform and the social report has
a level of legitimacy that run-of-the-mill PR efforts do not have.
Effective reputational risk management contributes significantly to gaining and
maintaining a competitive advantage. Today’s informed consumers are increasingly
concerned with the ethical characteristics of a business. And companies that have
values closely aligned with wider societal demands are better placed to recruit and
retain talented employees. A brand associated with ethical business conduct is better
protected in the global market because it enjoys hardier loyalty. Engaging in a social
accounting process, thoroughly and transparently, will enhance your company’s
competitive edge. Some of the social indicators are as follows:
1) Quality of Management
2) Human Rights
3) Environmental Performance
4) Health and Safety
5) Stakeholder Relationships
6) Corporate Social Investment
7) Employment Equity
8) Products and Services 105
Cost Volume Profit Through dialogue with stakeholders, an organization identifies social and ethical
Analysis indicators that will objectively reflect its performance in relation to corporate values
and objectives. The choice of indicators is based on the organization’s statement of
values and the standards, codes and guidelines to which the organization subscribes; on
stakeholders’ perception of the organization’s performance against its values, and in
respect of their specific needs and concerns; and on best practices established in
societies that are part of the social accounting scope, weighed against the societal
needs of the South African context.
Decision-makers must consequently determine which parts of the organization, such as
divisions, departments or sites, are to be measured. The process of improving social
and ethical performance takes time and an organization may choose to limit disclosure
while setting performance targets and goals for more comprehensive reporting over
time. These decisions should be declared in the social report if credibility is to be
maintained. Once indicators have been established and the parts of the organization to
be evaluated identified, relevant data must be collected. Initially this may prove
challenging because there is seldom a system in place for deliberately measuring social
impacts. Producing the first social performance report will educate the organization as
to the nature of Social Impact Accounting Systems (SIAS) needed for rigorously and
objectively measuring performance.
Collected data is analysed and a social performance report is produced. The manner in
which publication and distribution is addressed may be taken as indicative of the
organization’s commitment to ethical and socially responsible business practice.
Consequently, the report should be afforded the care and status devoted to the
traditional annual report on financial performance. And in the same way that a
company’s financial performance is audited for assurance, social performance should
be submitted to the same intense scrutiny.
The core business of community and social enterprises and of community organisations
is to achieve some form of social, community or environmental benefit. Financial
sustainability or profitability is essential to achieving that benefit, but subsidiary to it.
The organisation and all the people associated with it or affected by it need to know if
it is achieving its objectives, if it is living up to its values and if those objectives and
values are relevant and appropriate. That is what the social accounting process aims to
facilitate.
A full set of Social Accounts is likely to include the following:
1) A report on performance against the stated objectives (How well have we done
what we said we would do? )
2) An assessment of the impact on the community (Can this be measured? What do
people think?)
3) The views of stakeholders on our Objectives and Values (Are we doing the
“right” things? Are we “walking our talk”?)
4) A report on environmental performance (Are we “living lightly” and minimizing
resource consumption?)
5) A report on how we implement equal opportunities (Do we effectively encourage
social inclusion?)
6) A report on our compliance with statutory and voluntary quality and procedural
standards (Do we do what is expected of us, and more?)
Keeping social accounts gives us the information we need qualitative and quantitative
to tell us how we are performing and what people think about what we do, and how
we do it. This is a social balance sheet so that all stakeholders can decide for
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themselves whether to use, work for, support, or invest in the organisation. Through the Recent Developments in
production of audited social accounts the organisation can fulfil its accountability to its Accounting
stakeholders. The overarching principle of social accounting and audit is to achieve
continuously improved performance relative to the chosen social objectives and to the
stated values. Six specific key principles have been identified from recent theory and
practice as underpinning the concept and good practice.

19.6 ENVIRONMENTAL ACCOUNTING

Environmental accounting is defined as the accountants’ contribution towards
environmental sensitivity in organizations. It gained prominence in the 1990s. The
emphasis on the social responsibilities of the accountancy profession is not new, having
been led to prominence by the social accounting debate of the 1970s. The social
consciousness of the accountancy profession was started to receive its attention. It
focused on extending accountability to numerous stakeholders by necessitating
disclosure of social information in corporate annual reports. The accountability function
of accounting was believed to be fulfilled by reporting (financial and social) information
that stakeholders would find useful in their decision making process.
This led to the appearance of environmental, employee and ethical information on a
voluntary basis in modern day corporate annual reports. Unfortunately, social
accounting as discussed in the earlier section, failed to make its way into the
mainstream accounting agenda, largely due to lack of mandatory standards to guide it
and value judgments associated with determination of social responsibilities of an
organization. In spite of this, there has been renewed interest in social accounting in
the 1990s, triggered by the urgency associated with reducing environmental problems
that exist today.
Practical developments of environmental accounting saw tremendous growth in
research, with various initiatives and proposals being put forward by accountancy
bodies and related international organizations. In essence, environmental accounting
now plays a vital role in daily commercial undertakings, attempting to ensure that
development is not at odds with environmental protection. The potential for
accountants to make a significant contribution towards environmental consciousness in
organizations has been envisaged through their managerial, auditing and reporting skills.
Increasingly, the emphasis has shifted from social accounting in general to a more
specific environmental accounting. These days, social accounting has become
synonymous with the term social and environmental accounting (SEA), a linkage that
places due emphasis on the importance of environmental issues.
The fundamental premise behind environmental accounting is that organizations should
internalize environmental costs. Currently, these costs are externalized, which means
that the society bears the impact of an organization’s adverse activities on the
environment, largely due to the fact that is a “public good”. Internal environmental
accounting mechanisms such as life cycle costing or even full cost accounting attempt
to trace costs of the organization’s activities on the environment. It is believed that
once organizations are made accountable for these costs, they would be compelled to
minimize the potentially harmful effects of such activities. Further, environmental
accounting requires organizations to forecast the potential environmental impact of
their activities and accordingly estimate contingent liabilities and create provisions for
environmental risk.
Accountants’ role in environmental issues extends beyond management of the internal
mechanisms (environmental management accounting). They could be responsible for
the disclosure of environmental information, primarily in corporate annual reports, but
also through some other communication media. Environmental reporting provides
accountability to the wider society of the organization’s commitment to environmental 107
Cost Volume Profit consciousness. Disclosure could constitute monetary information such as
Analysis environmental costs, liabilities, provisions and contingencies, coupled with quantitative
and descriptive information such as ecological data (for example, physical
measurement of environmental impacts), environmental policies, targets and
achievements.
The Environmental Accounting was first considered a new field in accounting in during
1998 by the intergovernmental work group ISAR (United Nations Inter governmental
Working Group of Experts on International Standards of Accounting and Reporting).
Jointly with this work, ISAR has been coordinating efforts with IAPC (International
Auditing Practices Committee) to formalize a group of audit standards for verification
of the environmental performance reported on accounting statements. This work group
basically emphasised the need for environmental accounting to cover the following
basic objectives: (a) assistance of professionals in other fields of knowledge; (b) give
the status of the information system of the analyzed company, as regards the
preparation of its internal controls to provide its financial accounting with relevant
information on environmental aspects; and (c) effective contribution of various
external intervenors, as the consulting specialists, certification companies and
independent auditors, to grant an independent opinion on specific aspects of the report.
The concept of sustainable development catching on rapidly, corporate and industrial
houses across the world are increasingly incorporating the environmental element in
their day-to-day business operations. They are clear in their perception that along with
quality, safety of the environment, too, is an important factor in making a business
successful.
Activity 5
1) Take the annual report of top 5 companies in the Petrochemicals industry and find
out which part of the report covers the environmental accounting if given?
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2) How efficiently companies follow the environmental accounting requirements?
Do you find any deviance from what they actually practice and what they report
in their financial reports? If so, given an instance of any company violating the
same.
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19.7 INTERNATIONAL ACCOUNTING

Many Indian companies, particularly in pharmaceutical and software industry have
overseas operations. With trade liberalisation in place, many Indian companies would
be future multinationals. When firms operations move international, not only on
manufacturing and marketing but also investors, accounting of different business
operations located at different countries under one roof becomes difficult. There are
two potential problems that an accountant faces in dealing with such consolidation.
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Accounting standards differ in several countries and investors of those countries Recent Developments in
require the financial statements using their countries accounting standards to enable Accounting
them to compare the company with other company. For instance, if you are a
shareholder of Hindustan Lever Ltd., or Castrol India Ltd. you would like to have the
financial statements under Indian GAAP. Think about an investor of Unilever located
either in Netherlands or UK, who has majority stake in Hindustan Lever. While
consolidating the Hindustan Levers Ltd. financial statements with Unilever statements,
the investors of Unilever expects Hindustan Levers Ltd., financial data also reflects
their countries GAAP. The task turns complex further if the shareholders are located
in different countries. For instance, Infosys or many other top rated Indian companies
shares are held by several FIIs whose investors are located across the globe and
investors of ADR of these companies are also located in different parts of globe. If
Infosys prepares financial statements only on the basis of Indian GAAP, they will not
be happy. By virtue of agreement with overseas stock exchanges, Infosys may be
required to present a separate statement following the US GAAP. But what about the
investors in Japan, who has also purchased shares of infosys either directly or
indirectly through FII. Today, many companies started giving separate financial
statement using major countries GAAP to satisfy the investors of those countries.
While it adds cost of compiling financial reports, it brings lot of goodwill.
Firms operating in different countries also have certain peculiar problem. For instance,
your company’s overseas venture would have posted increased profit during a period
but when you convert the profit in your currency, you might be alarmed to see that
profit has actually come down from the previous year if there is a currency
depreciation in the country. On the other hand, the performance of overseas country
might have actually come down but when we convert the same to our currency, the
performance might have improved if our currency appreciates during the period.
Handling multi-currency business operations in consolidation is another complex task in
international accounting.
Activity 6
1) Collect or download from the company’s website the annual report of Infosys or
Wipro or Asian Paints. Read the statement of significant accounting polices of
consolidated financial statements. List down your observation/understanding?
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2) Visit http://www.icai.org and locate Accounting Standard page. Download AS 21
and AS 27. Write a one page note on each accounting standard after reading the
same.
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19.8 STRATEGIC COST MANAGEMENT

The field of management accounting has also seen considerable changes in recent
times. When industrialisation was limited and economies were closed for external
competition and also having restricted internal competition, managers decision making
scope was normally restricted to few operational decision making such as production
optimisation, product mix, setting discount policies, etc. Conventional cost and financial
accounting provide adequate information for such decisions. However, over a period
of time, business environment has completely changed and internal and external 109
Cost Volume Profit competitions have become the order of the day. Top management of any firm, small,
Analysis medium, large or multinational, are increasingly spending time on strategic decision and
cost and financial data are extensively used along with input drawn from the
environment, which includes competitors’ financial and non-financial information. A
new discipline called ‘strategic cost management’ or ‘strategic management
accounting’ addresses these issues. The following issues are typically addressed using
cost input from strategic perspective:
a) Value Chain Analysis : Let us take an example of a product say television
which we use daily in our life to understand the concept. The television set
which you are using is giving you some value - educative or entertainment value.
There are so many organisations, which are involved in the whole process of
manufacturing and delivering the television to you. All these organisations are
adding value at each stage to the product and what you get finally the collective
amount of all value addition. The value chain analysis looks into how much of
value addition has taken place at each stage of the whole process. It helps the
organisations to identify the place where they need to be there to maximise the
reward and at the same time using their expertise. If all organisations try to
reduce the total cost of the value chain, then customers get benefit out of such
exercise. For instance, if you are manufacturing PET bottles, which are used by
many mineral water manufacturing companies you have two options in setting up
your plant. One, you can put up a centralised huge plant to achieve economies of
scale but force your customers to hold more inventory since without bottles, it is
difficult to run the plant. Alternatively, you can put up smaller plants near
manufacturer. While this will add cost of manufacturing, but it will bring down
inventory level. As PET bottle manufacturer, you need to look beyond your
costing and see the value chain.
b) Activity-based-costing (ABC) : ABC looks into a firm as a bunch of activities
and hence focuses more on activity analysis, cost associated in performing such
activities and then finally ways to perform the activities better while reducing the
cost. ABC provides more accurate cost data than conventional costing system
and such reliable costing is often required for strategic decision. ABC is also
useful to identify value added and non-valued activities.
c) Customer cost analysis : Do you feel all your customers are equally important
to you? If you ask this question to MD of a large company, the answer will be
most probably ‘Yes’ since today every company wants to be customer focussed
and it is immaterial whether the customer is small customer or large customer.
Suppose you ask another question to the same MD - are all your customers
equally profitable? The answer need not be ‘Yes’ and often the answer is ‘No’.
Customers are increasingly demanding and hence the cost of providing services
to customers significantly differ from customers to customers. How many
companies trace the cost up to the customer level? They normally stop costing
exercise upto the product level and that too with some ad hoc overhead
allocation. You need reliable cost data to measure customer profitability.
d) Competitor cost analysis: Can you run a company without understanding
competitor? The answer would be probably ‘yes’ in some 15 years back and
today it is a strong ‘NO’. What do you want know about the competitor ?
Apart from several other things, you would like to know their cost structure. An
understanding of their cost structure is helpful in several ways. For instance, if
the material cost of the competitors is lower than your company, you can start
looking for alternative source of buying or changing material quality or change.
e) Target costing: Here, costing of product starts before the product gets into the
production stage. Many experts find that the best way to reduce the cost is spend
110 time while products are under development. Because, once a product design is
 completed, about 80% of the costs are pre-determined. For instance, imagine you Recent Developments in
want to construct a hotel and run profitably. The operating cost of running a hotel Accounting
is relatively small compared to fixed cost. So the best way to reduce the cost is
to spend more time and energy in drawing the construction plans and
economically using the space, material and other items. This applies to many
manufactured products like watch or television or air-conditioner. Target costing is
done with the help of set of employees drawn from several functional areas, who
together participate in the development exercise with a single goal of designing a
product whose cost is less than target cost.

In addition to the above, there are several other strategic cost management techniques
like life-cycle costing, capacity costing, etc. For all these techniques, activity based
costing is used as a principle cost information. we will discuss briefly the activity based
costing. Under 19.9 of this Unit.

Activity 7

1) How value chain analysis is different from value analysis?

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2) Indian Railways moves passengers and goods from one place to other place. Can
you perform value chain analysis for Indian Railways and find out how they can
add value to passengers and business communities, which use the freight service?

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3) Compare whether the profit changes are in line with the changes in cash flow
from operating activities.

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4) Suppose one of the co-operative banks want to consult you in helping customer
cost analysis. Can you briefly tell how you can go about in helping the bank?

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19.9 ACTIVITY BASED COSTING

Accurate and relevant cost information is critical to any organisation that hopes to
maintain, or improve, its competitive position. For years, firms operated under the
assumption that their cost information actually reflected the costs of their products and
services when, in reality, it did nothing of the kind. Over-generalised cost systems were
actually misleading decision makers, causing them to make decisions inconsistent with
their organisations’ needs and goals, principally because of misallocated costs. 111
Cost Volume Profit Activity-based costing (ABC) is a valuable concept that can be used to correct the
Analysis shortcomings in the cost systems of the past. It is a means of creating a system that
ultimately directs an organisation’s costs to the products and services that require those
costs to be incurred. ABC can be used this way because it provides a cross-functional,
integrated view of the firm, its activities and its business processes.

As a result, in many organisations, ABC has evolved beyond the point of simply
developing more accurate and relevant product, process, service and activity costs.
These organisations use ABC as a means of improving operations by managing the
drivers of the activities that cause costs to be incurred. They are using ABC to support
major decisions on product lines, market segments and customer relationships, as well
as to simulate the impact of process improvements. Organisations involved in Total
Quality Management processes are using both the financial and non-financial
information of ABC as a measurement system.

The basic distinction between traditional cost accounting and ABC is as follows:
traditional cost accounting techniques allocate costs to products based on attributes of
a single unit. Typical attributes include the number of direct labour hours required to
manufacture a unit, purchase cost of merchandise resold, or number of days occupied.
Allocations, therefore, vary directly with the volume of units produced, cost of
merchandise sold, or days occupied by the customer. In contrast, ABC systems focus
on activities required to produce each product or provide each service based on each
product’s or service’s consumption of the activities.

Using ABC, overhead costs are traced to products and services by identifying the
resources, activities and their costs and quantities to produce output. A unit of output
(a driver) is used to calculate the cost of each activity. Cost is traced to the product or
service by determining how many units of output each activity consumed during any
given period of time. An ABC system can be viewed in two different ways. The cost
assignment view provides information about resources, activities and cost objects. The
process view provides operational (often non-financial) information about cost drivers,
activities and performance.

ABC does not only apply to manufacturing organisations, it is also appropriate for
service organisations such as financial institutions, and medical care providers and
government units. In fact, some banking firms have been applying the concept for
years under another name - unit costing. Unit costing is used to calculate the cost of
banking services by determining the cost and consumption of each unit of output of
functions required to deliver the service.

Activity 8

1) How ABC is different from that of conventional costing?

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2) Can you list at least three examples where ABC gives different cost value
compared to conventional costing?

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112
3) List down any three uses of ABC in strategic cost application? Recent Developments in
Accounting
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19.10 IT DEVELOPMENTS IN ACCOUNTING

Accounting is one of the earliest operation that has seen computerisation in the
commercial world. Today, we have reached a stage in which almost all accounting
operations are done through computers. What is the use of computers in accounting?
Book-keeping is monotonous job and it is best done by machine than men. Further,
accuracy and speed of the operation improves considerably. Most importantly,
transactions are entered only once and all further operations are done by the machine.
Compare this with manual operations in which someone keep basic day books,
someone posts it to ledger and prepares trial balance and someone prepares financial
reports. When the level of computerisation expands and includes several other
business operations, the task improves considerably.
Today, many companies are using Enterprise Resource Planning (ERP) software like
SAP, Peoplesoft, etc. ERP attempts to integrate all departments and functions across a
company to create a single software program that runs off one database. For instance,
if your planning is very good, the ERP system operates like this. Suppose, the inventory
level has come down below certain level. Your ERP system immediately generates
purchase order and electronically placed the same to the pre-defined vendor. When the
vendor supplies the material, you are making two entries - one at the stores level for
the receipt of the material and one at the accounts department for invoice data. The
machine compares the two and pass the bill for payment. On the due date, cheques
are printed and accounting of payment is done electronically.
What is the use of such integration? It avoids duplication of systems and data entry or
data transport from system to another. Major benefit of ERP is better planning and
control. Suppose, you have made a plan for the next year sometime around January
2003 (for the period of April 2003 to March 2004). Sometime around July you have
found that the performance of the first quarter is better than what you have expected
and hence you want to increase your target and reset the budget. While it may be
easier to change overall budget values, no one knows what will be changes required at
various stages unless there is an integration. Planning doesn’t end with the boardroom.
To translate the planning into action, changes are required every stages and people
should realise what kind of problems it may pose when we change the plan. For
instance, such an upward revision may require additional working capital or identifying
new supplier for the material or booking of additional railway wagon. ERP software
typically identifies all such problems and helps you to optimise using simple to advance
modelling.

19.11 LET US SUM UP

Accounting primarily complies monetary transactions taken place between the
company and others and prepares financial statements. Accounting information is used
by several users. A significant part of the accounting system is today handled by
computers and hence requires accountants to upgrade the skills. Top management as
well as other stakeholders expect accountant to provide useful information in addition
to traditional income statement and balance sheet. For instance, the profit shown under
profit and loss account is unreliable in a situation of high inflation or when the assets
are very old. The company may not have adequate funds to meet the expenditure.
113
Cost Volume Profit Accountants are expected to provide insight on the future growth prospects of
Analysis companies in an inflationary condition. Similarly, stakeholders, particularly those other
than shareholders, would be interested to know the contribution of company to social
causes and how it respects environmental and other issues. Though in a narrow sense,
shareholders are not concerned on this issue, their interest is also affected if the firm
fails to consider the interest of society. Shareholders interest of automobile companies,
textile companies, tobacco companies, etc. is affected if these companies fail to
comply environmental issues. Accountants are also expected to provide information of
intangibles, which are particularly relevant for knowledge-based companies and other
service organisations. Human Resources Accounting, Brand Valuation, etc. are
important pieces of information that stakeholders expect to be incorporated in the
balance sheet. In addition to these inputs, accountants are expected to provide lot of
inputs that are used for strategic decision making process. For instance, accountants
have to collect the details on product-wise, geographic-wise, customer-wise, etc. and
also information pertaining to competitors. Accountant inputs are extensively used for
bench marking exercises and also decision such as out-sourceing. Since the
stakeholders are geographically spread all over the world, many companies are
showing accounting results under several accounting standards to satisfy the needs of
investors, employees, suppliers, customers and government authorities of several
countries. Modern accountants are also expected to be computer-savvy and be
familiar to work in a computerised networking environment. Companies spend
substantial money in IT and integrate all their operations. While on the one hand,
accountants role is declining on account of computerisation, accountant contribution
and involvement at high-end are increasing. For instance, today accounting processes
are centralised and concepts like shared service operation are emerging. In this, the
shared service operation provider maintains the accounts of several companies and
general many value added reports for the management. In other words, accounting
profession is as challenging as any other professions and also highly rewarding.
Interested students can refer the Shareholders Information section of the Annual
Report of Infosys Technologies Limited (page numbers (page number 137 to 162).
It covers intangible assets score sheet, human resources accounting and value-added
statement, brand valuation, balance sheet (including intangible assets), current-cost-
adjusted financial statements, economic value-added (EVA) statement, ratio analysis,
statutory obligations, value reporting and management structure. It gives you a real life
perspective on current trends in accounting. You can download the report from the
company’s website (http://infosys.com/investor/reports/annual/Infosys_AR03.pdf).

19.12 TERMINAL QUESTIONS

1) When conducting a social audit, what are the things must a company do?
2) What is the benefit of companies being socially responsible?
3) For what type of industries, Human Resource Accounting is most suitable? Is it
relevant to countries like India? Explain.
4) Inflation rates have come down in the last few years in many countries including
India. Do you feel inflation accounting has a role? Discuss your answer.
5) Is environmental accounting PR exercise? How do you perform environmental
accounting and auditing of fertiliser company?
6) How does activity based costing differ from traditional costing approach?
7) What is the role of cost accounting/cost data in strategic management?
8) Suppose your company wants to pursue product differentiation strategy. How as an
accountant you will be useful for this exercise?
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9) List down some of the major benefits to a company on account of computerised Recent Developments in
accounting system. Accounting

10) How implementation of ERP is different from computerisation of accounting function?

Note : These questions will help you to understand the unit better. Try to write
answers for them. But do not submit your answers to the University.
These are for your practice only.

19.13 FURTHER READINGS

Bowman, E. H. and M. Haire. 1976. Social Impact Disclosure and Corporate Annual
Reports. Accounting, Organizations and Society 1(1): 11-21.
Brandon, C. H. and J. P. Matoney, Jr. 1975. Social Responsibility Financial Statement.
Management Accounting (November): 31-34.
Cowen, S. S., L.. B. Ferreri and L. D. Parker. 1987. The Impact of Corporate
Characteristics on Social Responsibility Disclosure: A Typology and Frequency-based
Analysis. Accounting, Organizations and Society 12(2): 111-122.
Elias, N. and M. Epstein. 1975. Dimensions of corporate social reporting. Management
Accounting (March): 36-40.
Geoffrey Whittington (1983), Inflation Accounting: An Introduction to the Debate,
Cambridge University Press.
Gray, R. 2002. The Social Accounting Project and Accounting Organizations and
Society Privileging Engagement, Imaginings, New Accountings and Pragmatism Over
Critique? Accounting, Organizations and Society 27(7): 687-708.
Jack Quarter, Laurie Mook, Betty Jane Richmond (2002),What Counts: Social
Accounting for Non Profits and Cooperatives, Prentice -Hall.
Lehman, G. 1999. Disclosing new worlds: A Role for Social and Environmental
Accounting and Auditing. Accounting, Organizations and Society 24(3): 217-241
Lyn M Fraser and Aileen Ormiston, Understanding Financial Statements
(Sixth Edition), Prentice-Hall of India Private Ltd. New Delhi
Pramanik, Kumar A. (2002) Environmental Accounting and Reporting, New Delhi,
Deep & Deep, 2002.
Robert Bloom Araya Bebessay, Inflation Accounting: Reporting of General and
Specific Price Changes, Greenwood Publishing Group.
Roberts, R. W. 1992. Determinants of Corporate Social Responsibility Disclosure:
An application of stakeholder theory. Accounting, Organizations and Society
17(6): 595-612.

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