Engineered, discretionary and committed costs

Ajilal

ENGINEERED, DISCRETIONARY AND COMMITTED COSTS

Ajilal, GIMS

CONTENT• Introduction

• Engineered Cost

• Discretionary Cost

• Committed costs

• Steps

• Approaches

Ajilal, GIMS

INTRODUCTION

Responsibility CentersA responsibility center is an organizational subsystem charged with a well-defined mission and headed by a manager accountable for the performance of the center.

"Responsibility centers constitute the primary building blocks for management control." It is also the fundamental unit of analysis of a budget control system.

Ajilal, GIMS

CONT…

A Responsibility Center is an organization unit headed by a responsible manager.

There are four major types of responsibility centers are;

Cost centers

Revenues centers

Profit centers

Investment centers.

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Cost Centre

A cost centre is a responsibility centre in which manager is held responsible for controlling cost inputs.

There are two general types of cost centres

Engineered expense centres

Eiscretionary expense centres.

Cont…

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CONT…An engineered cost centre is a centre where an output can be quantitativelymeasured and there is a reasonably good understanding of the input/outputrelationship, i.e. the level of costs that should be incurred to achieve a specified level of output is known.

Examples of engineered cost centres in hotels include housekeeping

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DISCRETIONARY EXPENSE CENTRE

A Discretionary Expense Centre is a responsibility centre whose budgetary performance is based on achieving its goals by operating within predetermined expense constraints set through managerial judgement or discretion.

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Revenue CentreA revenue centre is a responsibility centre whose budgetary performance is measured primarily by its ability to generate a specified level of revenue.

Profit CentreIn a profit centre, the budget measures the difference between revenues and costs.

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Investment CentreAn investment centre is a responsibility centre whose budgetary performance is based on return on investment.

Engineered cost centres, discretionary expense centre, and revenue centres are more often used with Functional Organization Designs and with the function units in a Matrix Design.

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ENGINEERED COSTS

Engineered costs are elements of cost for which the "right" or "proper" amount of costs that should be incurred can be estimated with a reasonable degree of reliability.

For example : Costs incurred in a factory for direct labor, direct material, components, supplies, and utilities.

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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.

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DISCRETIONARY COSTS

Discretionary costs are those for which no such engineered estimate is feasible; the amount of costs incurred depends on management's judgment about the amount that is appropriate under the circumstances.

The costs of the inputs, or resources required to perform such activities are referred to as discretionary costs.

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CONT…

These costs are discretionary in the sense that management must choose the desired level of the activity based on intuition or experience because there is no well-defined cause and effect relationship between cost and benefits.

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Discretionary costs are usually generated by service or support

activities.

It is also called Discretionary Expenditure or Managed Cost

In terms of cost behavior, discretionary costs may be fixed, variable or

mixed.

Cont…

Ajilal, GIMS

Discretionary costs relate to company activities that are important but whose level of funding is subject to judgment.

Discretionary costs are generated by activities that vary in type and magnitude from day-to-day and whose benefits are often not measurable in monetary terms.

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CONT…

In addition, performance quality can also vary according to the task and employee skill levels involved.

Discretionary cost activities are usually service oriented and include employee travel, repairs and maintenance, advertising, research and development, and employee training and development.

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COMMITTED COSTS

Committed costs refers to the costs associated with establishing and maintaining the readiness to conduct business. The benefits obtained from these expenditures are represented by the company's infrastructure.

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.

These costs are mainly fixed in terms of cost behavior and expire to become expenses in the form of amortization and depreciation.

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Control of committed costs is first provided during the capital budgeting evaluation process when expected benefits are compared to the expected costs of investing in plant assets or human resources.

Managers must decide which activities are necessary to attain company objectives and determine which assets are needed to support those activities.

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CONT…

Another method of controlling committed costs involves comparing actual and expected results from plant asset investments (a post investment audit).

Company management is committed to the plant asset investments for some time period, but changes in circumstances might necessitate changes in the level of commitment.

STEPS TO IDENTIFY DIFFERENT TYPE OF COST

1A. Is management able to change in the short run the amount of a cost?

1B. If the answer is no, then the cost is committed and its level cannot be avoided

2A. Does the cost depend on the level of other variable such as sales volume, headcounts, product features?

2B. If the answer is yes then the cost is engineered

2C. If the answer is no, then the cost is a discretionary cost.

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APPROACHES TO BUDGETINGReference to Engineered, Standard & Discretionary Costs

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The starting point in preparing the budget is the current level of spending. The

budgeter adjusts these amounts for anticipated inflammation, cost implications

of the changes in the job to be done and in some cases for anticipated

productivity improvements. In some companies, the preparation of budget

preceded by a zero base review.

In the case of engineered expense centre/standard cost centre, management must

decide whether the proposed operating budget represented the cost of

performing a task efficiently for the coming period.

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CONT…

In the case of discretionary cost centre, while formulating the budget,

managements’ principal task is to decide on the magnitude of the job

that should be done, because based on such job expenses/resources are

budgeted.

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Thank You