Unit Based Costing and its Benefits at Hindustan Petroleum Corporation Ltd.

To support compliance with financial reporting requirements. Typically, costs are allocated for either valuation purposes (i.e., financial statements for external users) or decision-making purposes (i.e., internal uses) or both.

Traditional cost accounting system is often articulated with its general ledger system1) Accumulate costs within a production or non-production department; 2) Allocate non-production department costs to production department costs;3) Allocate the resulting (revised) production department costs to various products, services, or customers.

Non Production Cost

Production Cost

Production Cost (Revised)

Note: - Cost Derived from this traditional approach suffer from several defects that can result in distorted costs for decision-making purposes. For example if in a refinery, a unit is sitting idle than also the cost incurred by that unit will be allocated to the different products produced by refinery.

In order to remedy such distortions, many companies have adopted a different cost-allocation approach called ACTIVITY-BASED COSTING (ABC).In retrospect with traditional cost-accounting system, 1. The ABC accumulates overheads cost for different organizational activity, and2. Then assign the cost to the products, services or customers (cost objects)

causing that activity. 3. Thus it helps in measure of cost of different activities and resources and then

individually assigning their effects on the costs of making a product or providing a service.

•Cost of a product is the sum of the costs of all activities required to manufacture and deliver the product.•Products do not consume costs directly•Money is spent on activities•Activities are consumed by product/services•ABC assigns Costs to Products by tracing expenses to “activities”. Each Product is charged based on the extent to which it used an activity•The primary objective of ABC is to assign costs that reflect/mirror the physical dynamics of the business Provides ways of assigning the costs of indirect support resources to activities, business processes, customers, products.•It recognizes that many organizational resources are required not for physical production of units of product but to provide a broad array of support activities.

Building an ABC Model

IdentifyResources

IdentifyActivities

IdentifyCost Objects

DefineResource

Drivers

DefineActivityDrivers

EnterResource

Costs

EnterResourceDriver Qty.

EnterActivity

Driver Qty.

CalculateCosts

Current Methodology

• At present the costing done by Mumbai Refinery is absorption costing cum unit costing.

• The units taken into consideration into here are divided on the basis of final product.

• The two units which are taken into consideration are Lube Refinery and Fuel Refinery.

• Then the apportioned ratio of different products are attached to different cost heads.

Steps Involved

The apportioning of different product ratio is obtained by taking into consideration Sales realization, production and sales value of production. The ratio is obtained by multiplying sales value of realization (Per MT) and Total production of that particular product in a period and dividing it by total sales value of realization.

The weightage is obtained by: -Sales value of Production/Total Sales Value of Production = Weightage

STEP 1

Note: Sales Value of Production = Production*Sales Realization (Per MT) and

Sales Realization (Per MT) = Sales Realization (Total)/Sales Quantity (Per MT)

Steps Involved (Continued…)

In this step the cost is calculated on a whole, under different overheads. In particulars the cost is accumulated on total. This table is generated Under Para 5 of cost audit. The cost of different particulars are based on the actual entries under different sub-sections of general diary. In calculating costs no assumption is taken. Record for these are maintained by the finance department in the form of TRIAL BALANCE.

STEP 2

Steps Involved (Continued…)

In the second step for assigning cost, these calculated weighted average cost from the sales value of production are used. The Cost of Sales is calculated for individual products by assigning these apportions/ratios for different cost incurred during the process. Each Individual cost is assigned these ratios and then accordingly the cost is calculated for different products. The Refinery is divided into two Units. Two separate trial balances are made and Henceforth these apportions are assigned values.

Summer Internship HPCl\Reference\COST AUDIT 12-13 MAIN FILE.XLS

STEP 3

Short Comings Of Traditional Cost Accounting

An organization often has no clue about the origin and creation of the company costs, nor are most particularly concerned about who implemented the costing strategy. If employees only knew that a better costing method could save a ton of money, as well as impress the boss enough to earn that cozy corner office, then they would surely be more excited. Many companies and many live in the dark ages; they often use pricing models that were developed decades ago and were never updated.

NOTE: - When asked with a company how they came up with their pricing methods, the answer is usually ‘someone who worked here 15 years ago developed it and he’s no longer here’.

Unit Based Costing

The accounting performed for this project is based on the Activity Based Costing. In this different units are taken into considerations and overhead or indirect costs for these units is calculated. The costs taken into consideration are some where actual as accounted by different departments and at some places hypothetical based on a valid and technically sound apportion done by taking various factors into consideration.

The units taken into consideration are: -

1) Fuel Refinery*

2) Lube Refinery*

3) DHDS

4) Fuel Refinery-Boiler House

5) GFEC

6) Captive Power plant

7) OM&S

8) IETP

9) Lab

10) DHDS-Revamp

11) DHT

Note: -

1) FR consists of 10 units2) LR consists of 6 Units3) DHDS Revamp is

modified DHDS

Note: -

The implementation of this costing can be done for taking management decision to improve efficiency

and ultimately resulting in higher GRM or Gross Refinery Margin. The implementation of this project

for management decision is covered during later stages.

Goals of Unit Based Costing

Although the general goals of each Units may differ, but Unit wise cost accounting systems will generally try to satisfy three goals: • To allocate certain period costs to products so that

financial statements can be prepared monthly, quarterly, and annually

• To provide process control information to cost center managers

• To provide product cost estimates to product and business managers

Goals of Unit Based Costing (Continued…)

• First, financial statements are obviously an essential aspect of illustrating an organization’s yearly operations, expenses, and revenue. UBC’s goal is to better enhance the reliability of the financial statements for a proper representation of the yearly production expenses.• Second, cost managers rely on the UBC information to provide

detailed information regarding processes and how they affect the organization. • Third, product managers are in need of very accurate product cost

estimates. These estimates are generally much more reliable with an UBC method rather than a traditional cost method.

Steps Involved in UBC’s: -

Basic step Involved in UBC’s is accurate data and therefore success of UBC is highly dependent on accuracy of data available. The more accurate the data, the more accurate costs. These costs can then be taken into consideration for process optimization. The Overheads accounts for a massive 1900 Crores in Mumbai refinery alone.

The costs considered as overhead costs are:-

1. Process Materials/Chemicals

2. Utilities

a) Power

b) Steam

c) Water

3. Direct Employees Expenses

4. Direct Expenses

5. Consumables stores and spares

6. Repairs and Maintenance

7. Quality Control

8. Technical Knowhow

9. Depreciation/Amortization

10. Other Production Overheads

The various Overheads: -

• Process Materials/Chemicals: - Process material and chemicals accounts as an important cost in the refining of petroleum products. The revenue budget sheet is used as an approximation ratio for calculating costs for the year 2013-14.

• Utilities: -Utilities costs contain three sub-heads of Power, Steam and water in its subsection. Utilities are basically the energy consumed by different units in order to process the crude.

• Direct Employee Cost: - Direct employees cost contains salary and employee benefits paid to the employee in a given year. The logic behind calculating the ratio for direct employee ratio was based on the number of employee working is a given unit. Then this number was multiplied with the average employee cost incurred for the period 2013-14.

The various Overheads (Continued) : -

• Direct Expenses: - Direct expenses accounted for 275,310,501.95 Rs in the year 2013-14. It is very small when compared to other expenses but for the success of Unit Based Costing that not even the smaller costs are left accounted and they are also allocated under differ unit heads.

• Consumable Stores and Spares: - The expense for consumable stores and Spares for the year 2013-14 was nil. Therefore they are making no changes in the overall cost for the year 2013-14.

• Repairs and maintenance: - Repairs and maintenance form an important part for FR, LR and CPP. The values of repair and maintenance are actual values and they are the record maintained by the Maintenance department.

• Quality and Control Expenses: -Approximately 7.2 Million Metric Ton of Crude was converted in 29+ products in the year 2013-14 in Mumbai Refinery of HPCL. The apportioning of QC is done by taking the process and chemicals overhead as base ratio.

The various Overheads (Continued) : -

• Technical Knowhow: - There was no cost incurred in the FY 2013-14 for technical Knowhow. Technical Knowhow is basically for the services of the technology rendered. • Depreciation/Amortization: - Depreciation and amortization is done on the straight

line method in HPCL-MR. The values taken into consideration for this overhead is on actual basis. Project finance department keeps track record of all the depreciated and amortized assets• Other Production Overheads: -All other production over head are calculated in this

heading. The rationale behind finding the ratio for this overhead is taking cumulative average of the ratio of all the other overhead and then assigning these values to the total cost incurred in this sub-head.

Summer Internship HPCl\Project\Main ABC Working File.xlsx

Application of Unit Based Costing: -

Application of Unit Based Costing: -There are two broad purposes for using management accounting information:●Strategic cost management—to determine the right things to do, i.e., selecting the correct processes, suppliers, products, channels, and customers. ●Operational cost management—to perform well on those things identified as strategic, improve productivity, and remove waste.