Cost Accounting Manual (2nd Edition) PDF

Cost Accounting Manual 2012
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STUDY NOTES STUDY NOTES STUDY NOTES STUDY NOTES FOR COST FOR COST FOR COST FOR COST
ACCOUNTING ACCOUNTING ACCOUNTING ACCOUNTING

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$ast U%dated on: Sunda&, 'a& 1(, )*1)


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+I'A OFFICIAL TERMINOLOGY
Ters ,efinitions
+ost accounting Gathering of cost information and its attachment to cost
objects, the establishment of budgets, standard costs and
actual costs of operations, processes, activities or products;
and the analysis of variances, profitability or the social use
of funds.
+ost ob-ect A product, service, centre, activity, customer or distribution
channel in relation to which costs are ascertained.
+ost unit Unit of product or service in relation to which costs are
ascertained.
As a noun, cost is The amount of cash or cash
euivalent paid !.
As a verb, cost is To ascertain the cost of a specified
thing or activity.
The word cost can rarely stand alone and should be
ualified as to its nature and limitations.
_
> "roduct _ costing _: ._

,
: cost unit _
,
~
'
+ost +enter

,
. '
> cost unit ' _ ,':

,
.
+ost c!assification Arrangement of elements of cost into logical groups with
respect to their nature #fi$ed, variable, value adding%,
function #production, selling% or use in the business of the
entity.
,irect cost &$penditure that can be attributed to a specific cost unit, for
e$ample material that forms part of a product.
.rie cost Total of direct material, direct labor and direct e$penses.
Indirect cost or o/erhead &$penditure on labor, materials or services that cannot be
economically identified with a specific saleable cost unit.
.roduct cost 'ost of a finished product built up from its cost elements.
.eriod cost 'ost relating to a time period rather than to the output of
products or services.
Fi0ed cost 'ost incurred for an accounting period, that, within certain
output or turnover limits, tends to be unaffected by
fluctuations in the levels of activity #output or turnover%
(i$ed costs are the same, no matter how many units are
produced. )ote, however, that as the number of units
increases, the fi$ed cost %er unit actually decreases.
This concept may seem confusing at first and it*s best to
thin+ in terms of numbers.

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20X1 20X2
(i$ed cost #,s% -.,... -.,...
)o of units produced -.. /,... #Units have increased%
(i$ed cost per unit
#,s0 -.,...1no. of units% /.. -. #'ost per unit has decreased%
&ven though the costs are fi$ed, we still sometimes loo+ at
the cost per unit. 2on*t let this confuse you 3 total fi$ed
costs are fi$ed and do not vary with activity levels.
1ariab!e cost 'ost that varies with a measure of activity.
Sei2/ariab!e cost 'ost containing both fi$ed and variable components and
thus partly affected by a change in the level of activity.
3e!e/ant cost of an asset ,epresents the amount of money that a company would
have to receive if it were deprived of an asset in order to be
no worse off than it already is. 4e can call this the de%ri/a!
/a!ue.
&$ample0 2eprival value of an asset
A machine cost ,s0 /5,... ten years ago. 6t is e$pected that
the machine will generate future revenues of ,s0 /.,....
Alternatively, the machine could be scrapped for ,s0 7,....
An euivalent machine in the same condition would cost ,s0
8,... to buy now. 4hat is the deprival value of the
machine9
:olution
(irstly, let us thin+ about the relevance of the costs given to
us in the uestion.
'ost of machine ; ,s0 /5,... ; past1sun+ cost
(uture revenues ; ,s0 /.,... ; revenue e$pected to be
generated
)et reali<able value ; ,s0 7,... ; scrap proceeds
,eplacement cost ; ,s0 8,...
4hen calculating the de%ri/a! /a!ue of an asset, use the
following diagram.
$4563 4F
,&"=A'&>&)T ?6G?&, @(
'@:T #,s0 /.,...%
#,s0 8,...%
),A &B"&'T&2 ,&A&)U&:
#,s0 7,...% #,s0 /.,...%
Therefore, the deprival value of the machine is the lower of
the replacement cost and ,s0 /.,.... The deprival value is
therefore ,s0 8,....


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3e!e/ant range Activity levels within which assumptions about cost
behavior in brea+even analysis remain valid
The relevant range also broadly represents the acti/it&
!e/e!s at 8hich an organi9ation has had e0%erience of
o%erating at in the %ast and for which cost inforation is
a/ai!ab!e. 6t can therefore be dangerous to attempt to
predict costs at activity levels which are outside the relevant
range.
A%%ortion To spread indirect revenues or costs over two or more cost
units, centers, accounts or time periods.
3e2a%%ortion The reCspread of costs apportioned to service departments
to production departments.
4/erhead absor%tion
rate
A means of attributing overhead to a product or service,
based for e$ample on direct labour hours, direct labour cost
or machine hours. There are a number of different bases of
absor%tion #or *overhead reco/er& rates*% which can be
used. &$amples are as follows.
/C A percentage of direct materials cost
DC A rate per machine hour
EC A percentage of direct labour cost
5C A rate per direct labour hour
-C A percentage of prime cost
FC A rate per unit
'argina! cost "art of the cost of one unit of product or service that would
be avoided if the unit was not produced, or that would
increase if one e$tra unit were produced.
+ontribution :ales value 3 variable cost of sales
'argina! (or /ariab!e#
costing
Assigns only variable costs to cost units while fi$ed costs are
written off as period costs.
FIF4 (first in, first out# Used to price issues of goods or materials based on the cost
of the oldest units held, irrespective of the seuence in
which the actual issue of units held ta+es place. 'losing
stoc+ is, therefore, valued at the cost of the oldest
purchases.
$IF4 (!ast in, first out# Used to price issues of goods or materials based on the cost
of the most recently received units. 'ost of sales in the
income statement is, therefore, valued at the cost of the
most recent purchases.
A/erage cost Used to price issues of goods or materials at the weighted
average cost of all units held.
+ost2/o!ue2%rofit
ana!&sis (+1.
:tudy of the effects on future profit of changes in fi$ed cost,
variable cost, sales price, uantity and mi$.

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;reake/en %oint =evel of activity at which there is neither profit nor loss.
+<S ratio (.<1 ratio# A measure of how much contribution is earned from each
,s0 / of sales.
'argin of safet& 6ndicates the percentage by which forecast revenue e$ceeds
or falls short of that reuired to brea+ even.
As well as being interested in the brea+even point,
management may also be interested in the amount by
which actual sales can fall below anticipated sales without a
loss being incurred. This is the argin of safet&"
$iiting factor or ke&
factor
Anything which limits the activity of an entity. An entity
see+s to optimi<e the benefit it obtains from the limiting
factor. &$amples are a shortage of supply of a resource or a
restriction on sales demand at a particular price.
6t is assumed in limiting factor analysis that management
wishes to ma$imi<e profit and that %rofit 8i!! be a0ii9ed
8hen contribution is a0ii9ed #given no change in fi$ed
cost e$penditure incurred%. 6n other words, argina! costing
ideas are a%%!ied.
Standard cost "lanned unit cost of a product, component or service.
Standard costing 'ontrol techniue that reports variances by comparing
actual costs to preCset standards so facilitating action
through management by e$ception.
'anageent b&
e0ce%tion
"ractice of concentrating on activities that reuire attention
and ignoring those which appear to be conforming to
e$pectations. Typically standard cost variances or variances
from budget are used to identify those activities that reuire
attention
.erforance standard Idea! standards are based on the most favorable operating
conditions, with no wastage, no inefficiencies, no idle time
and no brea+downs. These standards are li+ely to have an
unfavorable motivational impact, because employees will
often feel that the goals are unattainable and not wor+ so
hard.
Attainab!e standards are based on efficient #but not
perfect% operating conditions. :ome allowance is made for
wastage, inefficiencies, machine brea+downs and fatigue. 6f
wellCset they provide a useful psychological incentive, and
for this reason they should be introduced whenever
possible. The consent and coCoperation of employees
involved in improving the standard are reuired.
+urrent standards are standards based on current wor+ing
conditions #current wastage, current inefficiencies%. The
disadvantage of current standards is that they do not

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attempt to improve on current levels of efficiency, which
may be poor and capable of significant improvement.
;asic standards are standards which are +ept unaltered
over a long period of time, and may be outCofCdate. They are
used to show changes in efficiency or performance over an
e$tended time period. Gasic standards are perhaps the least
useful and least common type of standard in use.
1ariance The difference between a planned, budgeted, or standard
cost and the actual cost incurred. The same comparisons
may be made for revenues.
,irect ateria! tota!
/ariance
>easurement of the difference between the standard
material cost of the output produced and the actual
material cost incurred.
,irect ateria! %rice
/ariance
2ifference between the actual prices paid for the purchased
materials and their standard cost.
,irect ateria! usage
/ariance
>easures efficiency in the use of material, by comparing
standard material usage for actual production with actual
material used, the difference is valued at standard cost.
,irect !abor tota!
/ariance
6ndicates the difference between the standard direct labor
cost of the output which has been produced and the actual
direct labor cost incurred.
,irect !abor rate
/ariance
6ndicates the actual cost of any change from the standard
labor rate of remuneration.
,irect !abor efficienc&
/ariance
:tandard labor cost of any change from the standard level of
labor efficiency.
,irect !abour id!e tie
/ariance
@ccurs when the hours paid e$ceed the hours wor+ed and
there is an e$tra cost caused by this idle time. 6ts
computation increases the accuracy of the labor efficiency
variance.
1ariab!e %roduction
o/erhead tota! /ariance
>easures the difference between variable overhead that
should be used for actual output and variable production
overhead actually used.
1ariab!e %roduction o/erhead
e0%enditure /ariance
6ndicates the actual cost of any change from the standard
rate per hour.
1ariab!e %roduction 41H
efficienc& /ariance
:tandard variable overhead cost of any change from the
standard level of efficiency.
Sa!es %rice /ariance 'hange in revenue caused by the actual selling price
differing from that budgeted.
Sa!es /o!ue
contribution /ariance
The sales volume variance in units is the difference between
the actual units sold and the budgeted uantity. This
variance in units can be valued in one of three ways0
6n terms of standard revenue,

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:tandard gross margin or
:tandard contribution margin.
#a% At the standard gross %rofit argin %er unit. This is the
sa!es /o!ue %rofit /ariance and it measures the change in
profit #in an absorption costing system% caused by the sales
volume differing from budget.
#b% At the standard contribution %er unit. This is the sa!es
/o!ue contribution /ariance and it measures the change
in profit #in a marginal costing system% caused by the sales
volume differing from budget.
#c% At the standard re/enue %er unit. This is the sales
/o!ue re/enue /ariance and it measures the change in
sales revenue caused by sales volume differing from that
budgeted.

:uppose that a company budgets to sell 7,... units of
product H for ,s0 /D per unit. The standard variable cost per
unit is ,s0 5 and the standard full cost is ,s0 I per unit.
Actual sales were I,I.. units, at ,s0 /D.-. per unit.

The sales volume variance in units is E.. units adverse
#7,... units budgeted 3 I,I.. units sold%. The variance is
adverse because actual sales volume was less than
budgeted. The sales volume variance in units can be
evaluated in the three ways described above.

#a% :ales volume profit variance ; E.. units J standard gross
profit margin per unit
; E.. units J ,s0 #/D 3 I% ; 3s: 1,:** (A#

#b% :ales volume contribution variance ; E.. units J
standard contribution per unit
; E.. units J ,s0 #/D 3 5% ; 3s: ),7** (A#

#c% :ales volume revenue variance ; E.. units J standard
revenue per unit
; E.. units J ,s0 /D ; 3s: (,=** (A#

)ote that the sales volume profit variance #in an absorption
costing system% and the sales volume contribution variance
#in a marginal costing system% can be derived from the sales
volume revenue variance, if the profit mar+Cup percentage
and the contribution to sales #'1:% ratio respectively are

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+nown.

6n our e$ample the profit mar+Cup percentage is 5/.FIK #,s0
-1,s0 /D% and the '1: ratio is FF.FIK #,s0 71,s0 /D%.

Therefore the sales volume profit variance and the sales
volume contribution variance, derived from the sales
volume revenue variance, are as follows.

:ales volume profit variance ; ,s0 E,F.. #A% J 5/.FIK ; ,s0
/,-.. #A%, as above

:ales volume contribution variance ; ,s0 E,F.. #A% J FF.FIK
; ,s0 D,5.. #A%, as above

H has the following budget and actual figures for year 5.
Budget Actual
:ales units F.. FD.
:elling price per unit ,s0 E. D8
:tandard full cost of production ; ,s0 D7 per unit.
:tandard variable cost of production ; ,s0 /8 per unit

'alculate the following sales variances
#a% :elling price variance #c% :ales volume contribution
variance
#b% :ales volume profit variance #d% :ales volume revenue
variance
Answer
#a% :ales revenue for FD. units should have been #J ,s0 E.%
/7,F.. but was #J ,s0 D8% /I,87.. :elling price variance FD.
#A%

#b% Gudgeted sales volume F.. units
Actual sales volume FD. units
:ales volume variance in units D. units #(%
:ales volume profit variance ; D. units J ,s0 #E. 3 D7% ; ,s0
5. #(%

#c% :ales volume contribution variance ; D. units J ,s0 #E. 3
/8% ; ,s0 DD.#(%

#d% :ales volume revenue variance ; D. units J ,s0 E. ; ,s0
F..#(%

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6n this uestion you were as+ed to calculate both the sales
volume profit variance and the sales volume contribution
variance to give you some practice. ?owever, the two
variances would never be found together in the same
system in a real situation. &ither a marginal costing system is
used, in which case the sale volume contribution variance is
calculated, or an absorption costing system is used, in which
case a sales volume profit variance is calculated.
;udget %ur%oses Gudgets may help in authori<ing e$penditure,
communicating objectives and plans, controlling operations,
coCordinating activities, evaluating performance, planning
and rewarding performance. @ften, reward systems involve
comparison of actual with budgeted performance.
;udget Luantitative e$pression of a plan for a defined period of
time. 6t may include planned sales volumes and revenues;
resource uantities, costs and e$penses; assets, liabilities
and cash flows.
;udget %eriod "eriod for which a budget is prepared, and used, which may
then be subCdivided into control periods.
;udget anua! 2etailed set of guidelines and information about the budget
process typically including a calendar of budgetary events,
specimen budget forms, a statement of budgetary
objectives and desired results, listing of budgetary activities
and budget assumptions, regarding, for e$ample, inflation
and interest rates.
.rinci%a! budget factor =imits the activities of an underta+ing. 6dentification of the
principal budget factor is often the starting point in the
budget setting process. @ften the principal budget factor
will be sales demand but it could be production capacity or
material supply.
;udget f!e0ing (le$ing variable costs from original budgeted levels to the
allowances permitted for actual volume achieved while
maintaining fi$ed costs at original budget levels.
Integrated accounts :et of accounting records that integrates both financial M
cost accounts using a common input of data for all
accounting purposes.
.rocess costing (orm of costing applicable to continuous processes where
process costs are attributed to the number of units
produced. This may involve estimating the number of
euivalent units in stoc+ at the start and end of the period
under consideration.
Aora! !oss &$pected loss, allowed for in the budget, and normally

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calculated as a percentage of the good output, from a
process during a period of time. )ormal losses are generally
either valued at <ero or at their disposal values.
Abnora! !oss Any loss in e$cess of the normal loss allowance.
Abnora! gain 6mprovement on the accepted or normal loss associated
with a production activity.
Scra% 2iscarded material having some value.
6Bui/a!ent units )otional whole units representing incomplete wor+. Used to
apportion costs between wor+ in progress and completed
output.
Coint %roducts Two or more products produced by the same process and
separated in processing, each having a sufficiently high
saleable value to merit recognition as a main product.
;&2%roduct @utput of some value produced incidentally while
manufacturing the main product.
Cob 'ustomer order or tas+ of relatively short duration.
Cob costing (orm of specific order costing where costs are attributed to
individual jobs.
;atch costing (orm of specific order costing where costs are attributed to
batches of product #unit costs can be calculated by dividing
by the number of products in the batch%.
+ontract costing (orm of specific order costing where costs are attributed to
contracts.
,e%artenta!<functiona!
budget
Gudget of income and1or e$penditure applicable to a
particular function freuently including sales budget,
production cost budget #based on budgeted production,
efficiency and utili<ation%,
purchasing budget, human resources budget, mar+eting
budget and research and development budget.
A%%roaches to
budgeting

1 2 Increenta! budgeting
The traditiona! a%%roach to budgeting is to base ne0t &earDs
budget on the current &earDs resu!ts %!us an e0tra aount
for estiated gro8th or inf!ation ne0t &ear. This approach
is +nown as increenta! budgeting since it is concerned
mainly with the increments in costs and revenues which will
occur in the coming period.
) 2 Eero2based budgeting
Eero2based budgeting involves preparing a budget for each
cost centre from a <ero base. &very item of e$penditure has
then to be justified in its entirety in order to be included in
the ne$t year*s budget.
NGG rejects the assumption inherent in incremental

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budgeting that ne$t year*s budget can be based on this
year*s costs.
( 2 3o!!ing budgets
As an organi<ation and the environment it operates in are
dynamic #always changing% management may decide to
introduce a system of ro!!ing budgets #also called
continuous budgets%.
A ro!!ing budget is a budget which is continuously updated
by adding a further accounting period #a month or uarter%
when the earlier accounting period has e$pired.
7 2 .artici%ati/e budgeting
.artici%ati/e budgeting is *A budgeting system in which all
budget holders are given the opportunity to participate in
setting their own budgets*.
+ash budget 2etailed budget of estimated cash inflows and outflows
incorporating both revenue and capital items.
Fi0ed budget Gudget set prior to the control period and not subseuently
changed in response to changes in activity, costs or revenue.
6t may serve as a benchmar+ in performance evaluation.


1)

IT6'S F43'U$A6
1 .rie<;asic<F!at +ost ,irect 'ateria! F ,irect $aborF ,irect 60%enses
) Auber of Unit 'ade Unit So!d F +!osing unit of finished goods 2
4%ening unit of finished goods
( .er unit +ost +ost of Good 'anufactured < Unit 'ade
7 5ork2In2.rocess +!osing Stock ,irect 'ateria! F ,irect $abor F Factor&
4/erhead
: Gross .rofit Sa!es H +ost of Goods So!d
= Finished Goods +!osing Unit .er unit cost I F"G c!ose unit
> Sa!es Gross .rofit F +ost of goods so!d
? Under<4/er A%%!ied Actua! F4H H A%%!ied F4H (Actua! Hours I F4H
A%%!ied 3ate#
@ Unit +onsued 4%ening Stock F.urchases H +!osing Stock
1* Gross .rofit<Aet .rofit .er Unit Gross .rofit or Aet .rofit < unit so!d
11 F4H A%%!ied 3ate Tota! F4H cost < +a%acit& $e/e! I 1**
1) Sa!es in Aet Incoe Aet Incoe < J I 1**
1( Gross .rofit<Aet .rofit to Sa!es Gross .rofit or Aet .rofit < Aet sa!es I1**
17 .urchases (3a8 'ateria!# 3a8 'ateria! in .rocess F 3"'" +!osing H 3"'"
4%ening
1: Tota! 'anufacturing +ost ,irect 'ateria! F ,irect $abor F ,irect 60%enses
F Factor& 4/erhead
1= +on/ersion +ost ,irect $abor F Factor& 4/erhead
1> .er Unit Sa!e .rice .rofit F 4%erating cost F .er unit cost
1? J of +ost Sa!e .rice .urchase at cost < .urchase at sa!e I1**
1@ .urchase at Sa!e .rice Sa!es F +!osing stock H 4%ening stock
)* Under<4/er F4H Ad-ustent Under or 4/er a%%!ied < +ost 4f Goods So!d or
5ork2In2.rocess or Finished Goods I 1**
)1 +ost 4f Goods So!d .er Unit +ost of Goods So!d < unit so!d
)) Auber of Unit So!d Tota! Gross .rofit !ast &ear < 60%ected Gross
.rofit %er unit I 1**
)( +ost 4f Goods 'anufactured Tota! 'anufacturing +ost F 4%en 5ork2In2
.rocess H +!osing 5ork2In2.rocess
)7 +ost 4f Goods So!d +ost 4f Goods 'anufactured F 4%en Finished
Goods H +!osing Finished Goods
): Increase b&< ,ecrease b& Increase b& K $ess & ,ecrease b& K Add

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F43'AT 4F +4ST 4F G44,S S4$, STAT6'6AT
4%ening 3a8 'ateria! LLL
.urchases BBB
Add22,irect 60%enses BBB
$ess H +!osing 3a8 'ateria! #BBB%
,irect 'ateria! Used LLL
,irect $abor BBB
,irect 60%enses BBB
Factor& 4/er Head< Su%%!eentar& +ost H 5: ) BBB
Tota! .roduction +ost (Aora!# H 5: 1 LLL
4%ening 5ork2In2.rocess BBB
+ost of Goods to be 'ade BBB
+!osing 5ork2In2.rocess #BBB%
+ost of Goods 'anufactured (Aora!# LLL
4%ening Finished Goods BBB
+ost of Goods to be So!d BBB
+!osing Finished Goods #BBB%
+ost of Goods So!d (Aora!# LLL
AddMUnder a%%!ied BBB
$essM4/er a%%!ied #BBB%
+ost of Goods So!d (Actua!# LLL
521 ; Also called Total >anufacturing 'ost 43 Total 'ost
52) ; (actory @verhead ; 6ndirect >aterial O 6ndirect =abor O 6ndirect &$penses
52( ; Actual (@? BBB
Applied (@? BBB
Under<4/er A%%!ied LLL
(ormula to decide Under<4/er A%%!ied is0
)@"U #)egative0 @ver applied M "ositive0 Under applied%
Gross .rofit ; :ales 3 'ost of Goods :old #Actual%


17


1:

.4IATS T36AT'6ATS
Good units

Foru!a ; Transfer O still O complete but still
There will be no loss adjustment in /
st
department as the
good units will absorb the bad 1 loss units.
6f losses are in accordance with normal practice i.e.
standard levels, they are termed as normal loss. 6f they
are above e$pectation, they are +nown as abnormal
losses.
Ad-ustent of !oss
units ()nd
de%artent#

Unit loss P unit cost of last deptt
Good units
43
Unit cost after adjustment #Total cost 1 good units% ; BBB
Unit cost before adjustment ; BBB
LLL
Aora! !oss at the
end

)o adjustment of loss units
=oss units are included in &",
'ost transfer to ne$t deptt #Transfer O =oss%
"er Unit 'ost 0 'ost Transfer
Unit Transfer
Increase in units

Adjustment of "er Unit cost0 'ost receive by last deptt
Good Units
)ormal spoilage in increase units needs no adjustment.
2ouble line under unit cost of last deptt in increase units
case only.
Adjusted cost of last deptt0
Unit still P unit cost of last deptt O adjustment of loss unit
6n case of increase units0 Unit still P adjusted per unit cost
In%ut ateria! &
ateria! introduced

>aterial introduced is e$tra material needed in the process M
should always be shown separately from input material.
4henever there are partly completed units at the end of the
period, they may contain two classification of material i.e.
6nput >aterial #i.e. previous process costs% ; Always /..K
complete.
>aterial 6ntroduced ; which may or may not be
complete.
6nput material may also be described as0
Units Transferred.
'ost of goods or units transferred.
"revious "rocess 'osts.

1=

543N IA .34G36SS ;6GIAAIAG IA16AT43O (A1+4#
=ife is very simple M easy in average costing. There is no need of
GyCfurcating of finished goods M no remaining percentages are to be considered
for opening units.
"lease add open 46" cost in per unit cost calculation.
There is no need to add opening 46" cost to finished goods at the end.
FI3ST ,6.A3T'6AT:
)o change in 6uivalent .roduction 3eport #6.3%.
'ost of 4or+C6nC"rocess beginning inventory included in Q'ost 'harged to
departmentR. 6gnore unit cost.
Unit +ost ca!cu!ation:
46" beginning inventory cost P cost charged by department
&", units
S6+4A, & FU3TH63 ,6.A3T'6AT:
)o change in 6uivalent .roduction 3eport #6.3%.
'ost of 46" beginning inventory included in Q'ost 'harged to departmentR.
6gnore unit cost.
Unit +ost ca!cu!ation:
46" beginning inventory cost P cost charged by department
&", units
+ost of %receding de%artent:
T"+" U"+.
'ost of last department BBB BBB
'ost of 46" opening inventory BBB BBB
LLL LLL


1>

543N IA .34G36SS ;6GIAAIAG IA16AT43O (FIF4#
Always ta+e remaining K #/..K C K given% for opening inventory in statement of
euivalent unit calculation.
2o not add opening 46" cost in per unit cost calculation.
"lease remember to add opening 46" cost to finished gods at the end.
Total of cost of opening 46" inventory is to be written in Q'ost 'harged to
departmentR.
)o unit cost written on opening 46" inventory.
T3AASF63 T4 A6LT ,6.A3T'6AT:
F34' +U336AT .34,U+TI4A #unit transfer P unit cost%
F34' 4.6AIAG 5I. IA16AT43O
6nventory 'ost #As given in the uestion%
2irect >aterial #46" unit P stage completion K P unit cost%
2irect labor #46" unit P stage completion K P unit cost%
(actory @verhead #46" unit P stage completion K P unit cost%
F34' +$4SIAG 5I. IA16AT43O
2irect >aterial #46" unit P stage completion K P unit cost%
2irect labor #46" unit P stage completion K P unit cost%
(actory @verhead #46" unit P stage completion K P unit cost%
A;A43'A$ $4SS
Abnormal losses cannot be foreseen. 6t should be e$cluded from routine
reporting M only normal costs charged to production. Abnormal losses are
costed on the same basis as good production.
(actors of Abnormal =oss0
"lant brea+ down.
6ndustrial accidents.
6nefficient wor+ing.
Une$pected defects.
Une$pected favorable conditions.
Foru!a: Abnormal loss #gain% ; Actual loss 3 )ormal loss.
)o adjustment of loss units
=oss units are included in &",


1?

+ost of abnora! !oss:
=ast deptt BBB #unit loss P unit cost%
>aterial BBB #unit loss P unit cost%
=abor BBB #unit loss P unit cost%
(@? BBB #unit loss P unit cost%
6PUI1A$6AT .34,U+TI4A 36.43T
F43 FIF4
.re/ious
,e%tt
,irect
'ateria!
,irect
$abor
F4H
Transfer BBB BBB BBB BBB
4%ening 5I. ( Gi/en# BBB BBB BBB BBB
Abnora! $oss BBB BBB BBB BBB
Abnora! Gain #BBB% #BBB% #BBB% #BBB%
+urrent .roduction LLL LLL LLL LLL
4%ening 5I. (1 H J I 1**# BBB BBB BBB BBB
+!osing 5I. ( Gi/en# BBB BBB BBB BBB
T4TA$ UAITS LLL LLL LLL LLL
F43 4TH63S
.re/ious ,e%tt ,irect
'ateria!
,irect
$abor
F4H
Transfer BBB BBB BBB BBB
+!osing 5I. BBB BBB BBB BBB
Abnora! $oss BBB BBB BBB BBB
Abnora! Gain #BBB% #BBB% #BBB% #BBB%
Aora! $oss ()
nd
,e%tt# BBB BBB BBB BBB
Aora! $oss at end BBB BBB BBB BBB
T4TA$ UAITS LLL LLL LLL LLL
+4ST .63 UAIT ; Total costs<Total euivalent production units
T4TA$ +4ST F43 .63I4, ; Aalue of completed units O Aalue of 4C6C"
An euivalent unit means eBua! to one finished unit of out%utS.
@ne fullyCfinished unit of production ; / euivalent unit
@ne unit -.K complete ; ..-. euivalent units. 5.. units -.K complete ; D..
euivalent units.

1@

@ne unit D.K complete ; ..D. euivalent units. 5.. units D.K complete ; 7.
euivalent units.
'osts are shared between finished units and inventory by calculating a cost per
euivalent unit0
'ost per euivalent unit ; 'osts of the process1)umber of euivalent units
produced

6Bui/a!ent units of
c!osing in/entor&
6t is normally assumed that direct materials are added to the
production process at the beginning of the process and that
direct labor operations are carried out throughout the process.
4hen this assumption is used, units of closing inventory are0

/..K complete for direct material costs added at the
beginning of the process,
@nly partlyCcomplete for direct labor and production
overhead costs,
@nly partly complete for additional materials that are
added throughout the process.

The number of euivalent units of direct materials cost in a
period will therefore differ from the number of euivalent units
of conversion costs #direct labor and production overhead%.
6Bui/a!ent units:
8eighted a/erage
cost ethod
The assumption is that all units produced during the period and
all units of closing inventory should be valued at the same cost
per euivalent unit for materials and the same cost per
euivalent unit for conversion costs.

An average cost per euivalent unit is therefore calculated for
all units of output and closing inventory. This includes the units
that were partlyCcompleted at the beginning of the period #and
which were therefore valued as closing 46" at the end of the
previous period%.
6Bui/a!ent units: fifo
ethod

6t is assumed that all units of output in a period have the same
cost per unit.

4ith the firstCin, firstCout #(6(@% method of process costing, it is
assumed that the opening units of wor+CinCprocess at the
beginning of the month will be the first units completed. The
cost of these units is their value at the beginning of the period
plus the cost to complete them in the current period.


)*

.34+6SS A++4UAT 2 1A3IATI4AS
S"Ao Aerican A%%roach ;ritish A%%roach
1 '", "rocess A1'
) 2epartments "rocesses
( 4or+ in process 4or+ in progress
7 )o abnormal gain concept abnormal gain concept
: :crap value of )ormal =oss is
ignored
:crap value of )ormal =oss is considered
= )ormal =oss is calculated at the end
of process
)ormal =oss is considered from
beginning M considered specific value
while computing cost of finished goods
> K of )ormal =oss is applied on input
1output
K of )ormal =oss is always applied on
input

.34+6SS A++4UAT H ;3ITISH A..34A+H

.articu!ars Pt& Aount .articu!ars Pt& Aount
3s" 3s"
@pening Galance BBB BBB Transfer to ne$t deptt BBB BBB
2irect >aterial BBB )ormal =oss BBB BBB
2irect =abor BBB Abnormal =oss BBB BBB
(actory @verhead BBB
Additional @verhead BBB
2irect &$penses BBB
(@? Allocated BBB
Abnormal Gain BBB BBB
T4TA$ LLL T4TA$ LLL
Aotes:
1" The output of one process becomes the input to the ne$t until the finished
product is made in the final process.
)" "rocess account is no more than a ledger with debit M credit entries.
(" Luantity column is just a memorandum column which means that we just have
to balance it.
7" 2irect labor M factory overhead may be treated together as conversion cost.
:" Aaluation of abnormal loss ; Total 'ost 3 :crap1)ormal production
=" Aaluation of abnormal gain ; Total 'ost 3 :crap1)ormal production
>" Aora! !oss 1S Abnora! !oss

)1

.oints Aora! $oss Abnora! $oss
Aature
Unavoidable Avoidable
60istence
6nherent )onC 6nherent
Factors
/. :hrin+age
D. evaporation
E. spoilage
/. Unforeseen factors
D. Abnormal conditions li+e0
>aladministration
Gad design
)egligence on part of labor
Inc!usion
'redited to process account 'redited to process account
=" )ormal loss ; normal loss units P scrap value
)ormal loss is not given in cost if it does not have a scrap value.
Units of normal loss are valued at <ero euivalent units i.e. they donSt
carry any of the process costs.
)ormal loss types0
Start ,uring 6nd
)ot included in &", )ot included in &", 6ncluded in &",
>" Abnormal loss ; abnormal loss units P per unit cost
?" Abnormal Gain ; abnormal gain units P per unit cost
@" Ho8 to deterine Abnora! $oss < GainQ
Total Units BBB
)ormal =oss #BBB%
Transfer #BBB%
Abnora! $oss< Gain LLL
,6+ISI4A 3U$6
.ositi/e Abnora! $oss
Aegati/e Abnora! Gain
1*" +ost .er Unit:
Total cost 3 )ormal =oss scrap value 3 ),A of by product produced
Total units 3 )ormal loss Units 3 Gy "roduct Units
43
Transfer O Abnormal =oss 3 Abnormal Gain

))

11" 'ompletion :tages for &", as per ;3ITISH A..34A+H0
Aora! $oss at the end /..K completed units
Abnora! $oss /..K completed units
Abnora! Gain /..K completed units
1)" Accounting for Scra% 1a!ues:
Aora! $oss 'redited to process account
Abnora! $oss 'redited to abnormal loss account. "rocess account is
credited with per unit cost only.
Abnora! Gain 2ebited to abnormal loss account. "rocess account is
debited with per unit cost only.

1(" Foru!a to deterine Abnora! $oss< Gain:
ST6. R *1
Total 6nput BBB
&$pected @utput #BBB%
Aora! $oss LLL
ST6. R *)
Actual =oss BBB
)ormal =oss #BBB%
Abnora! $oss LLL
,6+ISI4A 3U$6
.ositi/e Abnora! $oss
Aegati/e Abnora! Gain
17" Abnora! $oss Account
Abnormal loss is not e$pected and should not happen. 6t therefore ma+es
sense to give it a cost.
Total loss ; )ormal loss O Abnormal loss.
Units of abnormal loss are given a cost. 6f it is assumed that all losses in
process occur at the end of the process, units of abnormal loss are costed in
e$actly the same way in the as units of finished output.
The cost of units of abnormal loss is treated as an e$pense for the period,
and charged as an e$pense in the income statement for the period.
)ormal loss has no value1cost, abnormal loss has a cost.
:crap value treatment of abnormal loss.


)(

The cost of e$pected units of output is calculated in the usual way. 6n the 46" account
the cost of abnormal loss ; units of abnormal loss J cost per e$pected unit of output.
The scrap value of abnormal loss is set off against the cost of abnormal loss in the
abnormal loss account, not the process account #46"%.
2ebit0 'ash #; scrap value0 money from sale of the scrapped units%
'redit0 Abnormal loss account #abnormal loss units J scrap value per unit%
The net cost of abnormal loss #; cost of abnormal loss minus its scrap value% is then
transferred as a cost to the cost accounting income statement at the end of the
accounting period.

3s" 3s"
"rocess Account BBB BBB :crap Account #units P
scrap value%
BBB BBB

"rofit M =oss Account BBB BBB
T4TA$ LLL T4TA$ LLL
1:" Abnora! Gain Account
Actual loss ; )ormal loss 3 Abnormal gain
The differences between costing for abnormal loss and costing for abnormal gain
are that0
Abnormal gain is a benefit rather than a cost0 whereas abnormal loss is
written off as a cost at the end of the financial period, abnormal gain is an
adjustment that increases the profit for the period.
Abnormal gain is recorded as a debit entry in the process account, because it
is a benefit.
The other half of the double entry is recorded in an abnormal gain account.
At the end of the period, the balance on the abnormal gain account is then
transferred to the income statement as a benefit for the period, adding to
profit.
4hen loss has a scrap value, the value of abnormal gain is actually less than the
amount shown in the 46" account. This is because actual revenue from scrap
will be less than the e$pected revenue, due to the fact that actual loss is less
than the e$pected loss.
Accounting for the scrap value of abnormal gain is similar to accounting for the
scrap value of abnormal loss.
6n the process account #46"%, abnormal gain is valued at the cost per
e$pected unit of output.
The scrap value of normal loss is normal loss units J scrap value per unit.
The scrap value of abnormal gain is the scrap revenue that has been lostS
because actual loss is less than e$pected loss. This is abnormal gain units J
scrap value per unit.

)7

The scrap value of abnormal gain is recorded as a debit entry in the abnormal
gain account #in a similar way to recoding the scrap value of abnormal loss as
a credit entry in the abnormal loss account%.
The scrap value of the abnormal gain is set off against the value of the
abnormal gain in the abnormal gain account, not the process account.
The balance on the abnormal gain account is the net value of abnormal gain
#; value of abnormal gain minus the scrap value not earned%. This balance is
transferred as a net benefit to the cost accounting income statement at the
end of the accounting period.

3s" 3s"
:crap Account #units P
scrap value%
BBB BBB "rocess Account BBB BBB
"rofit M =oss Account BBB BBB

T4TA$ LLL T4TA$ LLL


):

+4ST 4F .34,U+TI4A 36.43T H A'63I+AA A..34A+H

PUAATITO S+H6,U$6:

Units :tarted1put into process BBB
Units added BBB
Units received from last deptt BBB LLL
Units transferred to ne$t deptt BBB
Units 'ompleted in deptt BBB
Abnormal =oss BBB
)ormal loss at the end BBB LLL

+4ST +HA3G6, ;O TH6 ,6.TT:

+ost of %receding de%tt:
Tota! +ost Unit +ost
'ost of 46" @pening inventory #@pen 46" Units 0 BBB%
'ost of previous deptt #=ast deptt Units 0 BBB%
#Total Units 0 BBB% BBB #4C/%
+ost added b& the de%tt:
'ost added during month0
2irect >aterial BBB BBB
2irect =abor BBB BBB
(actory @verhead BBB BBB
'ost of @pening 46"0
2irect >aterial BBB BBB
2irect =abor BBB BBB
Total 'ost Added by the deptt BBB BBB
Adjustment of normal loss units BBB BBB
Tota! +ost To ;e Accounted For LLL LLL

T4TA$ +4ST A++4UAT6, F43 AS F4$$45S:

'ost of goods transferred BBB
'ost of preceding deptt1Adjusted 'ost of last deptt BBB
'losing 46"0
2irect >aterial BBB
2irect =abor BBB
Tota! +ost Accounted For LLL


)=

Aotes:
1" 2irect labor M factory overhead may be treated together as conversion cost.
)" Aora! !oss t&%es:
Start ,uring 6nd
)ot included in &", )ot included in &", 6ncluded in &",
(" There is no concept of Abnormal =oss in American system.
7" There is no concept of Abnormal Gain in American system.
:" Adjustment of normal loss units #Dnd 2eptt M Above%
Unit loss P unit cost of last deptt
Good Units
=" 'ost "er Unit0
Total cost 3 )ormal =oss scrap value
&", units
>" 'ompletion :tages for &", as per A'63I+AA A..34A+H0
Aora! $oss at the end 6nspection K
Abnora! $oss 6nspection K
Abnora! Gain 6nspection K


)>

'ain < Coin %roduct:
4hen two or more products arise simultaneously in the course of processing, each of
which has a significant sale value in relation to each other.
Hoint product is a result of utili<ation of the same raw material and same processing
operations. The processing of a particular raw material may result into the output of
two or more products.
All the products emerging from the manufacturing process are of the same
economic importance. 6n other words, the sales value of those products may be
more or less same and none of them can be termed as the major product.
The products are produced intentionally which implies that the management of
the concerned organi<ation has intention to produce all the products.
:ome of joint products may reuire further processing or may be sold directly
after the split off point.
The manufacturing process and raw material reuirement is common up to a
certain stage of manufacturing. After the stage is crossed, further processing
becomes different for each product. This stage is +nown as split offS point. The
e$penditure incurred up to the split off point is called as joint cost and the
apportionment of the same to different products is the main objective of the
joint product accounting.
The management has little or no control over the relative uantities of the
various products that will result.
Hoint products are commonly produced in industries li+e, chemicals, oil refining,
mining, meatpac+ing, automobile etc. 6n oil refining, fuel, oil, petrol, diesel,
+erosene, lubricating oil are few e$amples of the joint products.
;& .roduct:
A product which arises incidentally in the production of the main product M which has a
relatively small sale value compared with the main product. 4hatever revenue entity
earns is the bonus for them.
This term byCproductsS is sometimes used synonymously with the term minor
productsS.
The byCproduct is a secondary product, which incidentally results from the
manufacture of a main product.

)?

Gy3products are also produced from the same raw material and same process
operations but they are secondary results of operation. The main difference
between the joint product and byCproduct is that there is no intention to
produce the byCproduct while the joint products are produced intentionally. The
relationship between the byCproduct and the main product changes with
changes in economic or industrial conditions or with advancement of science.
4hat was once a byCproduct of an industry may become a main product and one
time main product may become a byCproduct subseuently. (or e$ample, during
the :econd 4orld 4ar, glycerin, a byCproduct in soap ma+ing was in such a
demand that it became virtually the main product while the soap was reduced to
the byCproduct. 4hat is byCproduct of one industry may be a main product of
another industry. )ormally in continuous process industry, the by3products
emerge. :ome of the e$amples of byCproducts are given below0
6n sugar manufacturing, bagasse Tresidual of sugarcane after the
juice is e$tractedU, molasses Tresidual of sugarcane juice after the
impurities are ta+en outU and press mud are the three byC
products, which emerge at different stages of manufacturing.
6n cotton te$tile, the cottonCseed, which is ta+en out before the
manufacturing process, is a byCproduct.
S%!it off %oint: :plit off point also called separation point consists of all the costs
incurred prior to separation point.
This is a point up to which, input factors are commonly used for production of multiple
products, which can be either joint products or byCproducts. After this point, the joint
products or byproducts gain individual identity. 6n other words, up to a certain stage,
the manufacturing process is the same for all the products and a stage comes after
which, the individual processing becomes different and distinct. (or e$ample, in a dairy,
several products li+e, mil+, ghee, butter, mil+ powder, iceCcream etc. may be produced.
The common material is mil+. The pasteuri<ation of mil+ is a common process for all the
products and after this process; each product has to be processed separately. All costs
before split off point1 separation point is common cost or joint cost that is irrelevant for
decision ma+ing purposes.
Coint +osts: Hoint cost is the preCseparation cost of commonly used input factors for
the production of multiple products. 6n other words, all costs incurred before or up to
the split off point are termed as joint costs or pre separation costs and the
apportionment of these costs is the main objective of joint product accounting. 'osts
incurred after the split off point are post separation costs and can be easily identified
with the products.s


)@

;O .34,U+T +HA3T:

A++4UATIAG F43 ;O .34,U+T 3616AU6
/. 6ncome from byCproduct added to sales of the main product
D. GyC"roduct income treated as a separate source of income
E. :ales income of the byCproduct deducted from the cost of production in the
period
5. ),A of the byCproduct deducted from the cost of production in the period.
A31 '6TH4,:
,evenue by sale of by product BBB
=essC 'ost of further processing BBB
'ost of disposal BBB #BBB%
Aet 3ea!i9ab!e /a!ue LLL
),A of the byCproduct is to be deducted from cost of production. 6n case of details
wor+ing, to be deducted from cost of material M more specifically from the cost of
material of previous cost.
),A has same treatment as we did with normal loss in process costing. 4e will not
assign cost to byCproduct as we not assign to normal loss. ),A of byCproduct produced
#not sold% is to be ta+en to value the byCproduct in process costing.
Aora! $oss ;&2.roduct
:crap value ),A
)ot assign cost )ot assign cost

(*

.63 UAIT +4ST F43'U$A:
Total cost 3 scrap value of normal loss 3 ),A of byCproduct produced
&uivalent units 3 GyCproduct
A$$4+ATI4A 4F C4IAT +4STS
'A3N6T 1A$U6< SA$6 1A$U6 '6TH4,
Total joint product cost P /..
Total mar+et cost
; Answer P each mar+et value ; apportionment of joint cost
The assu%tion behind this method is that the price obtained for an item is directly
related to its cost.
A163AG6 UAIT +4ST '6TH4,
Total number of unit produced
; Answer P uantity produce ; apportionment of joint cost
56IGHT6, A163AG6 '6TH4,
Total number of unit weight
; Answer P individual weight ; apportionment of joint cost
A31 '6TH4,
(inal sale value BBB
=essC :ubseuent processing costs BBB
Coint cost LLL


(1

A4T6:
6t must be emphasi<ed that whatever method is used for apportioning joint
costs, it is a convention only M its accuracy cannot be tested. 6t is totally
unsuitable for any form of decision ma+ing.
The amount of joint cost M the method by which joint costs are apportioned are
irrelevant.
C4IAT 1S ;O .34,U+T:
,IFF636A+6 C4IAT .34,U+T ;O .34,U+T
SA$6 1A$U6 ?igh =ow
FU3TH63 .34+6SS After spit off point )ot economical
A++4UATIAG Allocate on various bases >any >ethods
IAT6ATI4A T4 .34,U+6 6ntentionally )o intention
,ecision 'aking .oint:
1" Hoint cost is irrelevant for decision ma+ing.
)" =oss on individual joint product is irrelevant. The +ey to decision is that
process as a whole is profitable.
(" >ethod0
6ncremental ,evenue ; BBB
6ncremental 'osts ; BBB
Increenta! .rofit ; LLL


()

H45 T4 ATT6'.T ,6+ISI4A 'ANIAG PU6STI4A
F43 T54 .34,U+TS
,6T63'IAIAG $I'ITIAG FA+T43 < 36S4U3+6:
2emand P "er Unit scarce ?our BBB
=essC Available hour BBB
Shortfa!! (if %ositi/e# LLL
AU'63I+A$ .43TI4A:
:ale #"er Unit% BBB
=essC Aariable &$penses #"er Unit% BBB
'ontribution >argin #"er Unit% LLL
V S
"er Unit :carce ?our BBB
+ontribution 'argin (.er Scarce Hour# LLL
3AANIAG #F43'U$A ; ?igh to low depending on 'ontribution >argin #"er :carce
?our%%
,6'AA, ; demand P scarce hour
A!!ocate deand as %er ranking obtained"
4%tiu .!an:
2emand P 'ontribution >argin per Unit BBB
T4TA$ +4AT3I;UTI4A LLL
Aote: Unit contribution is not the correct way to decide priorities.


((

'436 THAA T54 .34,U+TS
AU'63I+A$ .43TI4A:
:ale #"er Unit% BBB
V S
?our%%
A%%ro%riate 'i0:
2emand P :carce ?our BBB
'IAI'U' ,6'AA, GI16A


(7

AU'63I+A$ .43TI4A:
:ale #"er Unit% BBB
V S
?our%%
A%%ro%riate 'i0:

Total 2emand CC >inimum 2emand P :carce ?our BBB
36$61AAT +4ST
/. (ive Aital 'riteria0
Gearing on the future. #re!ate, incur & _:> _:> _:> _:> with future%. They cannot
include any costs that have already occurred in the past.
2iffer among the alternatives. #also called differential cost%
,elevant costs of a decision are costs that 8i!! occur as a direct
conseBuence of aking the decision.
,elevant costs are cash f!o8s. )otional costs, such as depreciation
charges, notional interest costs and absorbed fi$ed costs cannot be
relevant to a decision.
The concept of relevant costs also applies to revenue #i.e. the changes in
cash revenue arising as a direct conseuence of a decision%.

(:

D. :crap :ale "roceed as it is e$pected future inflow that usually differs among
alternatives.
E. @pportunity 'ost.
5. Avoidable 'ost.
-. 2epreciation on new euipment that is to be purchased.
F. (uture 'ost that differ between alternatives.
I. Aariable @verhead.
7. Additional 'ost.
8. Actual @verhead.
/.. 6ncremental cost that could be avoided if contract not underta+en. "rovided that
this additional cost is a cash flow.
//. 2ifferential cost provided that this additional cost is a cash flow.
/D. ,elevant cost M revenue are those that are affected by change in level of activity.
/E. 2irectly attributable fi$ed cost that although fi$ed are relevant to decision0
/5. 6ncrease if certain e$tra activities are underta+en.
/-. 2ecrease or eliminated entirely if a decision were ta+en either to reduce the
scale of operation or shut down entirely.
I336$61AAT +4ST
/. Goo+ value as it is past 1 historical cost. Goo+ Aalue is irrelevant even if income
ta$es are considered. Goo+ Aalue is essential information for predicting the
amount M timing of future ta$ cash flows, but, by itself, the boo+ value is
irrelevant.
D. 2epreciation on old euipment as it is past cost. ?istorical cost depreciation that
has been calculated in the conventional manner. :uch depreciation calculations
do not result in any future cash flows. They are merely the boo+ entries that are
designed to spread the original cost of an asset over its useful life.
E. (i$ed cost is irrelevant. (i$ed overheads that will not increase or decrease as a
result of the decision being ta+en. 6f the actual amount of overhead incurred by
the company will not alter, then the overhead is not a relevant cost. This is true
even if the amount of overhead to be absorbed by a particular cost unit alters as
a result of the companySs cost accounting procedures for overheads.
5. Uniti<ed fi$ed cost.
-. 2iscretionary cost is fi$ed cost.
F. Allocated1Absorbed1General overhead.
I. Unavoidable 'ost because the decision will not affect the cost in any way.
7. :un+ 1 "ast 'ost. #4ater under the bridgesWdo not affect the future%.
8. @riginal cost is irrelevant.
/.. &stimation cost is past cost.
//. Administration overhead, estimating M design department cost is sun+ cost.
/D. (uture 'ost that donSt differ between alternatives.
/E. 'ost of material in stoc+ 1 component no longer used in production process.

(=

/5. ,eCallocation of e$isting overhead is irrelevant for decision ma+ing purposes.
/-. 'ommitted cost. &$penditure that will be incurred in the future, but as a result of
decisions ta+en in the past that cannot now be changed. These are +nown as
committed costs. They can sometimes cause confusion because they are future
costs. ?owever, a committed cost will be incurred regardless of the decision
being ta+en and therefore it is not relevant. An e$ample of this type of cost could
be e$penditure on special pac+aging for a new product, where the pac+aging has
been ordered and delivered but not yet paid for. The company is obliged to pay
for the pac+aging even if they decide not to proceed with the product; therefore
it is not a relevant cost.
60ercise
Test your understanding of relevant and nonCrelevant costs by seeing if you can identify
which of the following costs are relevant0
#a% The salary to be paid to a mar+et researcher who will oversee the development of a
new product. This is a new post to be created specially for the new product but the ,s0
/D,... salaries will be a fi$ed cost. 6s this cost relevant to the decision to proceed with
the development of the product9
#b% The ,s0 D,-.. additional monthly running costs of a new machine to be purchased to
manufacture an established product. :ince the new machine will save on labour time,
the fi$ed overhead to be absorbed by the product will reduce by ,s0 /.. per month. Are
these costs relevant to the decision to purchase the new machine9
#c% @ffice cleaning e$penses of ,s0 /D- for ne$t month. The offi ce is cleaned by
contractors and the contract can be cancelled by giving one monthSs notice. 6s this cost
relevant to a decision to close the office9
#d% &$penses of ,s0 I- paid to the mar+eting manager. This was to reimburse the
manager for the cost of travelling to meet a client with whom the company is currently
negotiating a major contract. 6s this cost relevant to the decision to continue
negotiations9

So!ution
#a% The salary is a relevant cost of ,s0 /D,.... 2o not be fooled by the mention of the
fact that it is a fi$ed cost, it is a cost that is relevant to the decision to proceed with the
future development of the new product. This is an e$ample of a directly attributable
fi$ed cost. A directly attributable fi$ed cost may also be called a productCspecific fi$ed
cost.
#b% The ,s0 D,-.. additional running costs are relevant to the decision to purchase the
new machine. The saving in overhead absorption is not relevant since we are not told
that the total overhead e$penditure will be altered. The saving in labour cost would be
relevant but we shall assume that this has been accounted for in determining the
additional monthly running costs.

(>

#c% This is not a relevant cost for ne$t month since it will be incurred even if the contract
is cancelled today. 6f a decision is being made to close the office, this cost cannot be
included as a saving to be made ne$t month. ?owever, it will be saved in the months
after that so it will become a relevant cost saving from month D onwards.
#d% This is not a relevant cost of the decision to continue with the contract. The ,s0 I- is
sun+ and cannot be recovered even if the company does not proceed with the
negotiations.
A4TI4AA$ +4ST
The value of benefit where no actual cost is incurred. There is no actual outflow of cash.
)otional costs such as notional rent and notional interest. These are only relevant if
they represent an identified lost opportunity to use the premises or the finance for
some alternative purpose. 6n these circumstances, the notional costs would be
opportunity costs.
.4IATS T4 +4ASI,63 IA +$4S6 4F ;USIA6SS
/. 2ifficult to recapture mar+et due to heavy advertising e$penses.
D. (ear of retrenchment of wor+er.
E. =oss to reputation of business.
5. Temporary close down is not good if relationship with supplier adversely
affected in any way.
-. (ear of nonCcollection of dues.
F. "lant become obsolete M heavy capital e$penditure needed to restart the
business.
+4ATIAU6 .34,U+TI4A IF SA$6 .3I+6 IS ;6$45 'A3GIAA$ +4ST
/. 6ntroducing new product.
D. &$ploring foreign mar+et.
E. "urchase of large uantity of material.
5. &liminate competitor.
-. "erishable nature of goods.
F. &mployee cannot be retrenched.
I. :ale of one product at below marginal cost pushes up sale of other product.
,6+ISI4A 'ANIAG TI.S
/. 6n heavy demand T ?igh '1> ratio will earn high profit due to high contribution.
D. 6n =ow demand T =ow Grea+ &ven "oint means high profit as it starts earning
profit at low level of sales.
E. 2onSt eliminate the product if the contribution is positive.

(?

5. 2onSt accept order from local mar+et if price is below sale price as it will affect
the relationship.
-. To foreigner, it should be accepted if price is below sale price.
F. 'ost that is relevant in one situation might be irrelevant in other situation.
'AN6 43 ;UO < 4UTS4U3+IAG
6t is the process of obtaining good1service by outside supplier.
,evenue BBB
=essC 'ost BBB
:avings BBB
Avoidable cost BBB #BBB%
LLL
UTI$ISATI4A 4F ST43AG6 +A.A+ITO
Accept orders if these uestions are replied in QOesR0
/. :pare capacity available.
D. 'ontribution is positive.
6ncremental ,evenue BBB
6ncremental 'ost BBB
Increenta! +ontribution LLL
3616$AAT 3AAG6 4F A+TI1ITO
,ange within which unit price are li+ely to be constant.
/. :tep is large.
D. :tep is small. ,eason is that cost is variable cost.
6n short term, cost is fi$ed which become variable with the passage of time.
A++6.T 43 36C6+T
:ale price X variable manufacturing cost Y Accept order.
:ale price Z variable manufacturing cost Y ,eject order.
?ere, variable manufacturing cost means0

(@

Aariable manufacturing cost BBB
AddCC @pportunity 'ost BBB
=essW:avings BBB
T4TA$ LLL
'AN6 43 ;UO ; Aariable manufacturing cost X Guy cost Y Guy.
Aariable manufacturing cost Z Guy cost Y >a+e.
'a0iu .rice ; Aariable manufacturing cost.
4%%ortunit& +ost The ma$imum available contribution to profit forgone #or passed
up 1 loss of revenue% by using limited resources for particular purposes. This cost will
never appear in the set of double entry cost accounts.
The best way to demonstrate opportunity costs is to consider some e$amples0

#a% A company has some obsolete material in stoc+ that it is considering using for a
special contract. 6f the material is not used on the contract it can either be sold bac+ to
the supplier for ,s0 D per tonne or it can be used on another contract in place of a
different material that would usually cost ,s0 D.D. per tonne. The opportunity cost of
using the material on the special contract is ,s0 D.D. per tonne. This is the value of the
ne$t best alternative use for the material, or the benefit forgone by not using it for the
other contract.

#b% ' is deciding whether or not to ta+e a s+iing holiday this year. The travel agent is
uoting an allCinclusive holiday cost of ,s0 FI- for a wee+. ' will lose the chance to earn
,s0 D.. for a partCtime job during the wee+ that the holiday would be ta+en. The
relevant cost of ta+ing the holiday is ,s0 7I-. This is made up of the outCofCpoc+et cost
of ,s0 FI-, plus the ,s0 D.. opportunity cost that is the partCtime wages forgone.

Aotiona! costs and 4%%ortunit& costs
)otional costs and opportunity costs are in fact very similar. This is particularly
noticeable in the case of notional rent. The notional rent could be the rental that the
company is forgoing by occupying the premises itself, i.e. it could be an opportunity
cost. ?owever, it is only a true opportunity cost if the company can actually identify a
forgone opportunity to rent the premises. 6f nobody is willing to pay the rent, then it is
not an opportunity cost.
Increenta! cost: 6ncrease of output due to change in cost result in change in
activity level. Also called ,ifferentia! +ost"

7*

,ecreent cost: A differential cost is therefore an amount by which future costs
will be higher or lower, if a particular course of action is chosen.
4ut of %ocket e0%enses: Those costs that entail current or near future outlays for
the decision at hand. &.g the business man can either use his car to attend meeting at
cost of ,s0 D-1C or he can drive to the station #cost ,s0 /1C% M let the train ta+e the train
at cost of ,s0 D.1C. The out of poc+et e$pense is the additional cash e$pense of ,s0 -/CD-
; DF.
Sunk +ost: >oney already spent that cannot now be recovered. >ore specifically
Qwater under the bridgesR @, Qbygones are bygonesR. An e$ample of a sun+ cost is
e$penditure that has been incurred in developing a new product. The money cannot be
recovered even if a decision is ta+en to abandon any further development of the
product. The cost is therefore not relevant to future decisions concerning the product.
,irect!& Attributab!e F+: This cost has two features0
6ncrease if certain e$tra activities were underta+en.
2ecrease or be eliminated entirely if a decision were ta+en either to reduce
the scale of operations or shut down entirely.
S+A3+6 36S4U3+6 < $I'ITIAG FA+T43
Anything that limits the activity of an entity is called limiting factor. &.g0
/. 2emand
D. >aterial
E. =abor hour
5. >achine hour
Ao $iiting Factor ?igh '> ratio is good.
$iiting Factor ?igh contribution per scarce resource is
good.

IA+36'6ATA$ AAA$OSIS
6ncremental analysis considers only that item of revenue, cost M volume that will change
if new program is implemented.


71

&$pected '1> #&$pected sale P '1> ratio% BBB
"revious '1> #@ld sale P '1> ratio% BBB
6ncreased '1> BBB
=essC Additional :ales BBB
Increased Aet 4%erating Incoe LLL
,6+ISI4A 'ANIAG '4,6$

SA'6 +<' .63 $I'ITIAG FA+T43:
SA$6S A ; +
'> # "er limiting
factor%
57 5. 5.
3anking 1 ) )
Identif&
4b-ecti/es
Search for
.ossib!e
+ourses of
Actions
Identif& States
of Aature
$ist .ossib!e
4utcoes
'easure
.a&offs
Se!ect +ourse
of Action

7)

/. 4hen there is same contribution margin per limiting factor, firm is indifferent in
that case.
D. "roduct mi$ is irrelevant here.
E. 4hatever product entity made, it never matters.
S.6+IA$ 43,63

+4A+6.TS
+AS6 R 1: Luantity is not same but A' per unit is same, then we will get total cost
by this formula0 uantity P A' per unit
A ; T4TA$
Lty /.. E.. 5..
A' "er unit E E E
Tota! 1+ (** @** 1)**

+AS6 R ): Luantity is same but A' per unit is not same, then we will get total cost
by this formula0 uantity P A' per unit
A ; T4TA$
Lty D.. D.. 5..
A' "er unit D E
Tota! 1+ 7** =** 1***
+AS6 R (: Luantity is not same M A' per unit is also not same, then we will get total
cost by this formula0 weighted average cost
A ; T4TA$
Lty E.. -.. 7..
A' "er unit / 5
Tota! 1+ (** )*** )(**
_
> _
,
' _
,
. .
_ =oss .': _
4%%ortunit& $oss _
,
~
'

_
> _
,
' _
,
. .
_ Gain .': _
4%%ortunit& Gain _
,
~
'


7(

5H6A T4 US6 56IGHT6, A163GA6 3ATI4
/. Luantity is different M cost is different, total cost will be distributed by weighted
average cost.
D. Total cost M brea+ up not given, calculated weighted average ratio.
E. >ore than one ratio given for calculating cost, use weighted average ratio.
I!!ustration to abo/e conce%t R *1:
Total Aariable 'ost 7EF...
A' ,atio / /.- /.I-
Units /-... /.... /....
So!ution to abo/e i!!ustration R *1:
Lty ,atio /.- / /
A' ,atio / /.- /.I-
4eighted Average
/.- /.- /.I-
1+ %er unit:

)=7***<1:*** K
1>"=
)=7***<1****K)="7 (*?***<1****K(*"?

I!!ustration to abo/e conce%t R *):
(irm convert into company on ./C.-C.8. (inancial year ends on E/
st
dec, D.//
"re incorporate sale ; ,s0 E.....
"ost incorporate sale ; ,s0 8.....
'@G: ; ,s0 7.....
)o change in sales but '@G: reduces by /.K in post incorporation period.
3eBuired: "re M "ost incorporation period.
So!ution to abo/e i!!ustration R *):
.re .ost Tota!
:ales E..... 8..... /D.....
'@G: #D/FD/F% #-7EI7E% #7.....%
Gross .rofit ?(>?7 (1=)1> 7*****
Gross .rofit (J# )>"@(J (:"1(J


77

4or+ing0 4eighted average is calculated as followsC
Lty E 8
A' / ..8 #/C/.K%
( ?"1

6IGHT +436 +4A+6.TS 4F ,6+ISI4A 'ANIAG
1" 'IAI'U' .34FIT K 6t is to be ignored as it is irrelevant cost.
)" +4ST 4F T6A,63 & F6ASI;I$ITO STU,O
6rrelevant for decision ma+ing as it is common cost which is to be paid
regardless of acceptance or rejection.
(" F4H

FIL6, +4STS:
/. 'hange as a decision ; 6ncrease in fi$ed costs is incremental cost M
is relevant for decision.
D. )ot change as a decision ; 6rrelevant for decision. (i$ed costs are
ignored as there is no incremental fi$e costs e$penditure.

1ariab!e F4H K Always relevant

Fi0ed<Absorbed< A!!ocated<
A%%ortioned F4H K Always
irrelevant

7:
For Suggestions & Feedbacks, contact:

Aariable 'ost
#)o of hr P per hr
=abor C D
(ull 'apacity
:pare 'apacity
Cost Accounting Manual
7" $A;43 2 1
$A;43 2 )
=abor
Aariable 'ost
#)o of hr P per hr
rate%
'ommitted 'ost
/ C 6rrelevant upto
committed level
D C ,elevant over M
above that level
:hift in =abor
/ C Aariable 'ost
D C @pportunity 'ost #
)o of hr P per hr
contribution%
(ull 'apacity
Additional wor+
cannot be done1
underta+en
?ire :taff
)ot ?ire :taff
:pare 'apacity
Additional wor+ can
be done1 underta+en
)6= ,elevant 'ost
ATAUSH SHAFI (ataushshafi@gai!"co#

:hift in =abor
Aariable 'ost
@pportunity 'ost #
)o of hr P per hr
contribution%
?ire :taff 'urrent "ay
)ot ?ire :taff
/ C Aariable &$pense
O
D C =ost 'ontribution
)6= ,elevant 'ost

7=

,egular Use1
Alternative Use 1
,eplacement
'urrent
replacement price #
)o of +g used P per
+g%
3egu!ar Use
3a8 'ateria! bought for
regu!ar use K 'urrent
replacement "rice
3a8 'ateria! not bought
for regu!ar use K =oss of
contribution margin of
regular use
:" 'AT63IA$
>aterial
replacement price #
)on C ,egular Use 1
)on C Alternative
Use 1 )on C
,eplacement
?ave no resale
value
,esale Aalue
?ave some value
@, reslae value
?igher of other
value @, reslae
value
3A5 'AT63IA$ A$36A,O .U3+HAS6,
Ao 3egu!ar < A!ternati/e Use
Scra% 1a!ue ; =oss of scrap
value
Ao Scra% 1a!ue ; )6=
+ost of dis%osa! ; :avings of
cost of disposal #opportunity
gain%
D

)o resale value @,
other use
N&,@
A!ternati/e Use
?igher of
/ 3 :crap value
43
D 3 Aalue in alternative use

7>

T )et boo+ value1 written down value is not relevant for decision ma+ing as it is
determined by accounting method M not by cash flow method.

A$36A,O ;4UGHT
/ 3 (all in resale value is relevant
#Gefore0 F.... X )ow0 5.... ;
2ifference of D.... is relevant%.
D 3 ,unning M >aintenance cost
E 3 2epreciation is irrelevant
5 3 2eprival value #=ower of
,eplacement cost 43 ?igher of ),A @,
Aalue in Use%
=" A4A +U336AT ASS6TS
)et boo+ value1 written down value is not relevant for decision ma+ing as it is
determined by accounting method M not by cash flow method.
>" 'A+HIA63O
)on 'urrent Asset
,egular Use1
Alternative Use 1
,eplacement
'urrent
replacement price
)on C ,egular Use 1
)on C Alternative
Use 1 )on C
,eplacement
?igher of
:ale "roceed # if
sold%
)et 'ash (low # if
not sold%
A$36A,O ;4UGHT
(all in resale value is relevant
#Gefore0 F.... X )ow0 5.... ;
2ifference of D.... is relevant%.
,unning M >aintenance cost
2epreciation is irrelevant
2eprival value #=ower of
?igher of ),A @,
T4 ;6 ;4UGHT
(ollowing is relevant cost here0
/ C 'ost
D C ,unning M >aintenance cost
E C 2epreciation

)et boo+ value1 written down value is not relevant for decision ma+ing as it is
)et 'ash (low # if
T4 ;6 ;4UGHT
(ollowing is relevant cost here0
,unning M >aintenance cost


7?

2epreciation is not relevant for decision ma+ing but using machinery will involve some
incremental costs. These costs may be referred to as user costs M they include repair
costs arising from use, hire charges Many fall in resale value of owned assets which
result from their use.
?" 36PUI36,<A1AI$A;$6
+AS6 R *1

+AS6 R *)

+AS6 R *(

+3IT63IA:
/ 3 ,euired is more.
D 3 Available is less.
E 3 ,egular uses
,euired Unit ; BBB
Available Unit ; #BBB% P current
replacement price
Galance ; LLL P current
replacement price
+3IT63IA:
D 3 Available is less.
E 3 )on C ,egular uses
,euired Unit ; BBB
Available Unit ; #BBB% P disposal cost
Galance ; LLL P current
replacement price

+3IT63IA:
/ 3 ,euired is less.
D 3 Available is ?igh.
E 3 ,egular uses

3eBuired Unit I current re%!aceent
%rice


7@

+AS6 R *7

+AS6 R *:

+AS6 R *=

+AS6 R *=

+AS6 R *>

Fu!! cost is re!e/ant

+3IT63IA:
D 3 Available is none.
E 3 4ill have to buy
+3IT63IA:
/ 3 ,euired is less.
D 3 Available is high.
E 3 )on C ,egular uses

3eBuired Unit K LLL I dis%osa! cost
+3IT63IA:

,euired ; Available.
3eBuired Unit K LLL
43
A/ai!ab!e Unit K LLL I dis%osa! cost

+3IT63IA:
/ 3 6dle hour
D 3 ,ate as per agreement

E634 re!e/ant cost


:*

:ubstitute indicates that opportunity cost e$ists.
6f two opportunity costs are given, then select the one with higher value.
:carce ,esource U Alternative use U @pportunity 'ost
4%%ortunit& +ost foru!a K
=ower of ,eplacement cost 43 ?igher of ),A12isposal Aalue @, Aalue in
Use1 &conomic Use
TI.S
6gnore opening stoc+ as we assume constant stoc+ per level.
&$istence of spare capacity means N&,@ ,&=&AA)T '@:T.
(ull wage cost is irrelevant in short supply.
,IFF636ATIA$ 1S IA+36'6ATA$ +4STIAG

,ifferentia! +osting Increenta! +osting
,efinition Alternative course of action 'hange in (' due to increase or
decrease in output
A%%roach Absorption 1 >arginal costing 'ontribution
Oard Stick 6ncrease or 2ecrease in revenue 'ontribution >argin
He!% >anagerial M non accounting
decisions
All decisions. Goth accounting M non
accounting
Fi0ed +ost (' is not added (' is added

PU6STI4AS F43 .3A+TIS6
Puestion R *1
6G6 has been as+ed to prepare a tender for a contract to produce a special batch of D.. paints to be
completed by 2ecember E/
st
. [ou have obtained the following information0
/. &ach paint reuired0
>aterial C 5 +g of A
-+g of G
=abor C D hrs for s+illed
E hrs for semi s+illed

:1

D. /... +g of material A is in stoc+ for which the company has paid ,s0 E per +g. The price of this
material has recently risen to ,s0 - per +g M is e$pected to stay at that level for some time. The
company uses the material regularly for its normal production.
E. Aariable overhead are incurred at the rate of ,s0 5 per direct labor hour.
5. (i$ed overhead are recovered at the rate of ,s0 F per direct labor hour.
-. The cost of preparing the tender is ,s0 E...
F. :+illed wor+ers are paid ,s0 I per hour with a guaranteed wee+ly minimum of ,s0 D5- per wee+.
The wor+ forces of 7- are only utili<ed for E. hours per wee+.
I. :emi s+illed wor+ers are paid ,s0 - per hour with time M a third for overtime. The wor+forces of
/.. are currently fully utili<ed.
7. A special machine will have to be bought at a cost of ,s0 E... which could subseuently be sold
for ,s0 D-... Alternatively, the machine converted at a cost of ,s0 /... M retained for use
elsewhere in the business; the company has intended to buy an additional machine for this
purpose towards the end of D.BB at a cost of ,s0 EI...
8. The company has F.. +g of material G in stoc+. 6t bought this sometime ago at a cost of ,s0 5...
but it currently is not in regular use by 6G6. The current cost is ,s0 8 per +g. >aterial G could be
used to ma+e a different product in place of a material that has a current purchase price of ,s0 -
per +g #substitution on a /0/ basis%. There is none of this other material in stoc+.
So!ution R *1
'ateria! K
/... P - -...
A 0 F.. P - E...
G 0 5.. P 8 EF..
$abor K
:+illed #7- P -% 5D-
:emi :+illed #/.. P F.FI% FFI
4or+ing 3 - O- P/1E ; /.FI Z- O/.FI ; F.FIX
1ariab!e 4/erhead :
:+illed #7-P5% E5.
:emi :+illed #/..P5% 5..
'achine K
@utflow E...
6nflow #D-..% -..
@utflow 5... #E...O/...%
6nflow #EI..% E..
T4TA$ 17)()
Aote:
/. (i$ed overhead are recovered at the rate of ,s0 F per direct labor hour is 6,,&=&AA)T for decision
ma+ing.
D. The cost of preparing the tender is ,s0 E.. are 6,,&=&AA)T for decision ma+ing.


:)

Puestion R *)
>r. Gill Gates has been as+ed to uote a price for a special contract. ?e ahs recently prepared his tender
but has as+ed you to review it for him.
?e has pointed out to you that he wants to uote the minimum price as he believes this will lead to more
lucrative wor+ in the future. >r. Gill Gates tender0
'ateria!:
A 0 D... +g \ ,s0 /. per +g D....
G 0 /... +g \ ,s0 /- per +g /-...
' 0 -.. +g \ ,s0 5. per +g D....
2 0 -. liter \ ,s0 /D per liter F..
$abor:
:+illed 0 /... hrs \ ,s0 D- per hr D-...
:emi C :+illed 0 D... hrs \ ,s0 /- per hr E....
Un :+illed 0 -.. hrs \ ,s0 /. per hr -...
Fi0ed o/erhead : E-.. hrs \ ,s0 /D per hr 5D...
+osts of %re%aring the tender :
>r. Gill Gates time /...
@ther e$penses -..
>inimum profit #-K of total costs% IID-
'iniu tender %rice 1==?):

4ther inforation:
'ateria! H A: /... +gs of this material is in stoc+ of ,s0 - per +g. >r. Gill Gates has no alternative use for
his material M intends selling it for ,s0 D per +g. ?owever, if he sold any he would have to pay a fi$ed sum
of ,s0 E.. to cover delivery costs. The current purchase price is ,s0 /. per +g.
'ateria! H ;: there is plenty of this material in stoc+ at a cost of ,s0 /7 per +g. . The current purchase price
ahs fallen to ,s0 /- per +g. This material is constantly used by >r. Gill Gates in his business.
'ateria! H +: the total amount in stoc+ of ,s0 -.. +gs was bought for ,s0 /.... some time ago for
another oneC off contract which never happened. >r. Gill Gates is considering selling it for ,s0 F... in
total or using it as a substitute for another material constantly used in normal production. 6f used in this
latter manner, it would save ,s0 7... of the other material. 'urrent purchase price is ,s0 5. per +g.
'ateria! H ,: there are /.. liters of this material in stoc+. 6t is dangerous M is not used in this contract,
will have to be disposed of at a cost to >r. Gill Gates of ,s0 -. per liter. The current purchase price is ,s0
/D per liter.
Ski!!ed $abor: >r. Gill Gates only hires s+illed labor when he needs it. ,s0 D- per hour is the current hourly
rate.
Sei Ski!!ed !abor: >r. Gill Gates has wor+force of -. semi s+illed laborers who are not currently fully
employed. They are on normal contracts M the number of spare hours currently available for this project

:(

is ,s0 /-... Any hours in e$cess of this will have to be paid for at time M a half. The normal hourly rate is
,s0 /- per hour.
Un2ski!!ed !abor: these are currently fully employed by >r. Gill Gates on jobs where they produce a
contribution of ,s0 D per uns+illed labor hour. Their current rate is ,s0 /. per hour, although e$tra could
be hired at ,s0 D. an hour if necessary.
Fi0ed 4/erhead: this is considered by >r. Gill Gates to be an accurate estimate of the hourly rate based
on e$isting production.
+osts of %re%aring the tender: >r. Gill Gates has spent /. hours wor+ing on this project at ,s0 /. per
hour, which he believes is his chargeCout rate. @ther e$penses include the cost of travel M research spent
by >r. Gill Gates on the project.
.rofit: this is >r. Gill Gates minimum profit margin which he believes is necessary to cover Qgeneral day to
day e$penses of running a businessR
So!ution R *)
'ateria!:
A 0 /... +g \ ,s0 /. per +g /....
/...PD ; D... 3 E.. ; /I.. Z4or+ing 3 ,s0 E.. are opportunity savingsX /I..
G 0 /... +g \ ,s0 /- per +g /-...
' 0 ?igher of ,s0 F...1C @, ,s0 7...1C 7...
2 0 #-. P -.% Z opportunity savingsX #D-..%
$abor:
:+illed 0 /... hrs \ ,s0 D- per hr D-...
:emi C :+illed 0 ,euired ; D...
Available ; #/-..%
:hortfall ; -.. #-.. P DD.-.%
4or+ing 3 overtime of ,s0 DD.-. #/-O-.K% will always be paid at premium.
//D-.
Un :+illed 0 #-.. P D ; /...% M #/. P -.. ; -...% ; #/...O-... ; F...% F...
'iniu Tender .rice >77:*
Aotes:
/. (i$ed @verhead 0 N&,@. 6,,&=&AA)T for decision ma+ing.
D. 'osts of preparing the tender 0 N&,@. 6,,&=&AA)T for decision ma+ing.
E. "rofit 0 N&,@. 6,,&=&AA)T for decision ma+ing.
Puestion R *(
>r. 4inston 'hurchill runs a business of manufacturing airplanes. ?e has recently completed a special
custom built aeroplane for a customer who ahs become insolvent M is unable to ta+e delivery.
(ortunately, the customer has paid a nonCreturnable deposit of ,s0 -... on ordering the aeroplane M this
money together with the cash proceed of ,s0 5... now available for scrapping the aircraft will cover >r.
4inston 'hurchill costs.

:7

>r. 4inston 'hurchill has suddenly met a new customer, G@G, who is interested in buying the aircraft but
only after certain information. Gob wants to +now how much the aeroplane will cost M has as+ed >r.
4inston 'hurchill to prepare a tender for them.
>r. 4inston 'hurchill has investigated the modifications reuired M prepared a costing statement0
'ateria!:
A 0 - +g \ ,s0 /.. per +g -..
G 0 /. +g \ ,s0 /-. per +g /-..
' 0 /. +g \ ,s0 I- per +g I-.
2 0 I +g \ ,s0 /. per +g I..
$abor:
:+illed 0 /.. hrs \ ,s0 /. per hr /...
:emi C :+illed 0 I- hrs \ ,s0 I per hr -D-
Un :+illed 0 7. hrs \ ,s0 - per hr 5..
Aariable overhead 0 D-- hrs \ ,s0 E per hr IF-
(i$ed overhead 0 D-- hrs \ ,s0 D per hr -/.
'osts of preparing the statement /..
'iniu tender %rice =>:*

?e is uncertain about the price at which to tender and has as+ed you to review his figures for a fee of ,s0
/-.. [ou establish the followings0
>aterial 3 A0 there are /D +g in stoc+ originally purchased for ,s0 /.. per +g. The price has recently risen
to ,s0 /E. per +g. >r. 4inston 'hurchill normally sells material for ,s0 /D. per +g. >r. 4inston 'hurchill
+eeps stoc+ of >aterial 3 A as it is essential component for all of his aeroplanes.
>aterial 3 G0 the price of ,s0 /-. per +g for material G also represent the historical cost of purchase of the
/. +g which are in stoc+. >r. 4inston 'hurchill normally sells material G to his customers as separate
accessory. ?e has recently buying stoc+s at ,s0 /F. per +g M selling them on for ,s0 D. per +g.
>aterial 3 '0 this is no use elsewhere in the business although >r. 4inston 'hurchill has 5 +g in stoc+ M
could sell these for a total of ,s0 /... The price on the costing statement was the historical cost of
purchase, which has not changed for some time.
>aterial 3 20 there are D. +g of this in stoc+ M these are of no use elsewhere in the business. 6t will be
necessary to dispose of any remaining >aterial 3 2 at a lump sum cost of ,s0 D...
=abor0 s+illed labor is paid on hourly basis at a rate shown in the statement above with a guaranteed
minimum wage rate of ,s0 E.. per wee+. >r. 4inston 'hurchill has /- s+illed wor+ers, all of whom are
wor+ing only D- hours per wee+ at present. :emi s+illed labor is currently fully employed but could be
diverted from a product which earns a contribution #after semi s+illed labor% of ,s0 F per semi s+illed labor
hour. Alternatively semi s+illed labor could be hired at a cost of ,s0 D. per hour. Uns+illed labor is hired on
a causal basis. The contract will need to be completed in one wee+.
@verhead0 the variable overhead recovery rate of ,s0 E per labor hour wor+ed were established by a
detailed investigation of the business costs. The fi$ed overhead absorption rate of ,s0 D per hour is
designed to cover general overhead of the whole business of ,s0 D/., the rent of wor+shop to carry out

::

the modification wor+ of ,s0 /.. M the hire of a special machine costing ,s0 D.. needed to shape the
components. ,euired ; determine the minimum price to be tendered. :how all wor+ings.
So!ution R *(
'ateria!:
A 0 higher of ,s0 /D.1C @, ,s0 /E.1C ; /E.P- F-.
G 0 higher of ,s0 D..1C @, ,s0 /F.1C ; D..P/. D...
' 0 #5P/.. ; 5..% M #F P I- ; 5-.% 0 Z5..O5-.;8-.X 8-.
2 .
$abor:
:+illed 0 #D-P/.% D-.
:emi C :+illed 0 #I-PF ; 5.. M I-PI;-D-%
4or+ing 3 lower of ,s0 /-.. #I-PD.;/-..% @, ,s0 8I-
8I-
Un :+illed 0 #7.P-% 5..
Aariable overhead #DD-PE% IF-
,ent of wor+shop for modification wor+ /..
'ash proceeds 5...
?ire of special machine D..
'iniu Tender .rice 1*)@*

Puestion R *7
AG' =td is deciding whether or not to proceed with a special order. Use the details below to
determine the relevant cost of the order.

#a% >aterials " and L will be used for the contract. /.. tonnes of material " will be needed and
sufficient material is in stoc+ because the material is in common use in the company. The
original cost of the material in stoc+ is ,s0 / per tonne but it would cost ,s0 /.D. per tonne to
replace if it is used for this contract. The material L reuired is in stoc+ as a result of previous
over purchasing. This material originally cost ,s0 -.. but it has no other use. The material is
to$ic and if it is not used on this contract, then AG' must pay ,s0 D7. to have it disposed.
#b% The contract reuires D.. hours of labour at ,s0 - per hour. &mployees possessing the
necessary s+ills are currently employed by the company but they are idle at present due to a lull
in the companySs normal business.
#c% @verhead will be absorbed by the contract at a rate of ,s0 /. per labour hour, which consists
of ,s0 I for fi$ed overhead and ,s0 E for variable.
#d% The contract will reuire the use of a storage unit for three months. AG' is committed to
rent the unit for one year at a rental of ,s0 -. per month. The unit is not in use at present. A
neighbouring business has recently approached AG' offering to rent the unit from them for ,s0
I. per month.
#e% Total fi$ed overheads are not e$pected to increase as a result of the contract.

So!ution R *7
#a% The relevant cost of a material that is used regularly is its replacement cost. Additional stoc+s
of the material will need to be purchased for use in this contract. The relevant cost of material "

:=

is therefore ,s0 /.D. per tonne. >aterial L has a negativeS cost if used for the contract. That is,
there is a relevant saving made from not having to pay the disposal cost of ,s0 D7..
#b% The relevant cost of labour is <ero. The labour cost is being paid anyway and no e$tra cost
will be incurred as a result of this contract.
#c% The fi$ed overhead is not relevant because we are told that fi$ed overheads are not e$pected
to increase. The relevant variable overhead cost is0 ,s0 E per hour P D.. hours ; ,s0 F... &ven if
you are not specifically told that fi$ed overheads will remain unaltered, it is usual to assume that
they will not increase, stating the assumption clearly.
#d% The rental cost of ,s0 -. per month is not relevant because it will not be affected by the
contract. The relevant cost of using the storage unit is the forgone rental income of ,s0 I. per
month.

Suar& of re!e/ant costs

>aterial 3 " /D.
>aterial CC L #D7.%
=abour .
Aariable overhead F..
,ent forgone D/.
Tota! re!e/ant cost =:*
60ercise: ake or bu&<outsourcing decision and acce%t<re-ect an order

A company manufactures two models of a poc+et calculator. The basic model sells for ,s0 -, has
a direct material cost of ,s0 /.D- and reuires ..D- hours of labour time to produce. The other
model, the :cientist, sells for ,s0 I.-., has a direct material cost of ,s0 /.FE and ta+es ..EI-
hours to produce. =abour, which is paid at the rate of ,s0 F per hour, is currently very scarce,
while demand for the companySs calculators is heavy. The company is currently producing 7,...
of the basic model and 5,... of the :cientist model per month, while fi$ed costs are ,s0 D5,...
per month.
An overseas customer has offered the company a contract, worth ,s0 E-,..., for a number of
calculators made to its reuirements. The estimating department has ascertained the following
facts in respect of the wor+0
The labour time for the contract would be /,D.. hours.
The material cost would be ,s0 8,... plus the cost of a particular component not
normally used in the companySs models.
These components could be purchased from a supplier for ,s0 D,-.. or alternatively,
they could be made internally for a material cost of ,s0 /,... and an additional labour
time of /-. hours.
3eBuireent
Advise the management as to the action they should ta+e.
So!ution
6n view of its scarcity, labour is ta+en as the limiting factor. The decision on whether to ma+e or
buy the component has to be made before it can be decided whether or not to accept the
contract. 6n order to do this the contribution per labour hour for normal production must first
be calculated, as the contract will replace some normal production.

:>

Normal products Basic ci!"tist

'ode! 2 1 'ode! H )
3s: 3s:
:elling price -... I.-.
>aterials /.D- /.FE
=abour /.-. D.D- #D.I-% #E.77%
+ontribution D.D- E.FD
S V V
=imiting (actor ..D- ..EI-
+ontribution %er direct !abour hour @"** @"=:

Therefore, if the company is to ma+e the component it would be better to reduce production of
the basic model, in order to accommodate the special order. The company should now compare
the costs of ma+ing or buying the component. An opportunity cost arises due to the lost
contribution on the basic model.

p!cial co"tract Ma"u#actur! o# compo"!"t
,s0
>aterials /,...
=abour #,s0 F P/-. hours% 8..
@pportunity cost #/-. hours P ,s0 8...% /,E-.
(,):*
:ince this is higher than the boughtCin price of ,s0 D,-.. the company would be advised to buy
the component from the supplier if they accept the contract. The contract can now be
evaluated0

Co"tract co"tri$utio"

3s:
:ales revenue E-,...
>aterials 8,...
'omponent D,-..
=abour #,s0 F P /,D..% I,D.. #/7,I..%
+ontribution /F,E..
+ontribution %er direct !abour hour 1(":?

:ince the contribution is higher than either of the e$isting products, the company should accept
the contract assuming this would not prejudice the mar+et for e$isting products. As the
customer is overseas this seems a reasonable assumption.

Gecause the contribution is higher for the :cientist model it would be wise to reduce production
of the basic model. ?owever, the hours spent on producing the basic model per month are
7,... units P ..D- hours ; D,..., and so the contract would displace more than a fortnightSs
production of the basic model. The recommendation assumes that this can be done without
harming longCterm sales of the basic model.

:?

60ercise: discontinuing a %roduct

4ye plc ma+es and sells four products. The profit and loss statement for April is as follows0

%roduct & X Y ' Total
3s: 3s: 3s: 3s: 3s:
:ales E.,... D.,... E-,... /-,... /..,...
'ost of sales /F,... 7,... DD,... /.,... -F,...
Gross profit /5,... /D,... /E,... -,... 55,...
@verhead cost0
:elling 7,... I,... 7,-.. F,-.. E.,...
Administration D,... D,... D,... D,... 7,...
Aet %rofit 7,*** (,*** ),:** ((,:**# =,***

The management team is concerned about the results, particularly those of product N, and it has
been suggested that 4ye plc would be better off if it ceased production of product N. The
production manager has said that if product N was discontinued the resources which would
become available could be used to increase production of product [ by 5. per cent. [ou have
analy<ed the cost structures of each of the products and discovered the following0

3s: 3s: 3s: 3s: 3s:
Aariable costs 5,7.. /,F.. /E,D.. -,... D5,F..
(i$ed costs //,D.. F,5.. 7,7.. -,... E/,5..
Total 1=,*** ?,*** )),*** 1*,*** :=,***

The total fi$ed costs figure includes ,s0 D.,... which is not specific to any one product, and
which has been apportioned to each product on the basis of sales values. 6f the uantity of any
product increases by more than D- per cent, then the specific fi$ed production costs of the
product will increase by E. per cent.
The selling overhead comprises a fi$ed cost of ,s0 -,... per product plus a variable cost
which varies in proportion to sales value. The fi$ed cost is not specific to any product but the
sales director believes that it should be shared eually by the four products.
The administration cost is a central overhead cost; it is not affected by the products made.
3eBuireents
#a% "repare a statement which shows clearly the results of continuing to produce products 4, B,
[ and N at the same volumes as were achieved in April. "resent your statement in a format
suitable for management decisionCma+ing
#b% #i% "repare a statement showing clearly the results if product N is discontinued, and
the number of units of [ is increased in accordance with the production managerSs statement.
#Assume that no change in selling price per unit is necessary to sell the additional units.%
#ii% ,econcile the profit calculated in #a% and #b% #i% above; advice the management team as to
whether product N should be discontinued.
#c% &$plain briefly any nonCfinancial factors which should be considered before discontinuing a
product.

:@

So!ution

#a% The profit statement needs to be restated in a marginal costing format if it is to be useful for
decisionCma+ing.
3s: 3s: 3s: 3s: 3s:
:ales E.,... D.,... E-,... /-,... /..,...
Aariable 'ost of sales 5,7.. /,F.. /E,D.. -,...
Aariable selling overheadP E,... D,... E,-.. /,-..
'ontribution DD,D.. /F,5.. /7,E.. 7,-..
:pecific fi$ed costs #4/% -,D.. D,5.. /,7.. D,...
)et benefit /I,... /5,... /F,-.. F,-.. -5,...
)onCspecific fi$ed cost of sales #D.,...%
(i$ed selling overhead #4D% #D.,...%
Administration costs #7,...%
Aet %rofit =,***

ITotal overhead less ,s0 -,... fi$ed cost

5orkings

1"
3s: 3s: 3s: 3s: 3s:
(i$ed costs //,D.. F,5.. 7,7.. -,... E/,5..
)onCspecific fi$ed costP F,... 5,... I,... E,... D.,...
:pecific fi$ed costs -,D.. D,5.. /,7.. D,... //,5..

PGiven as ,s0 D.,... apportioned on the basis of sales values #E0D0E.-0/.-%
)" ,s0 -,... per product P5 ; ,s0 D.,...

#b% #i% N discontinued
,s0
'ontribution from 5.K additional sales of [ #,s0 /7,E.. P ..5% I,ED.
Additional specific fi$ed costs #,s0 /,7.. P ..E% #-5.%
=oss of net benefit from N #F,-..%
Aet gain )?*
#ii% "rofit reconciliation
,s0
&$isting profit F,...
2iscontinuation of N #F,-..%
Additional contribution from [ I,ED.
Additional specific fi$ed costs #-5.%
"rofit if N is discontinued and sales of [ substituted =,)?*


=*

The company should therefore discontinue product N and substitute production and sales of
product [ in the proportions given. 6t should be noted, however, that the incremental gain is not
significant and any errors in the estimates used could mean the wrong decision is ta+en.

#c% )onCfinancial factors to consider include0

"ossible redundancies among the wor+force;
:ignals which it may give to competitors, who may perceive the company as being
unwilling to support its products;
The reaction of customers, particularly those who may recently have purchased the
product.

:ometimes, even when management has made the decision to discontinue a product or
activity, there is still a further decision to be made0 when to discontinue it. The following
e$ercise shows how such a decision could be made.
60ercise: deciding 8hen to c!ose a de%artent or factor&

6t is possible that some costs are avoidable in the longer term but not in the short term.
(or instance, it may be necessary to give notice to cease renting a space occupied by a
department. 6f the notice reuired is, say, three months then the rental is an unavoidable cost
until the three months S notice has e$pired. After that time it becomes an avoidable cost, as long
as notice is given now.

The idea of costs being unavoidable in the short term adds a new dimension to our decisionC
ma+ing. )ot only is it necessary to decide whether costs are inherently avoidable, but we may
also need to determine when they will become avoidable.

6n the very short term almost all costs are unavoidable. 6n the long term almost all costs are
avoidable because the whole organi<ation could be shut down completely. ?ere we are tal+ing
about time hori<ons in between these two e$tremes.


=1

;udgetar& contro! Use of budget to contro! organi9ation acti/ities"
Aeed for budgeting

To set standards.
To motivate managers.
"erformance evaluation
To coCordinate between different managers.
To coCordinate between different departments.
'aster budget :ummary of company plan that sets specific target for sale,
production, distribution M financing activities.
3es%onsibi!it& accounting >anager should be held responsible for those items that manager
usually control to significant event or for any deviation.
3o!!ing<continua!<%er%etu
a! budgeting
Twelve months budget that rolls forward one month as current
month is completed. 6t shows current prices.
Huan factor in
;udgeting
Gudget program will be succeeded if budget have complete
acceptance M support of person who occupy +ey management
positions. Top management should not use budget to
blame1pressuri<e employees. Use of budget in such a negative way
will breed hostility, tension, mistrust rather than cooperation M
productivity.
Increenta! a%%roach
budgeting
6n this approach, previous year budget is a baseline. "ast data is
used to forecast future. 6ts biggest disadvantage is that anomalies
have been transferred to future.
Eero base budgeting Hustify all budgeted e$penditures before its inclusion in the budget.
6ts baseline is <ero rather than last year budget. 6t reuires
considerable documentation. A more detailed approach M past
mista+es can not be carried forward.
6stiate "redetermination of future event either on simple guess or
scientific principles.
Forecast Assessment of probable future event.
;udget .adding Underestimating revenue M over estimating cost.
;udget 6mplication of a forecast M related to planned event.
;udgetar& S!ack The difference between the revenue or cost projection that a
person provides M a realistic estimate of the revenue or cost.
;U,G6T 1S F436+AST
;U,G6T F436+AST
3e!ate to %!anned e/ent" +oncern 8ith %robab!e e/ent"
+o%rise 8ho!e business unit" +o/er !iited function"
.!anned se%arate!& for each account %eriod" +o/er !ong %eriod"
Too! of contro!" Aot a too! for contro!"
;udget starts 8hen forecast ends & con/ert it
into budget"
Forecast end 8ith forecast of !ike!& e/ent"

=)

TO.6S 4F ;U,G6T
FIL6,:
6t is dawn for one level of activity M one set of condition. 6t is rigid M is based on
assumption that there will be no change in budgeted level of activity.
F!e0ib!e Gudget designed to change in accordance with level of activity
attained.
;asic 6t is prepared for use for a long period of time.
+urrent ,elate to current condition M is used over short time period.
$ong ter 6t is prepared for more than one year e.g.
'apital &$penditure Gudget.
,esearch M 2evelopment Gudget.
SH43T T63':
.eriod 6t is prepared for less than /D months.
Usefu! For =ower management level.
'ontrol purposes. e.g.

TH6 43,63 4F ;U,G6T .36.A3ATI4A

Assuming that the principal budget factor has been identified as being sales, the stages
involved in the preparation of a budget can be summari<ed as follows.

#a% The sa!es budget is prepared in units of product and sales value. The finished goods
in/entor& budget can be prepared at the same time. This budget decides the planned
increase or decrease in finished goods inventory levels.

#b% 4ith the information from the sales and inventory budgets, the %roduction budget
can be prepared. This is, in effect, the sales budget in units plus #or minus% the increase
#or decrease% in finished goods inventory. The production budget will be stated in terms
of units.

#c% This leads on logically to budgeting the resources for %roduction. This involves
preparing a ateria!s usage budget, achine usage budget and a !abor budget.

#d% 6n addition to the materials usage budget, a ateria!s in/entor& budget will be
prepared, to decide the planned increase or decrease in the level of inventory held.
@nce the raw materials usage reuirements and the raw materials inventory budget are
+nown, the purchasing department can prepare a ra8 ateria!s %urchases budget in
uantities and value for each type of material purchased.

=(

#e% 2uring the preparation of the sales and production budgets, the managers of the
cost centers of the organi<ation will prepare their draft budgets for the department
o/erhead costs. :uch overheads will include maintenance, stores, administration, selling
and research and development.

#f% (rom the above information a budgeted incoe stateent can be produced.

#g% 6n addition several other budgets must be prepared in order to arrive at the
budgeted stateent of financia! %osition. These are the ca%ita! e0%enditure budget
#for nonCcurrent assets%, the 8orking ca%ita! budget #for budgeted increases or
decreases in the level of receivables and accounts payable as well as inventories%, and a
cash budget.
.U3+HAS6 ;U,G6T
Gudgeted Unit :old BBB
AddC &nding 6nventory of (inished Goods BBB
Total needs BBB
=essC Geginning 6nventory of (inished Goods BBB
3eBuired %roduction<Units to be %roduced LLL
,I36+T 'AT63IA$ .U3+HAS6<USAG6 ;U,G6T
The materials purchases budget is the budget for the purchase cost of materials that will
be purchased in the budget period. The materials purchases budget might be prepared
for all materials, direct and indirect, or for direct materials only.

The purchases budget differs from the materials usage budget by the amount of the
planned increase or decrease in inventory levels of materials in the budget period.

,aw >aterial needed to meet the production schedule BBB
AddC &nding 6nventory of raw material BBB
Total ,aw >aterial needs BBB
=essC Geginning 6nventory of raw material BBB
3a8 'ateria! to be %roduction LLL
SA$6S ;U,G6T
:ale in units BBB
:ale price per unit BBB
Tota! .rice LLL

=7

>a+ing a sales forecast is li+e shooting an arrow. >ajor factors to consider while
forecasting sales includes0
/. "ast sales level M trends.
D. General economic trends.
E. "olitical M legal events.
5. "lanned advertising M product
promotion.
-. 6ntended pricing policy.
F. &$pected action of competitors.
I. &conomic trends in company
industry.
7. >ar+et research studies.
,I36+T $A;4U3 ;U,G6T
6t is a statement of the uantities of direct labour reuired for production, and its cost.
The budget is prepared for different grades of labour separately, but the total labour
cost should also be shown.
(or each grade of labour, the e$pected hours of wor+ should be calculated, for ma+ing
the budgeted production uantities of product individually and then for all the products
in total. The total budget in hours for each grade of labour is converted into a cost at the
standard1budgeted rate per hour for the grade of labour.

,euired "roduction #from production budget% BBB
2irect labor hour BBB
Total direct labor hour needs BBB
2irect labor cost per hour BBB
Tota! direct !abor cost LLL

4163H6A,S ;U,G6TS

@verheads budgets are prepared for each department or cost centre, in production,
administration and sales and distribution.

/. To prepare e$penditure budgets for each overhead cost centre, overhead
e$penditure is allocated and apportioned using available methods.
D. 6n an absorption costing system, an overhead absorption rate should then be
calculated from the total budgeted e$penditure and the budgeted volume of
activity. 4hen fle$ed budgets are prepared, overhead costs might be divided
into variable and fi$ed costs.

2irect >aterial BBB
2irect labor BBB
Aariable @verhead BBB
(i$ed @verhead BBB
Tota! 4/erhead cost LLL


=:

;U,G6TA3O +4AT34$

@ne of the main purposes of budgeting is budgetary control and the control of costs.
'osts can be controlled by comparing budgets with the results actually achieved.
2ifferences between e$pected results and actual results are +nown as variances.
Aariances can be either favorable #(% or adverse #A% depending on whether the results
achieved are better or worse than e$pected. (avourable variances increase profits and
adverse variances decrease profits.

There are three different types of budget.

/. (i$ed budgets
D. (le$ed budgets
E. (le$ible budgets.
Fi0ed budgets

1" The original budget prepared at the beginning of a budget period is +nown as the
fi$ed budget.
)" A fi$ed budget is a budget for a specific volume of output and sales activity, and
it is the master planS for the financial year that the company tries to achieve.
(" The term fi$edS in fi$ed budgetS means that the output and sales volumes are
for a fi$ed amount or uantity.
7" A fi$ed budget might be suitable as a plan, provided that the business
environment is fairly stable and sales and production volumes should be
predictable with reasonable accuracy.
:" (i$ed budgets are not suitable for budgetary control reporting because the
variances calculated with a fi$ed budget can provide misleading information

F!e0ed budgets

1" A fle$ed budget is a budget prepared to show the revenue, costs and profits that
should have been e$pected from the actual volumes of production and sale.
)" A fle$ed budget is prepared for the actual volume of sales and output, and it
allows for the fact that sales revenues and variable costs should be e$pected to
increase or fall with increases or falls in sales and output.
(" A fle$ed budget is prepared at the end of the budget period when the actual
results are +nown. 6t is used to compare0
/. the actual results with the fle$ed budget
D. the fi$ed budget with the fle$ed budget.
7" 6f a fle$ed budget is compared with the actual results for a period, the
differences between the two #variances% are much more meaningful than if the
fi$ed budget and actual results are compared.


==

F!e0ib!e budgets

(le$ible budgets are not the same as fle$ed budgets, although they are similar.

F!e0ed budgets are prepared at the end of a budget period and loo+ bac+ at what costs,
revenues and profits should have been in a period #based on actual activity levels%. They
are used to calculate variances for the purpose of management control and control
reporting #budgetar& contro!%.

F!e0ib!e budgets are forwardCloo+ing and are prepared at the beginning of a budget
period when the fi$ed #original% budget is prepared. (le$ible budgets are prepared to
show the results that would be e$pected at different levels of activity, for e$ample, at
I-K, 7.K and 7-K of the full capacity. They might be prepared when there is
uncertainty about what the actual volumes of sales and production will be, and several
budgets are therefore prepared for a number of different possible outcomes.
+ASH ;U,G6T
4%ening +ash ba!ance LLL OOO EEE
AddC ,eceipts from debtors BBB [[[ NNN
AddC :ales of 'apital items BBB [[[ NNN
AddC Any loan received BBB [[[ NNN
AddC "roceed for share issues BBB [[[ NNN
AddC Any other cash receipts BBB [[[ NNN
K Tota! +ash A/ai!ab!e LLL OOO EEE
=essC "ayments to creditors BBB [[[ NNN
=essC 'ash purchases BBB [[[ NNN
=essC 4ages M salaries BBB [[[ NNN
=essC =oan ,epayments BBB [[[ NNN
=essC 'apital e$penditure BBB [[[ NNN
=essC 2ividends BBB [[[ NNN
=essC Ta$ation BBB [[[ NNN
=essC Any other cash disbursements BBB [[[ NNN
K +!osing +ash ;a!ance LLL OOO EEE
2esired Galance BBB [[[ NNN
+ash ;a!ance before ;orro8ing LLL OOO EEE
AddC Gorrowings BBB [[[ NNN
=essC ,epayments BBB [[[ NNN
=essC 6nterest "ayments BBB [[[ NNN
+ash ;a!ance after ;orro8ing LLL OOO EEE


=>

'losing Galance BBB
2esired =evel BBB
LLL
)egative answer means that we have to borrow
"ositive answer means that we donSt have to borrow
36+4A+I$IATI4A 4F ;U,G6T6, +ASH F$45 & .34FIT
;udgeted +ash F!o8 LLL
Add 3 "ayments appearing in cash budget but never appearing in " M =
account
BBB
Add 3 ,eceipts appearing in the " M = account but never appearing in
the cash budget
BBB
=ess 3 'harges appearing in the " M = account but never appearing in
the cash budget
BBB
=ess C ,eceipts appearing in the cash budget but never appearing in the
" M = account
BBB
Add 3 :ales1receipts adjustment BBB
=ess 3 "urchases1payments adjustment BBB
=ess 3 &$penses1"ayments adjustment BBB
;udgeted .rofit LLL

;U,G6TA3O +4AT34$ AAA$OSIS
(i$ed
Gudget
(le$ible
Gudget
Actual
budget
Gudget
Aariances
"roduction M :ales #Units% LLL LLL LLL LLL
:ales BBB BBB BBB BBB
Aariable 'osts BBB BBB BBB BBB
2> BBB BBB BBB BBB
2= BBB BBB BBB BBB
A1(@? BBB BBB BBB BBB
:emi 3 Aariable 'osts BBB BBB BBB BBB
(i$ed 'osts BBB BBB BBB BBB
Total costs BBB BBB BBB BBB
.rofit LLL LLL LLL LLL

=?

A4T6:
/. Aariances are calculated by comparing actual results M the fle$ible budgets, not
actual budgets M the original budgets.
D. The correct approach is as follows0
6dentify fi$ed M variable costs
"roduce a fle$ible budget using marginal costing techniues.
F!e0ib!e ;udgeting: 6mportant points include0
1" )o concern with actual results.
)" 'lassification of cost by behaviors is the most important element in
fle$ible budgeting.
(" 6f cost is variable, identify that it is variable with reference to0 no of units1
no of hours.
7" 6f cost is semi variable, then normally high M low method is used to
apportion fi$ed M variable portion.
:" "lease remember that ,4 A4T fle$ fi$ed cost.
ST6.S IA TH6 .36.A3ATI4A 4F +A.ITA$ 6L.6A,ITU36 ;U,G6TS

Ste% 1 An accountant or budget officer shou!d be res%onsib!e for the capital
e$penditure budget. Their tas+s should include communicating between interested
parties, providing necessary data to assist in budget preparation, drawing up a timetable
to ensure that proper consultation ta+es place and so on.
Ste% ) :ales, production and related budgets cover, in general, a /DCmonth period. A
detailed ca%ita! e0%enditure budget shou!d be %re%ared for the budget %eriod but
additiona! budgets shou!d be dra8n u% for both the ediu and !ong ter" This
reuires an inCdepth consideration of the organisation*s reuirements for land,
buildings, plant, machinery, vehicles, fi$tures and fittings and so on for the short,
medium and long term.
Ste% ( The budget co/ering the 1) onth %eriod should be broken do8n into onth!&
or Buarter!& s%ending, and details incorporated into the cash budget.
Ste% 7 :uitable financing must be arranged as necessary.
Ste% : The capital e$penditure budget should take account of the %rinci%a! budget
factor. 6f available funds are limiting the organisation*s activities then they will more
than li+ely limit capital e$penditure.
Ste% = As part of the overall budget coordination process, the capital e$penditure
budget must be re/ie8ed in re!ation to the other budgets. "roposed e$pansion of
production may well reuire significant nonCcurrent asset e$penditure which should be
reflected in the budget.
Ste% > The capital e$penditure budget should be u%dated on a regu!ar basis since both
the timing and amount of e$penditure can change at short notice.

=@

.36.A3ATI4A 4F F$6LI;$6 ;U,G6TS

Ste% 1 The first step in the preparation of a fle$ible budget is the deterination of cost
beha/iour %atterns, which means deciding 8hether costs are fi0ed, /ariab!e or sei2
/ariab!e.
] (i$ed costs are easy to spot. They remain constant as activity levels change.
] (or nonCfi$ed costs, divide each cost figure by the related activity level. 6f the
cost is a variable cost, the cost per unit will remain constant. 6f the cost is a semiC
variable cost, the unit rate will reduce as activity levels increase.
Ste% ) The second step in the preparation of a fle$ible budget is to calculate the budget
cost a!!o8ance for each cost item.

;udget cost a!!o8ance K budgeted fi0ed costI F (nuber of units J /ariab!e cost %er
unit# II
P )il for variable cost
PP )il for fi$ed cost
:emiCvariable costs therefore need splitting into their fi$ed and variable components so
that the budget cost allowance can be calculated.


>*

/. The term standard refers to preC determined, estimated unit costs M revenues.
D. @ften called Q Gudget for an individual unit of productionR
E. :tandard cost system applies to standard cost center.
5. :ale variance applies to revenue center.
-. Genchmar+ for measuring performance.
STAA,A3, +4STIAG: "reCdetermined estimated unit cost used for stoc+
valuation M control. 6t may be used both in absorption costing M marginal costing.
_: _: _: _: , ,, , _-:: _-:: _-:: _-:: cost _
_

,
~
'
,
_-;. _
_

,
~
'
,
_-;. _
_

,
~
'
,
_-;. _
_

,
~
'
,
_-;. Actual "roduction
,
~
.

,
~
.

,
~
.

,
~
.

+4'.A3IS4AS:
:tandard 8i!! be co%ared to Actual
:tandard 8i!! A4T be co%ared to Gudgeted
Gudgeted 8i!! be co%ared to Gudgeted
Actual 8i!! A4T be co%ared to Actual
STAA,A3, H4U3: ?our which measure the amount of wor+ that should be
performed in one hour under standard condition.
SUITA;I$ITO: 'ommon 1 repetitive operations. &.g. manufacturing M service.
$6SS4AS:
1" 'learly label variance as A2A&,:& or (AA@,AG=&.
)" (le$ed budgeted figures are to be used.
(" 6n marginal costing, fi$ed volume variances will not e$ist.
STAA,A3, 1S ;U,G6T6, +4ST
STAA,A3, +4ST ;U,G6T6, +4ST
Unit Aount Tota! Aount
.art of doub!e entr& s&ste Aot %art of doub!e entr& s&ste
+ontro!!ing cost .!anning cost
6stiate of actua! ca%acit& 6stiate of nora! ca%acit&
+ost e0%ectation of %er unit of acti/it& +ost e0%ectation of tota! unit of acti/it&


>1

TO.6S
;asic Use for comparison.
Unchanged over long period.
Idea! ,epresent perfect performance.
>inimum cost possible under perfect information.
)ot used in real world due to adverse impact on
employee motivation.
+urrent!& attainab!e Use for plan M control.
:hould be incurred under efficient operating condition.
2ifficult not impossible to achieve.
;3ITISH ,6+ISI4A 3U$6:
Actua! is HIGH Adverse
Actua! is $45 (avorable
A4T6: The abo/e ru!e 8i!! not a%%!& to Sa!es & 1o!ue 1ariances"
A'63I+AA ,6+ISI4A 3U$6:
.ositi/e (avorable
Aegati/e Adverse

A'63I+AA A..34A+H T4 1A3IAA+6 AAA$OSIS
T54 1A3IAA+6
+4AT34$$A;$6 1A3IAA+6:
Actual (@? BBB
Gudgeted (@? for 'apacity Attained BBB
LLL
T Gudgeted (@? for 'apacity Attained ; #(i$ed 'ost O :tandard ?our P
:tandard Aariable ,ate%
2ecision ,ule0

Actual ?igh Ad/erse
Actual =ow Fa/orab!e

>)

14$U'6 1A3IAA+6:
Applied (@? BBB
LLL
T Applied (@? ; #:tandard ?our P Total :tandard ,ate%
2ecision ,ule0

Gudgeted ?igh Ad/erse
Gudgeted =ow Fa/orab!e

TH366 1A3IAA+6
+A.A+ITO 1A3IAA+6:
Applied (@? BBB
LLL
T Gudgeted (@? for 'apacity Attained ; #(i$ed 'ost O Actual ?our P :tandard
Aariable ,ate%
2ecision ,ule0


S.6A,IAG < 6L.6A,ITU36 1A3IAA+6:
Actual (@? BBB
LLL
TGudgeted (@? for 'apacity Attained ; #(i$ed 'ost O Actual ?our P :tandard Aariable ,ate%

>(

2ecision ,ule0

Actual ?igh Ad/erse
6FFI+I6A+O 1A3IAA+6:
Actual ?our 4or+ed P :tandard ,ate BBB
:tandard ?our Allowed P :tandard ,ate BBB
LLL
2ecision ,ule0

Actual ?igh Ad/erse

F4U3 1A3IAA+6
+A.A+ITO 1A3IAA+6:
Applied (@? BBB
LLL
T Gudgeted (@? for 'apacity Attained ; #(i$ed 'ost O Actual ?our P :tandard Aariable
,ate%
2ecision ,ule0

S.6A,IAG < 6L.6A,ITU36 1A3IAA+6:
Actual (@? BBB
LLL

>7

Aariable ,ate%
2ecision ,ule0

Actual ?igh Ad/erse

FIL6, 6FFI+I6A+O 1A3IAA+6:
Actual ?our 4or+ed P :tandard (i$ed ,ate BBB
:tandard ?our Allowed P :tandard (i$ed ,ate BBB
LLL
2ecision ,ule0

Actual ?igh Ad/erse

1A3IA;$6 6FFI+I6A+O 1A3IAA+6:
Gudgeted (@? for :tandard ?our 4or+ed BBB
LLL
Aariable ,ate%
T Gudgeted (@? for :tandard ?our 4or+ed ; #(i$ed 'ost O :tandard ?our P :tandard
Aariable ,ate%
2ecision ,ule0



>:

'AT63IA$ 1A3IAA+6S

G,6T6:? A>&,6'A)
(Actua! +ost H Standard +ost# #:tandard cost of material 3 Actual cost of
>aterial%
43
#:tandard base on actual output P standard
rate% 3 #Actual usage P Actual rate%
4here,
:tandard base on actual output ; unit
made P per +g 1 hr
Actual ,ate ; 'ost 1 hrs

>aterial Aariances are divided into t8o variances0
1" >aterial "rice Aariance.
)" >aterial Luantity1Usage Aariance.

;3ITISH Actual Lty # A, 3 :,%
43
Actual 'ost 3 # Actual Lty
P :,%
43
#AL P A,% 3 #AL P :,%
A'63I+AA Actual Lty # :, 3 A,%

;3ITISH :, #Actual Lty 3 :LA%
Z :tandard Lty Allowed X
A'63I+AA :tandard rate #:tandard
based on actual output 3
Actual usage%
4here,
/. :tandard base on
actual output ;
unit made P per +g
1 hr
2. Actual ,ate ; 'ost
1 hrs
Tota! 'ateria! 1ariance: >aterial "rice Aariance O >aterial Usage Aariance

Tota! ,irect 'ateria! 1ariance
,irect 'ateria! .rice 1ariance ,irect 'ateria! Usage 1ariance

>=

.3I+6 1A3IAA+6 1A3IATI4AS
.U3+HAS6 PUAATITO
3a8 'ateria!
"urchase # AL P A,% "rice Aariance AL #A,C:,%
Lty Aariance :, #AL C:LA%
46" #:LA P :,%
'losing :toc+ # Actual Lty 3 Lty 'onsumed% P :,
A4T6: +!osing stock is recorded at S3"

;3ITISH
#Actual 'ost 3 :tandard 'ost%
:' ; :LA P :,
A' ; 'onsume cost #not purchase cost%
#@1GA= O "U, 3 '1GA=%


;3ITISH Actual Lty # A, 3 :,%
@,
Actual 'ost 3 # Actual Lty
P :,%
,irect 'ateria! .rice 1ariance ,irect 'ateria! Usage 1ariance

>>

+4ASU'6 PUAATITO
3a8 'ateria!
"urchase # AL P A,% "rice Aariance 'L #A,C:,%
Lty Aariance :, #AL C:LA%
46" #:LA P :,%
'losing :toc+ # Actual Lty 3 Lty 'onsumed% P A,
A4T6: +!osing stock is recorded at A3"

;3ITISH
:' ; :LA P :,
A' ; 'onsume cost #not purchase cost%
#@1GA= O "U, 3 '1GA=%


1a!ue of +!osing Stock of 3a8 'ateria! +a!cu!ation of .rice 1ariance
Standard +ost 'ateria! .urchased
Actua! +ost 'ateria! Used
,IFF636A+6 ;6T566A T54 '6TH4,S
.U3+HAS6 PTO +4ASU'6 PTO
"eriod 'ost "roduct 'ost
)ot considered for stoc+ valuation 'onsidered for stoc+ valuation
'ost charge in period in which it is incurred 'ost charge in period in which it is sold

;3ITISH 'onsumed Lty # A, 3 :,%

,irect 'ateria! .rice 1ariance
,irect 'ateria! Usage 1ariance

>?

5HI+H '6TH4, T4 US6
.U3+HAS6 PTO +4ASU'6 PTO
'losing stoc+ is valued at :, 'losing stoc+ is valued at A,
Aariance is considered as period cost Aariance is considered as product cost
Aariance is recorded at earliest stage CC
IA,I+ATI4A: )o indication is given U use purchase ty method.
$A;43 1A3IAA+6S

;3ITISH #Actual 'ost 3 :tandard 'ost%
A'63I+AA #:tandard cost of =abor 3 Actual cost of =abor%
@,
#:tandard base on actual hour P standard rate% 3
#Actual hour P Actual rate%
4here,
/. :tandard base on actual hour ; unit hour P
per +g 1 hr
2. Actual ,ate ; 'ost 1 hrs

;3ITISH Actual ?r # A, 3 :,%
43
Actual 'ost 3 # Actual ?r P :,%
A'63I+AA Actua! Hr ( S3 H A3#
Actual hour M productive
hour is same thing.
"roductive hour ; Actual
hour 3 6dle hour

;3ITISH S3 (Actua! Hr H SHA#
Z :tandard ?r Allowed X
#Actual [ield P :tandard time
per unit%
A'63I+AA Standard rate (Standard
based on actua! hr H Actua!
hr#
4here,
:tandard base on actual hr ;
unit hr P per +g 1 hr
Actual ,ate ; 'ost 1 hrs

Tota! ,irect $abor 1ariance
,irect $abor 3ate 1ariance ,irect $abor 6fficienc& 1ariance

>@

Id!e hour 1ariance: :tandard rate P idle time
4here, 6dle time ; Actual hour 3 "roductive hour
Aote: 6dle hour variance will always be adverse.
Tota! !abor 1ariance: =abor "ay ,ate Aariance O =abor &fficiency Aariance O
6dle hour Aariance
1A3IA;$6 F4H 1A3IAA+6S

FIL6, F4H 1A3IAA+6

Tota! 1ariab!e F4H 1ariance
AA' 3 #:?A P :A,%
S%ending 1ariance
#AA' 3 :A'%
#A? P AA,% 3 #A? P :A,%
A? #AA, 3 :A,%
AA' 3 #A? P :,%
1ariab!e 6fficienc& 1ariance
:A, #A? 3 :?A%
Tota! Fi0ed F4H 1ariance
#A(' 3 :('%
Fi0ed 1o!ue 1ariance
:, #G?C:?A%
Fi0ed 60%enditure 1ariance
G('CA('
+a%acit& 1ariance
:(, #G?CA?%
:(, #G? 3A?%
Fi0ed 6fficienc& 1ariance
:(, #A?C:?A%
(A, #A? 3 :?A%

?*

G34SS .34FIT AAA$OSIS
Gudgeted Actual
:ales Units /.... 87..
:ales "er Unit /. /..7
'ost "er Unit 8 7.F
:ales /..... /.-75.
'ost of :ales #7....% #75D7.%
Gross .rofit )**** )1:=*
A4T6: last year actual figures are assumed to be budgeted if two years are
involved. This year will be actual year.
US6 4F SPA & ;P
Standard Puantit& A!!o8ed ,aw >aterial
;udgeted Puantit& (inished Goods

,6+ISI4A 3U$6 F43 G. AAA$OSIS
G. < Sa!es is .ositi/e (AA@U,AG=&
G. < Sa!es is Aegati/e A2A&,:&
+GS is .ositi/e A2A&,:&
+GS is Aegati/e (AA@U,AG=&

Tota! Gross .rofit ,ifference
#Actual G" 3 Gudgeted G"%
Sa!es 1ariance
#Actual :ales 3 Gudgeted :ales%
+GS 1ariance
#Actual 'G: 3 Gudgeted 'G:%
.rice 1ariance
AL #A,C:,%
Pt& 1ariance
:, #ALCGL%
.rice 1ariance
AL #A,C:,%
Pt& 1ariance
:, #ALCGL%

?1

+A$+U$ATI4AS 4F G. AAA$OSIS
Gross .rofit ,ifference D/-F. 3 D.... ; /-F. #A%
Sa!es /.-75. 3 /..... ; -75. #(%
+GS 75D7. 3 7.... ; 5D7. #A%
Sa!e .rice 87..#/..7C/.% ; I75. #(%
Sa!e Puantit& /.#87..C/....% ; D... #A%
+GS .rice 87..#7.FC7% ; -77. #A%
+GS Puantit& 7#87..C/....% ; /F.. #(%
T54 43 '436 'IL +AS6S
+ost 1o!ue F Sa!es 1o!ue K Aet 1o!ue < Sa!es 'argin
S3 of Gross .rofit (AP 2 ;P# D#87..C/....% ; 5... #A%
S3 of Gross .rofit (AP at Actua! 'i0 2 ;P#

(ollowing three variance are used in Gross "rofit analysis0
1" :ale price
)" 'ost price
(" )et volume
STAA,A3, +4ST 3ATI4S
.roduction 1o!ue 3atio :(,#G?C:?A% T :?A1G? P /..
.roduction +a%acit& 3atio :(,#G?CA?% T A?1G? P /..
.roducti/it&<6fficienc& 3atio :(,#A?C:?A% T :?A 1A? P /..
,6+ISI4A 3U$6
6fficient Greater than /..K
In2efficient =ess than /..K
+A$6A,A3 1A3IAA+6
:, of (i$ed 'ost per day #Gudgeted 2ays 3 Actual 2ays%

SA$6S 'IL 1A3IAA+6
:, of Gross "rofit #AL at Actual
>i$ 3 AL at :tandard >i$%
SA$6S 14$U'6 1A3IAA+6
:, of Gross "rofit #AL at :tandard
>i$ C GL%

?)

'IL 1A3IAA+6S
This involves two or more raw material.
This includes mi$ M yield variances.
A..34A+H R *1 (THIS 4A6 IS 36+4''6A,6,#
,' Tota! +ost 1ariance
.3I+6 1A3IAA+6 USAG6 1A3IAA+6
AL #A, 3:,% :, #AL at Actual >i$ 3 :LA%
A' 3 #AL P :,% #ALP:,% 3 #:LAP:,%
#ALPA,% 3 #ALP:,%
Usage 1ariance is di/ided into 'i0 & Oie!d 1ariance
'IL 1A3IAA+6 OI6$, 1A3IAA+6
:, #AL at Actual >i$ 3 AL at :tandard >i$ %
:, #AL at :tandard >i$ 3 :LA%
#ALP:,% C #Total ALP4eighted "er Unit 'ost%

_: _: _: _: , ,, , : : : : Luantity _ '
,
. _ '
,
. _ '
,
. _ '
,
. :tandard >i$ _: _
,
. _: _
,
. _: _
,
. _: _
,
. 4eighted Average
cost per unit ':;. '
'
,
.: _'.>:. ':;. '
'
,
.: _'.>:. ':;. '
'
,
.: _'.>:. ':;. '
'
,
.: _'.>:.
3a8 'ateria! Ng 3ate .er Ng +ost
A /D - F.
G 7 /D.- /..
D. ? (1=*<)*# /F.

7 is the weighted average cost per unit
The weighted average cost per unit is used where uantities are given in the
ratio of F.05. of standard.
A..34A+H R *)
'ateria! .rice 1ariance #ALPA>PA,% 3 #ALPA>P:,%
'ateria! 'i0 1ariance #ALPA>P:,% 3 #ALP:>P:,%
'ateria! Oie!d 1ariance #ALP:>P:,% 3 #:LP:>P:,%


?(

SPIS' is ca!cu!ated as fo!!o8s:
S"Ao +ases Foru!ae
1 Unit "roduce is given Unit produce P Total Actual Lty 1 Total Actual Lty 3 =oss
) Unit "roduce is not
given
Total Actual Lty1 Total :tandard Lty P Total :tandard 3
=oss

'ateria! Oie!d 1ariance can a!so be ca!cu!ated as fo!!o8s:
#Actual [ield 3 :tandard [ield on Actual 6nput% P :,
Actual [ield ; Total Units 3 =oss Units
:, ; Total 'ost 3 )ormal =oss scrap value
Total Units 3 )ormal =oss units
4<S F .U3+HAS6S H +<S IS GI16A
'ateria! .rice 1ariance "urchases will be actual uantity
'ateria! 'i0 1ariance Actual 'onsumption will be actual uantity
'ateria! Oie!d 1ariance Actual 'onsumption 1 Total :tandard Lty P Total :tandard
3 =oss

Actual 'onsumption ; @pening Galance O "urchases 3 'losing Galance
6.3 A,CUST'6AT
&", balance will be used for :tandard Luantity Allowed M :tandard ?our Allowed in
>aterial Usage Aariance M =abor &fficiency Aariance.
Standard Puantit& A!!o8ed (;ased on FIF4# ; Actual Unit P :tandard
consumption per unit
Standard Hour A!!o8ed (;ased on FIF4# ; Actual Unit P :tandard time
per unit
5ASTAG6S
1" )ormal =oss is not inefficiency.
)" Aariance is due to Abnormal =oss.
(" AL ; 7/.. M :LA ; 8... M AL of 2> ; 8.I.. :o, 8.I.C7... ; 8I. #)ormal =oss0
8.. M Abnormal =oss0 I.%

?7

7" =oss to be adjusted in :LA as follows0 Actual Lty P /..K 1 /..K C)ormal =oss K
,$ Tota! +ost 1ariance
3AT6 1A3IAA+6 6FFI+I6A+O 1A3IAA+6
A? #A, 3:,% :, #A? at Actual >i$ 3 :LA%
A' 3 #A? P :,% #A?P:,% 3 #:?AP:,%
#A?PA,% 3 #A?P:,%
6fficienc& 1ariance is di/ided into 'i0 & Oie!d 1ariance
'IL 1A3IAA+6 OI6$, 1A3IAA+6
:, #A? at Actual >i$ 3 A? at :tandard >i$ %
:, #A? at :tandard >i$ 3 :?A%

1" =abor >i$ Aariance is also called Gang Aariance @, Team 'omposition Aariance.
)" =abor [ield Aariance is also called Gang "roductivity Aariance @, Team
"roductivity Aariance.
I,$6 H4U3 1A3IAA+6
:, #A? "aid 3 :?A%
I,$6 TI'6 1A3IAA+6 36A$ 6FFI+I6A+O 1A3IAA+6
:, #A? "aid 3 A? wor+ed %
:, #A? wor+ed 3 :?A%
,$ 6FFI+I6A+O 1A3IAA+6
:, #A? 3 :?A%
36A$ 6FFI+I6A+O 1A3IAA+6 OI6$, 1A3IAA+6
:, #A? 3:?A for :tandard [ield % :, #:?A for :tandard [ield 3 :?A for Actual [ield%

SHA for Standard Oie!d ; Actual [ield P input @, hour reuired 1 output
SHA for Actua! Oie!d ; :tandard [ield P input @, hour reuired 1 output
Standard Oie!d 0 Actual 6nput P @utput 1 6nput


?:

36+4A+I$IATI4A 4F ;U,G6T & A+TUA$ .34FIT H A;S43.TI4A +4STIAG
;udgeted .rofit (budgeted sa!es I standard %rofit# LLL
:ale Aolume Aariance BBB
Standard %rofit on actua! sa!es ( actua! sa!es I standard %rofit# BBB
:ale price variance BBB
.rofit before cost /ariance BBB
+ost 1ariance:
A2A (AA
>aterials 3 "rice BBB BBB
C Usage BBB BBB
=abor C ,ate BBB BBB
C &fficiency BBB BBB
Aariable @verhead 3 :pending BBB BBB
(i$ed @verhead 3 &$penditure BBB BBB
C Aolume BBB BBB
C 'apacity BBB BBB
C &fficiency BBB BBB BBB
Actua! .rofit LLL
Standard %rofit ;sales 3 direct material 3 direct labor 3 variable e$pense 3 fi$ed @verhead
36+4A+I$IATI4A 4F ;U,G6T & A+TUA$ .34FIT H 'A3GIAA$ +4STIAG
Gudgeted "rofit #budgeted sales P standard contribution% LLL
=ess C Gudgeted fi$ed overhead cost #BBB%
;udgeted +ontribution BBB
:ale Aolume Aariance BBB
Standard +ontribution on actua! sa!es ( actua! sa!es I standard contribution# BBB
:ale price variance BBB
+ontribution before cost /ariance BBB
1ariab!e +ost 1ariance:
A2A (AA
>aterials 3 "rice BBB BBB
C Usage BBB BBB
=abor C ,ate BBB BBB
Aariable @verhead 3 :pending BBB BBB
(i$ed @verhead 3 Gudgeted BBB BBB
C &$penditure BBB BBB BBB
Actua! .rofit LLL


?=

Standard contribution ;sales 3 direct material 3 direct labor 3 variable e$pense.
+4ST 36+4A+I$IATI4A STAT6'6AT
:tandard 'ost BBB
'ost Aariance0
Adv (av
BBB BBB
BBB BBB
BBB BBB
BBB BBB BBB
Actua! +ost LLL
1" (avorable 3 =&::
)" Adverse ; A22
(" 6t includes only cost variance.
.34FIT 36+4A+I$IATI4A STAT6'6AT
Gudgeted "rofit BBB
:ale Aariance0
Adv (av
BBB BBB
BBB BBB
BBB BBB
BBB BBB BBB
'ost Aariance0
Adv (av
BBB BBB
BBB BBB
BBB BBB
BBB BBB BBB
Actua! +ost LLL
1" (avorable 3 A22
)" Adverse ; =&::
(" 6t includes cost M sales variance.


?>

.34FIT 36+4A+I$IATI4A STAT6'6AT (F43 'A3GIAA$ +4STIAG#
Gudgeted "rofit BBB
AddC Gudgeted (i$ed 'ost BBB
Gudgeted 'ontribution BBB
:ale Aariance0
Adv (av
BBB BBB
BBB BBB
BBB BBB
BBB BBB BBB
'ost Aariance0
Adv (av
BBB BBB
BBB BBB
BBB BBB
BBB BBB BBB
Actua! 'ontribution LLL

:tandard >i$ ; 5..
4eight :, per +g
A E. D5.
G D- ED.
Actual >i$ ; /8D
4eight A, per +g
A /F DE.
G /E E.7
:tandard uantity allowed will be calculated as follows0
6f :tandard >i$1"roduction ; 5.. Then standard uantity ; E.
6f Actual >i$1"roduction ; /8D Then standard uanti ty al l owed ; 9
the formula will be0 Actual >i$1"roduction P 6ndividual :tandard uantity
:tandard >i$1"roduction
A /8D P E. ; /5.5
5..
; /8D P D- ; /D
5..


??

:tandard >i$ ; /...
4eight :, per +g
A 5-. D.
G 5.. 5.
' D-. F.
//..
=oss /..
/...
Actual >i$ ; D....
4eight A, per +g
A /.... /8
G 7-.. 5D
' 5-.. F-
6f :tandard >i$1"roduction ; /... Then total standard uantity ; //..
6f Actual >i$1"roduction ; D.... Then standard uanti ty al l owed ; 9
the formula will be0 Actual >i$1"roduction P Total :tandard uantity
:tandard >i$1"roduction =&:: any =oss
D.... P //.. ; DD...
/...
T?6: above DD... is total unit which will be allocated as follows0
A DD... P 5-. 1 //.. ; 8...
; DD... P 5.. 1 //.. ; 7...
+ DD... P D-. 1 //.. ; -...
))***
Aote that in !oss
case, 8e 8i!! take
tota! standard
Buantit&" 5e 8i!! not
take indi/idua!
standrad Bt&


?@

:tandard >i$ ; /8..
4eight :, per +g ,s
A /... /. /....
G F.. /D ID..
' 5.. /5 -F..
D...
=oss /..
/8..
Actual >i$ ; THIS 5I$$ A6163 ;6 GI16A IA PU6STI4A"
@pening
:toc+
"urchases
'losing
:toc+
'onsump
tion
A, per +g
A D.. /D.. E.. //.. 8.-
G /.. 7.. D.. I.. /D.-
' 5.. I.. -.. F.. /5
)7**
4astage of D.. is also occurred.
6f :tandard >i$1"roduction ; /8.. Then individual standard cost ; /....
6f Actual >i$1"roduction ; D5.. Then s tandard uanti ty al l owed ; 9
the formula will be0 Actual >i$1"roduction P 6ndividual :tandard 'ost
:tandard >i$1"roduction =&:: any =oss
A D5.. C D.. P /.... ; //-I7
/8..
; D5.. C D.. P ID.. ; 7EEF
/8..
+ D5.. C D.. P -F.. ; F575
/8..
Aote that 8e 8i!! take
Indi/idua! standard
cost in this case


@*

:tandard >i$ ; /... +g
Lty :, per +g
A 5-. D.
G 5.. 5.
' D-. F.
//..
:tandard =oss /..
:tandard @utput /...
Actual >i$ ; D.... +g
Lty :, per +g
A /.... /8
G 7-.. 5D
' 5-.. F-
'ateria! .rice 1ariance K
A /.... #(%
G /I... #A%
' DD-.. #A%
D8-.. #A%
'ateria! 'i0 1ariance K
A //7D. #A%
G -57. #A%
' 5EFD. #(%
DFED. #(%
A ; 85.8
G ; 7EFE
' ; -DDI
'AT63IA$ 'IL 1A3IAA+6S I$$UST3ATI4A
DE... P 5-. 1//..
DE... P5.. 1//..
DE... PD-. 1 //..
Actual Lty #A, C:,%
:, # Actual Lty at Actual >i$ C Actual Lty at :tandard >i$%
Actual Lty at :tandard >i$ is calculated as follows0
/.... #/8CD.% ;
7-.. #5DC5.% ;
5-.. #F-CF.% ;
D. #/.... C 85.8% ;
5. #7-.. C 7EFE% ;
F. #5-.. C -DDI% ;


@1

'ateria! Oie!d 1ariance K
A 7/7. #A%
G /5-D. #A%
' /EFD. #A%
EFED. #A%
6f :tandard >i$1"roduction ; /... Then standard uantity ; 5-.
6f Actual >i$1"roduction ; D.... Then standard uanti ty al l owed ; 9
the formula will be0 Actual >i$1"roduction P 6ndividual :tandard uantity
:tandard >i$1"roduction
A D.... P 5-. ; 8...
/...
; D.... P 5.. ; 7...
/...
+ D.... P D.. ; -...
/...
'ateria! Usage 1ariance K
A D.... #A%
G D.... #A%
' E.... #(%
/.... #A%
43
'ateria! Usage 1ariance K >aterial >i$ Aariance O>aterial [ield Aariance
DFED. #(% O EFED. #A% ; /.... #A%
'ateria! +ost 1ariance K
; #/.... P /8% C #8... P D.%
#7-.. P 5D% C #7... P 5.%
#5-.. P F-% C #-... P F.%
; #/8....OE-I...OD8D-..% C #/7....OED....OE.....%
; 7E8-.. C 7..... ; E8-.. #A%
43
'ateria! +ost 1ariance K >aterial "rice Aariance O>aterial Usage Aariance
D8-.. #A% O /.... #A% ; E8-.. #A%
#Actual 'ost C :tandard 'ost%
:, # Actual Lty at :tandard >i$ C :tandard Lty Allowed%
:, # Actual Lty at Actual >i$ C :tandard Lty Allowed%
D. #/.... C 8...% ;
5. #7-.. C 7...% ;
F. #5-.. C -...% ;
:tandard Lty Allowed is calculated as follows0
D. #85.8 C 8...% ;
5. #7EFE C 7...% ;
F. #-DDI C -...% ;


@)

Gudgeted sales is as follows0
A 7.. units \ /.. per unit
; I.. units \ D.. per unit
Actual sales is as follows0
A 8.. units \ //. per unit
; 7.. units \ /7. per unit
'ost per unit0
A 7.
; /I.
+a!cu!ate sa!es /ariances"
Sa!es .rice 1ariance K
A 8... #(%
G /F... #A%
I... #A%
Sa!es 'i0 1ariance K
A /5. #A%
G D/. #(%
I. #(%
A ; 8.I
G ; I8E
A /.. C 7. ; D.
G D.. C /I. ; E.
Sa!es 1o!ue 1ariance K
A D/5. #(%
G DI8. #(%
58E. #(%
Sa!es Usage 1ariance K
A D... #(%
G E... #(%
-... #(%
E. #7.. C I..% ;
:, of Gross "roft is calculated as follows0
:, of Gross "rofit # Actual Lty at Actual >i$ C Actual Lty at :tandard >i$%
A, of Gross "roft is calculated as follows0
:tandard :ales C :tandrad 'ost
Actual :ales C :tandrad 'ost
D. #8.. C 8.I% ;
E. #7.. C I8E% ;
Actual Lty at :tandard >i$ is calculated as follows0
/I.. P 7..1/-..
/I.. PI..1/-..
:, of Gross "rofit # Actual Lty at :tandard >i$ C Gudgeted Lty%
D. #8.I C 7..% ;
E. #I8E C I..% ;
:, of Gross "rofit # Actual Lty at Actual >i$ C Gudgeted Lty%
D. #8.. C 7..% ;
Actual Lty #A, C:,%
8.. #//.C/..% ;
7.. #/7.CD..% ;
SA$6 'IL 1A3IAA+6S I$$UST3ATI4A

@(

'AT63IA$ +4STIAG '6TH4,S
(irst in first out #(6(@%
=ast in last out #=6(@%
?ighest in first out #?6(@%
:tandard 'osting #:'% ; Luantity issued P standard cost
,eplacement 'osting #,'% ; Luantity issued P replacement cost
Average 'osting #AA'@%
/. 'umulative Average 'osting #'A'% ; normal method that we use.
D. "eriodic Average 'osting #"A'%
'ost of unit received O cost of opening stoc+ 1 )o of unit received O no of opening stoc+
; answer P uantity issued #individual% BBB
=essC 'ost of unit received O cost of opening stoc+ BBB
1a!ue of +!osing stock LLL
IA16AT43O 1A$UATI4A '6TH4,S
'ost
:ale price
=ower of cost or mar+et value
=ower of cost or net reali<able value
=ower of cost or replacement value
F43'U$A6
Tota! 'ateria! Turno/er: >aterial Used1Average >aterial
Finished Goods Turno/er: (inished Goods :old<Average >aterial
A/erage 'ateria!: @pening stoc+ O 'losing stoc+1D
,a& 3eBuireent in A/erage In/entor&: EF- 1 Turnover ratio
,ate before Ae0t 4rder:

(reuency
2ay :upply left ; unit in inventory 1 &@L
P (reuency
)e$t @rder 0 :upply =eft 3 =ead Time


@7

$4563 4F +4ST & 'A3N6T 1A$U6
+AS6 +4ST 'A3N6T $+'
3e%!aceent
+ost
A31<+ei!ing Ad-
A31<
F!oor
'arket
($td b&
f!oor &
cei!ing#

BB BB BB BB BB BB BB
/ D E D
nd

number
is shown
here
$o8 of
arket
or cost
D / E
E D /
ST436 $6,G63 +A3,
'<S VVVVV
Store !edger card < bin card
('ethod nae#
,AT6 36+6I16, ISSU6, ;A$AA+6
Unit U"." Aount Unit U"." Aount Unit U"." Aount
BBCBBCD..B BB BB BB BB BB BB BB BB BB
BBCBBCD..B BB BB BB BB BB BB BB BB BB
S.4I$AG6 +A$+U$ATI4A
S%ecific (5I.#

6ntire (F4H#
3eco/er&

3eco/er& F !oss
.er unit cost change .er unit cost do not change
FG cost: Tota! cost F Additiona! cost H S%oi!age
cost
FG cost: Tota! cost H S%oi!age cost
S%oi!age distribution: S%oi!age cost < tota! cost
I 1**
S%oi!age distribution: .articu!ar cost < unit
ade I 1**


@:

,6F6+TI16 UAITS
S.6+IFI+ (5I.# 6ATI36 (F4H#
4or+ in "rocess 3 >aterial
4or+ in "rocess 3 =abor
4or+ in "rocess 3 (@?
>aterial
=abor
(actory @ver ?ead
>aterial
=abor
(actory @ver ?ead
>aterial
=abor
(actory @ver ?ead
(actory @ver ?ead
>aterial
=abor
(actory @ver ?ead
(inished Goods
(inished Goods
S.4I$AG6 UAITS
S.6+IFI+ (5I.# 6ATI36 (F4H#
>aterial
=abor
(actory @ver ?ead
>aterial
=abor
(actory @ver ?ead
:poiled Goods
(actory @ver ?ead
'ost of :poilage ; 2>O2=O(@? 3 :poilage :crap
:poiled Goods
(inished Goods
(inished Goods
6+4A4'I+ 43,63 PUAATITO
64P ; ^ D P A, P @'
'' O 6 P ".U.

@=

)umber of @rders )@ 0 A, 1 &@L
Total @rdering 'ost T@' 0 @) P T@'
Average 6nventory UA6 0 &@L 1 D
Total 'arrying 'ost T'' 0 UA6 P T''
(reuency of @rders EF- 1 )@
IA16AT43O +4AT34$S

5ithout Safet& Stock 5ith Safet& Stock
4rder $e/e! < .oint <
3e24rder $e/e!:

>a$imum usage during lead time
43
>a$imum usage P >a$ lead time
)ormal 1Average usage during
lead time O :afety :toc+
43
#)ormal 1Average usage P
lead time% O :afety :toc+
'iniu $e/e! < Sock
< .oint< ;uffer $e/e!

@rder =evel C )ormal 1Average
usage during lead time
43
@rder =evel 3 #)ormal 1Average
usage P lead time%
43
#>a$imum daily usage C )ormal
1Average daily usage% P lead time

C
'a0iu $e/e! <
Stock < .oint

@rder =evel O &@L C >inimum
usage during lead time
43
@rder =evel O &@L 3 #>inimum
daily usage P lead time%
@rder =evel O &@L C )ormal
1Average usage during lead
time
43
&@L O :afety :toc+

Safet& Stock:
#>a$imum Usage 3 Average Usage%
P lead time

A/erage Stock $e/e!:

_ #>inimum =evel O >a$imum
level%
43
_ #@pening :toc+ O 'losing :toc+%
&@L1D O :afety :toc+
,anger $e/e!

)ormal 1Average usage during lead
time for urgent supply
43
)ormal 1Average daily usage P lead
time for urgent supply

6+4A4'I+ ;AT+H PUAATITO<6;P<A'6A,6, 6+4A4'I+ 43,63 PUAATITO
64P ; ^ D'2
? #/ 3 21,%

@>

' :etup 'ost.
2 Annual 2emand.
? ?olding 'ost.
, "roduction ,ate per time period.
SA1IAGS +A$+U$ATI4A
6LISTIAG A65
4rdering +ost A, P @' 1 &@L A, P @' 1 &@L
+arr&ing +ost '' P 6 P "U P &@L 1 D '' P 6 P "U P &@L 1 D
.urchase +ost Unit made P per unit cost Unit made P per unit cost
LLL LLL
SA1IAGS ,ifference of 60isting & Ae8
F43'AT
1" (actory cost ; BBB
'ontribution reuired ; #(' O T" 1 total limiting factor hrs P limiting factor hr% ; BBB
",6'& ; LLL
)" =owest price0 Gasic unit O )et "rofit 3 @pening "rofit 1 'apacity
IA16AT43O ASS4+IAT6, +4ST
Annual purchase cost ; 6rrelevant
Annual ordering cost ; ,elevant
Annual carrying cost ; ,elevant
+4'.4A6AT 4F .U3+HAS6 +4ST
1" 6nvoice price
)" 2iscount
(" 6nsurance in transit
7" 'ommission or bro+erage
:" "urchase related ta$es M duties #non refundable M non adjustable%
=" Transportation cost if constant per unit
>" )on returnable container M pac+ing
+4'.4A6AT 4F 43,63IAG +4ST
1" 'lerical cost per order
)" 6nspection cost per order
(" Transportation cost if constant per order

@?

+4'.4A6AT 4F +A33OIAG +4ST (H4$,IAG +4ST < ST43AG6 +4ST#
1" 6nsurance
)" 4astage
(" >aterial handling cost
7" :torage charged if constant per order
:" 6nterest 1 wor+ing capital cost
2> &@L ; ,aw >aterial
46" &GL ; "roduction
(G 4or+ing 'apital >anagement ; :tore
2&GT@,: 2ebtor >anagement
'A:?
A;+ AAA$OSIS
1" "areto analysis
)" 7.0D. rule
(" Always better control
7" Alphabetical approach to inventory management
:" :elective inventory management
=" '.6.&. i.e. 'ontrol by importance M e$ception
>" A.&.2. i.e. Aital, 2esirable, &ssential
IA16AT43O 'AAAG6'6AT

&@L
,eorder
)ormal ma$
Absolute ma$
:afety stoc+ 1 buffer 1 >in stoc+
IA16AT43O 36+43,IAG SOST6'
1" "eriodic system )" "erpetual system

T54 ;IA SOST6'
(irst bin ; over M above reorder level :econd bin ; reorder level

3eorder !e/e! s&ste ) bin under reorder
!e/e! s&ste
.eriodic re/ie8 s&ste
Unit of reorder level
&$cess units
2esired
closing stoc+
:ale unit
Total reuired
@pening stoc+
to be bought

@@

64P
Annua! ordering cost K Annua! carr&ing cost
A2 P @' 1 &@L ; &@L P '' 1 D 43 &@L P 'U P ''K1D
64P
)
; D P A2 P @'1'U P ''K
64P

; W D P A2 P @'1'U P ''K

A163AG6 +4ASU'.TI4A A43'A$ +4ASU'.TI4A
@pening O closing 1 D /. ?ighest freuency
D. 'onsume most of time

1" Use normal consumption. 6f normal consumption not given, then use average
consumption.
)" 'onsumption M lead time ; base parameter will always be same
1" 2A[ ; 2A[
)" 4&&` ; 4&&`
ST4+N 4UT +4ST
1" ,estarting cost
)" =oss of goodwill M customers
(" =oss of contribution margin
7" &$tra cost associated with emergency purchase
:" 'onsumption X )ormal ; :toc+ out costs occurs
=" 'arrying cost of safety stoc+ ; safety stoc+ unit P '' per unit
>" )ote0 '' will not be divided by D as it is not used on regular basis.
?" :toc+ out cost 0 1 H "er time M ) H "er unit
AAAUA$ ,6'AA,
+ash sa!es unit BBB
+redit sa!es unit BBB
Tota! sa!es unit BBB
Add H +!osing FG BBB
$ess H 4%ening FG #BBB%
3eBuired LLL


1**

UA+63TAIATO T4 +63TAIATO
(ormula for 'ertainty &uivalents 0 Uncertainty figure P probability
I..... P -K I-...
-..... P I.K E-....
D..... P D-K D-...
7:****
64P 1S 6;P
64P 6;P
Annua! ,eand Annual production
+arr&ing cost Aariable manufacturing cost per unit
++J ''K
4rdering cost :et up cost per order
3eference to 3a8 'ateria! ,eference to (inished Goods
F366 ST4+N ;A$AA+6
"hysical stoc+ BBB
Add 3 @utstanding purchase order BBB
=ess 3 Unfulfilled share reuisition #BBB%
LLL
,AAG63 $616$
1" "oint below safety stoc+.
)" ,epresent limit at which emergency steps must be ta+en e.g. sending a man
personally to bring the reuired material.
+4ST 4F .36,I+TI4A 63343
6LISTIAG A65
4rdering +ost A, P @' 1 &@L A, P new @' 1 old &@L
+arr&ing +ost '' P 6 P "U P &@L 1 D '' P 6 P "U P old &@L 1 D
LLL LLL
SA1IAGS ,ifference of 60isting & Ae8


1*1

4163A$$ 1A3IAA+6 < T4TA$ 1A3IAA+6 < 4163 43 UA,63 A..$I6, F4H
Actual (@? #(i$ed O Aariable% BBB
Applied (@? #Actual capacity attained P (@? Applied ,ate% #BBB%
Under < 4/er A%%!ied LLL
F4H A%%!ied 3ate : &stimated (@?1&stimated 'apacity level
Under applied1 2r1 Unfavorable & @ver applied1 'r1 (avorable
+A.A+ITO < 14$U'6 1A3IAA+6
Applied (@? BBB
Gudgeted G@? for capacity attained #(i$ed (@? O Actual capacity
attained P (@? variable rate%
#BBB%
LLL
F4H 1ariab!e 3ate : &stimated Aariable (@?1&stimated 'apacity level
S.6A,IAG< ;U,G6T6, < 6L.6A,ITU36
Actual (@? #BBB%
LLL
F43'U$A6
Fi0ed F4H 6stiated Tota! F4H H 1ariab!e F4H
Tota! F4H (i$ed (@? O Aariable (@?
F4H a%%!ied rate (if /ariab!e F4H
is gi/en#
(i$ed (@?1&stimated capacity O Aariable rate
;udgeted /o!ue< nora!
ca%acit& < standard acti/it& !e/e!
(i$ed (@?1(i$ed (@? rate #Total rate 3 Aariable rate%
1ariab!e F4H 3ate 'hange in budgeted (@?1'hange in activity level
;udgeted Fi0ed F4H Total budgeted (@? C Aariable (@? #Gudgeted volume P
variable rate%
Fi0ed +ost Aariable (@? O Gudgeted fi$ed (@?
;udgeted F4H (i$ed cost O Aariable cost #Gudgeted volume P variable
rate%
+ost of Unused +a%acit& &stimated fi$ed (@? 3 (i$ed (@? Applied
Stages of absor%tion costing Allocation O Apportionment O Absorption
;!anket < .!ant 8ide< Sing!e 3ate Total (@? of the factory1Total activity level of the factory

1*)

,e%artenta! 3ate Total (@? of deptt1Total activity level of the deptt
Actua! 3ate Total Actual (@?1Total actual activity level
;ases of Acti/it& $e/e! #/% C >achine ?our #D% 3Luantity #E% C "rime cost
#5% C 2> cost #-% C2= cost #F% C 2= hours
Actua! +osting Actual 2irect >aterial 'ost O Actual 2irect =abor 'ost O
Actual 2irect &$penses 'ost O Actual (@? 'ost
Aora! +osting Actual 2irect >aterial 'ost O Actual 2irect =abor 'ost O
Actual 2irect &$penses 'ost O Applied (@? 'ost
Under<4/er a%%!ied ,ecision 3u!e A4.U
# )egative ; @ver applied M "ositive ; Under applied%
3eason of Under<4/er a%%!ied / C Actual @verhead costs are different from budgeted
overhead
D C Actual @verhead activity levels are different from
budgeted overhead
E C Actual @verhead costs M activity levels are different
from budgeted overhead
A++4UATIAG T36AT'6AT
Absor%tion +osting 'argina! +osting
.rie +ost "roduct 'ost "roduct 'ost
1ariab!e F4H "roduct 'ost "roduct 'ost
Fi0ed F4H "roduct 'ost "eriod 'ost
Adin H 1ariab!e "eriod 'ost "eriod 'ost
Adin H Fi0ed "eriod 'ost "eriod 'ost
Se!!ing H 1ariab!e "eriod 'ost "eriod 'ost
Se!!ing H Fi0ed "eriod 'ost "eriod 'ost
.362,6T63'IA6, F4H 3AT6
;ased on Actua! +a%acit& Attained:

&stimated (@? at actual capacity attained
&stimated 'apacity level at actual capacity
attained
;ased on Aora! +a%acit&:

&stimated (@? at normal capacity
&stimated 'apacity level at normal
capacity
6stiated F4H at nora! ca%acit&
(i$ed &$pected actual capacity O normal capacity hours P variable rate
1ariab!e 3ate: Aariable Actual 'apacity Attained1Actual 'apacity Attained ?ours


1*(

F4H +A.A+ITI6S
Id!e<3ate<Theoretica!
+a%acit&

/ C &stimated running ; D5 hr a day, EF- days in a year
D C &stimated machine hour ; D5PEF-P/. ; 7IF.. >achine
?ours
.ractica! +a%acit&

/ C &stimated running ; D. hr a day, - days per wee+, -.
wee+s per year
D C &stimated machine hour ; D.P-P-.P/. ; -.... >achine
?ours
Aora!<;udgeted +a%acit&

/ C Used for long run planning.
D C (oresee capacity
E C Gased upon past e$perience considering present
circumstances.
60%ected Actua! +a%acit&
Used for short run planning. &.g. seasonal.
36S.4ASI;I$ITO +6AT63S
+ost +enter .rofit +enter In/estent +enter 3e/enue
+enter
5hat is itQ "art of the
business for which
costs are
identified M
recorded.
"art of the
business for which
costs incurred M
revenue earned are
identified M
recorded.
"art of the
business for which
profits M capital
employed are
measured.
"art of the
business for
which revenue
earned are
identified M
recorded.
5here ight
it be foundQ
"roduction or
service location,
function, activity,
item of euipment
2ivision of large
organi<ations. >ay
include several cost
M revenue centers.
Gusiness units of
large organi<ations.
:ale divisions.
Ho8 is
%erforance
easuredQ
?ave cost targets
been achieved9
4hat profit has
been made by the
center9
,@'& 4hat revenue
has been
earned9
5hat are the
anagerXs
inforation
needsQ
'ost incurred M
charged to cost
centers.
6nformation about
costs M revenues
allocated to the
profit center.
6nformation about
costs, revenues M
capital employed
to the investment
center.
:ale revenue
earned by
individual
revenue
center.
60a%!es

Audit, Ta$ M
Accounting deptt
in accountancy
firms.
4holesale M retail
division in a paint
company.

U` M &uropean
division of
multinational
company.

,egional sales
areas within
the retail
division of
manufacturing
company.


1*7

F43'U$A6
;reak e/en %oint
Fixed Cost/C/M Ratio (Contribution Margin Ratio)
C/M Ratio = Contribution / Sales * 100
OR
Fixed Cost
1 !ariable cost / Sales
OR
Fixed Cost
Contribution "er unit (S#$# $er %nit !#C# $er %nit)
&' !A(%)S
Fixed Cost
C/M Ratio (Contribution Margin Ratio)
C/M Ratio = Contribution / Sales * 100
Contribution Margin= Contribution Sale * $ro+it
!olu,e#
In o%ening stock

Units from opening stoc+ O #total fi$ed cost 3 total contribution
from opening stoc+1'urrent 'ontribution per unit%
+ontribution argin
:ale 3 Aariable &$pense
.rofit co%utation
#:ale P '1> ,atio% 3 (i$ed 'ost
Ae8 fi0ed cost
:ale C a'1> 3 #>argin of safety P '1>%b
4!d fi0ed cost
#:ale 3 #/.. 3 >argin of safety% P '1> ,atio
1ariab!e e0%enses
#/ CC '1> ,atio% P :ales
+ontribution argin ratio
'ontribution P /..
:ales
43
'hange in "rofit P /..
'hange in :ales
43
'hange in 'ontribution P /..
'hange in :ale
43
'hange in Total 'ost P /..
'hange in :ale
43
:ale 3 Aariable &$pense P /..
:ales
,ecision +!ue K
?igher the '1> ratio Y more will be the profit.
=ower the '1> ratio Y lower will be the profit.
Sa!e %ro-ection
(i$ed 'ost O "rofit #=oss% "rojection
'1> ,atio #'ontribution >argin ,atio%

1*:

43
(i$ed 'ost O "rofit "rojection 1 #/Cta$ rate%
60tra units so!d to aintain
sae %rofit
,evised Units 3 &$isting Units
Increase in se!!ing %rice
4hen marginal cost is ,s0 B/B, the selling price is ,s0 BDB
4hen marginal cost is ,s0 BEB, the selling price is ,s0 BDB P
BEB 1 B/B.
6ncrease in selling price ; )ew "rice 3 @ld "rice
Ao of unit so!d to get desired
!e/e! of %rofit
IA UAITS:
Total ,euired 'ontribution #(i$ed cost O Target profit%
'ontribution per unit #:ale per unit 3 Aariable cost per
unit%
IA 1A$U6S:
Total ,euired 'ontribution #(i$ed cost O Target profit%
'1> ,atio ; 'ontribution 1 :ales P /..
Ta0 i%act
#'hange in volume in units% P #contribution margin per
unit% P #/ 3 ta$ rate%
Aet dec!ine in contribution
argin
2ecline in ,evenue #unit produce P old sale price 3 new
sale price% BBB
2ecline in 'ost #(urther "rocessing 'ost% BBB
LLL
)ote0 )o offer acceptance if net decline in contribution
margin M vice versa.
'argin Safet& 3atio

:elected sale figure 3 brea+ even point P /..
:elected sale figure
43
"rofit 1 '1> ,atio P /..
IA UAITS K Actual1Gudgeted unit sold 3 brea+ even unit
$a&an 3u!e
Total 'ost ; Total ,evenue
Accountant 3u!e
'ontribution >argin ; ('O "rofit
+ash ;6.
'ash (i$ed 'ost
'ash '1> "er Unit
'ash (' means all (' e$cluding 2epreciationO
Amorti<ation O all non cash items.
6t determines at point where total cash cost M
total sales line intersect each other.
3e/ised .<1 ratio ,evised contribution margin per unit
,evised sale price per unit
Ae8 +ontribution
Given 'ontribution 3 Aariable 'osts
3u!e )o variable e$pense, all sale price will be '1>
.rofit margin of safety K P '1> K
'argin of safet& total sales 3 brea+ even sales
'argin of safet& J total sales 3 brea+ even sales 1 total sales

1*=

Tota! sa!es >argin of safety profit
.rofit :ales P margin of safety K P '1> K
3eBuired +ontribution (i$ed 'ost O Target "rofit 3 Target =oss 3 2onation 3
:hut down
'argin of Safet& "rofit
'1> K
43
"rofit
'1> "er Unit
Sa!e .rice (i$ed 'ost1Unit O Aariable 'ost "er Unit
At ;reak 6/en $e/e! :ale 3 A' 3 (' ; "rofit
43
:ale ; A' O (' O "rofit
Target .rofit :ale ; A' O (' O "rofit
Ta0 I%act Gefore #2ivide% ; After Ta$ 6ncome1/Ct
After #>ultiply% ; Gefore Ta$ P #/Ct%
:ale P '1> ratio ; (' O "rofit
Grea+ even sale P '1> ratio ; (' 3 Grea+ even sales
.rofitabi!it& 'ontribution 1 +ey factor
+ontribution < ke& factor Annual production 1 6nstall capacity
#Grea+ even sale O >1: ratio% P '1> ratio ; 'ontribution
#Grea+ even sale O '1> ratio% P #>1: ratio P '1> ratio% ; (' O "rofit
.4IATS
/. 6t is the level of activity where total cost euals sale price.
D. 6t is the point where contribution is eual to fi$ed cost.
E. 6t is a point of no profit M no loss.
5. 6t is the point available to cover fi$ed e$penses M then to provide profits for the
period.
-. 6t is the logical e$tension of >arginal 'osting.
F. 6t is a powerful instrument for decision ma+ing.
I. 'ontribution means contribution towards fi$ed cost M profit.
7. Grea+ even point ; Nero profit point
ASSU'.TI4AS
/. All costs can be separated in fi$ed M variable costs.
D. )o change in operating efficiency.
E. )umber of units produced M sold will be the same so that there is no opening M
closing stoc+.
5. All fi$ed costs will fluctuate M will not change with change of activity level.

1*>

-. @nly product or in case of many products, product mi$ will remain unchanged.
F. :elling price will remain constant despite competition or change of volume.
I. Aariable cost will fluctuate in same proportion in which volume of output varies.
+H6+N
:ale BBB
=ess 3 Aariable 'ost BBB
'ontribution LLL
=essC (i$ed 'ost BBB
.rofit LLL
'A3GIA SAF6TO 3ATI4
:ale or output behind brea+ even point is called margin of safety. >argin of safety is
that sales or output which is above brea+ even point. All fi$ed costs are recovered at
brea+ even point, so fi$ed e$penses have been e$cluded from the formula of margin of
safety. The margin of safety at brea+ even point is nil as actual unit sold is eual to brea+
even unit sold. 6t can be increased by0
/. 6ncrease in level of production.
D. 6ncrease in sale price.
E. ,educe fi$ed cost or variable cost or both.
5. :ubstitute e$isting products by more profitable products.
$arge 'argin of Safet& 6ndicator of strength as substantial reduce in sales M
production, profit will be made.
Sa!! 'argin of Safet& 6ndicator of wea+ness as small reduce in sales M production,
loss will be made.
AAG$6 4F IA+I,6A+6
6t is an angle at brea+ even point where sales line cuts total cost line. 6t shows the rate at
which the profit is made.
$arge Ang!e of Incidence .rofit at high rate
Sa!! Ang!e of Incidence .rofit at !o8 rate
36PUI36, SA$6 T4 6A3A TA3G6T .34FIT
In 3u%ees In J
(i$ed cost O target profit 1 '> K (i$ed cost 1 '> K C Target "rofit K

1*?

AFT63 TAL +A$+U$ATI4AS
In 3u%ees In J
(i$ed cost O )et "rofit 1 #/Ct% 1 '> K (i$ed cost O 1 '> K C )et "rofit 1 #/Ct%
.34,U+T 'IL
In J .er Unit
(i$ed cost O Target "rofit 1 '> K (i$ed cost O Target profit 1 '> per unit

'1> K ; total contribution 1 total sales P /..
'1> per unit ; total contribution 1 total sales
Aote: 6n product mi$, there is only one fi$ed cost. That (' is common for all the
products.
Head Increase to be sho8n in
(' Total
A' "er unit
36PUI36, SA$6S
(i$ed 'ost O Target "rofit BBB
=ess C B M [ 'ontribution #2emandP'ontribution "er Unit% #BBB%
NSs 'ontribution BBB
2ivided Gy
"er Unit contribution of NSs BBB
3eBuired sa!es LLL
A++4UATAAT 1S 6+4A4'IST
Accountant 6conoist
@ne G&" Two G&"
Total 'ost is straight line Total 'ost is not a straight line
#first reduce M then climb as per law of diminishing
return%
,evenue =ine is straight line ,evenue =ine is not straight line
#less steep to depict the need to give discount to
achieve higher sale volume%
(i$ed 'ost is straight line C
6gnore economies 1 diseconomies of scale, elasticity
of demand; discount to secure increase in volume.
,ecogni<e economies 1 diseconomies of scale.

Grea+ even time ; sale ; (' O A' Grea+ even time ; Average revenue ; Average cost
Use is limited to area within relevant range. C
2ifficult to ma+e chart when step (' occurs. C
2 To increase sale, price reductions have to be

1*@

offered M as output increase, marginal cost of
additional production increases.
2 &conomist argues that accountant distinction
between (' M A' is unrealistic. 6n reality, whether
cost is fi$ed or variable depends on time frame
ta+en.
2 Grea+ even point is intersection of line representing
two functions

;36AN616A +HA3T ST6.S

t!p( 1) !l!ct appropriat! scal!s #or t*! a+!s a"d dra, a"d la$!l t*!m) "ut the
e$tremes of the a$es right at the end of the available space. The furthest point on the
vertical a$is will be the monthly sales revenue, that is, /, I.. units P ,s0 -. ; ,s0 7-,...
The furthest point on the hori<ontal a$is will be monthly sales volume of /,I.. units.
>a+e sure that you do not need to read data for volumes higher than /,I.. units before
you set these e$tremes for your scales.
t!p( 2) -ra, t*! #i+!d cost li"! a"d la$!l it) This will be a straight line parallel to the
hori<ontal a$is at the ,s0 D.,... levels. The ,s0 D.,... fi$ed costs are incurred in the
short term even with <ero activity.
t!p( .) -ra, t*! total cost li"! a"d la$!l it) The best way to do this is to calculate the
total costs for the ma$imum sales level, which is /,I.. units in our e$ample. >ar+ this
point on the graph and join it to the cost incurred at <ero activity, that is, ,s0 D.,...
,s0
Aariable costs for /,I.. units #/,I.. P ,s0 E.% -/,...
(i$ed costs D.,...
Total cost for /,I.. units >1,***
t!p( /) -ra, t*! r!0!"u! li"! a"d la$!l it) @nce again the best way is to plot the
e$treme points. The revenue at ma$imum activity in our e$ample is /,I.. P ,s0 -. ; ,s0
7-,.... This point can be joined to the origin, since at <ero activity there will be no sales
revenue.
t!p( 1) Mar2 a"3 r!4uir!d i"#ormatio" o" t*! c*art a"d r!ad o## solutio"s as r!4uir!d)
'hec+ that your chart is accurate by reading off the measures that we have already
calculated
in this chapter0 the brea+even point, the margin of safety, the profit for sales of /,I..
units.
t!p( 5) C*!c2 t*! accurac3 o# 3our r!adi"6s usi"6 arit*m!tic) 6t is always good
e$amination practice to chec+ the accuracy of your answers and ma+e adjustments for
any errors in your chart #if you have timec%

11*

+4AT3I;UTI4A ;36AN616A +HA3T

A contribution breake/en chart depicts variable costs, so that contribution can be read directly
from the chart. The main problem with the traditional brea+even chart is that it is not possible
to read contribution directly from the chart.
The contribution brea+even chart remedies this by dra8ing the /ariab!e cost !ine instead of
the fi0ed cost !ine. A contribution brea+even chart would include the variable cost line passing
through the origin and the total variable cost of ,s0 BBB for BBB units.


111

.34FIT<14$U'6 (.<1# G3A.H

The %rofit</o!ue #.<1# gra%h is a variation of the brea+even chart and illustrates the
relationship of profit to sales volume.

+onstruction of a %rofit</o!ue gra%h

#a% *"* is on the y a$is and actually comprises not only *profit* but contribution to profit #in
monetary value%, e$tending above and below the $ a$is with a <ero point at the intersection of
the two a$es, and the negative section below the $ a$is representing fi$ed costs. This means
that at <ero production, the firm is incurring a loss eual to the fi$ed costs.
#b% *A* is on the $ a$is and comprises either volume of sales or value of sales #revenue%.
#c% The profitCvolume line is a straight line drawn with its starting point #at <ero production% at
the intercept on the y a$is representing the level of fi$ed costs, and with a gradient of
contribution1unit #or the '1: ratio if sales value is used rather than units%. The "1A line will cut
the $ a$is at the brea+even point of sales volume. Any point on the "1A line above the $ a$is
represents the profit to the firm #as measured on the vertical a$is% for that particular level of
sales.

=et us draw a "1A graph for our e$ample. At sales of /D.,... units, total contribution will be
/D.,... J ,s0 #/ 3 ..-% ; ,s0 F.,... and total profit will be ,s0 D.,....

Ad/antages of the .<1 gra%h

(a# 6f the budgeted selling price of the product in our e$ample is increased to ,s0 /.D., with the
result that demand drops to /.-,... units despite additional fi$ed costs of ,s0 /.,... being
spent on advertising, we could add a line representing this situation to our "1A chart.
(b# At sales of /.-,... units, contribution will be /.-,... J ,s0 #/.D. 3 ..-.% ; ,s0 IE,-.. and
total profit will be ,s0 DE,-.. #fi$ed costs being ,s0 -.,...%.

11)

(c# The diagram shows that if the selling price is increased, the brea+even point occurs at a
lower level of sales revenue #I/,5D8 units instead of 7.,... units%, although this is not a
particularly large decrease when viewed in the conte$t of the projected sales volume. 6t is also
possible to see that for sales above -.,... units, the profit achieved will be higher #and the loss
achieved lower% if the price is ,s0 /.D.. (or sales volumes below -.,... units the first option will
yield lower losses.
(d# The "1A graph is the clearest way of presenting such information; two conventional
brea+even charts on one set of a$es would be very confusing.
(e# 'hanges in the variable cost per unit or in fi$ed costs at certain activity levels can also be
incorporated easily into a "1A graph. The profit or loss at each point where the cost structure
changes should be calculated and plotted on the graph so that the profit1volume line becomes
a series of straight lines.
(f# (or e$ample, suppose that in our e$ample, at sales levels in e$cess of /D.,... units the
variable cost per unit increases to ,s0 ..F. #perhaps because of overtime premiums that are
incurred when production e$ceeds a certain level%. At sales of /E.,... units, contribution
would therefore be /E.,... J ,s0 #/ C ..F.% ; ,s0 -D,... and total profit would be ,s0 /D,....

60a%!e
A company manufactures a single product which incurs fi$ed costs of ,s0 E.,... per annum.
Annual sales are budgeted to be I.,... units at a sales price of ,s0 E. per unit. Aariable costs
are ,s0 D7.-. per unit.
(a# 2raw a profit3volume chart, and use it to determine the brea+even point. The company is
now considering improving the uality of the product and increasing the selling price to ,s0 E-
per unit. :ales volume will be unaffected, but fi$ed costs will increase to ,s0 5-,... per annum
and variable costs to ,s0 EE per unit.
(b# 2raw, on the same graph as for part #a%, a second profit3volume chart and comment on the
results.

So!ution
The two lines have been drawn as follows0
ituatio" (a#" The profit for sales of I.,... units is ,s0 I-,....

11(

,s0 ...
'ontribution I.,... P ,s0 #E. C D7.-.% /.-
(i$ed costs #E.%
"rofit >:
This point is joined to the loss at <ero activity, ,s0 E.,..., that is, the fi$ed costs.
ituatio" (b7" The profit for sales of I.,... units is ,s0 8-,....
,s0 ...
'ontribution I.,... P ,s0 #E- C EE% /5.
(i$ed costs #5-%
"rofit @:
This point is joined to the loss at <ero activity, ,s0 5-,..., that is, the fi$ed costs.

+oent on the resu!ts
The chart depicts clearly the larger profits available from option #b%. 6t also shows that the
brea+even point increases from D.,... units to DD,-.. units but that this is not a large increase
when viewed in the conte$t of the projected sales volume. 6t is also possible to see that for
sales volumes above E.,... units the profit achieved will be higher with option #b%. (or sales
volumes below E.,... units option #a% will yield higher profits #or lower losses%.

The profit3volume chart is the clearest way of presenting information li+e this. 6f we attempted
to draw two conventional brea+even charts on one set of a$es the result would be a jumble
that would be very difficult to interpret.


117

'argina! costing ,irect 'ateria! F ,irect $abor F 1ariab!e F4H
Absor%tion costing 2irect >aterial O 2irect =abor O Total (@?
Fi0ed F4H (under absor%tion# (i$ed (@? P Actual capacity1"roduction
)ormal 'apacity
Aote: 6f actual capacity is missing, it is assume that normal
capacity is actual capacity.
Finished goods in/entor& Total '@G> P #purchase unit O @pening stoc+ 3 sale
unit%
Actual capacity1production
'argina! cost
The marginal cost of an item is its variable cost.
>arginal production cost ; 2irect materials O 2irect labour O
Aariable production overhead.
>arginal cost of sale for a product ; 2irect materials O 2irect
labour O Aariable production overhead O @ther variable
overhead #for e$ample, variable selling and distribution
overhead%.
>arginal cost of sale for a service ; 2irect materials O 2irect
labour O Aariable overhead.
6t is usually assumed that direct labour costs are variable #marginal%
costs, but in some situations, direct labour costs might be fi$ed costs,
and so would not be included in marginal cost.
A$T63AATI16 +4A+6.TS 4F 'A3GIAA$ +4STIAG
To econoist, marginal cost is the additional cost incurred by the production of one e$tra unit.
To accountant, marginal cost is average variable cost which is conventionally presumed to act
in linear fashion i.e. marginal cost per unit is assumed to be constant on the short run.
ASSU'.TI4AS IA 'A3GIAA$ +4STIAG

1" &very additional unit of output or sale, or every additional unit of activity, has the same
variable cost as every other unit. 6n other words, the variable cost per unit is a constant
value.
)" (i$ed costs are costs that remain the same in total in each period, regardless of how
many units are produced and sold.
(" 'osts are either fi$ed or variable, or a mi$ture of fi$ed and variable costs. >i$ed costs
can be separated into a variable cost per unit and a fi$ed cost per period. Techniues
such as high1low analysis or linear regression analysis should be used to do this.
7" The marginal cost of an item is therefore the e$tra cost that would be incurred by
ma+ing and selling one e$tra unit of the item.

11:

A;S43.TI4A<FU$$<T3A,ITI4AA$<+4A16ATI4AA$ +4STIAG
Sa!e LLL
$ess2 +ost of Goods So!d:
,irect 'ateria! BBB
,irect $abor BBB
Factor& 4/erhead A%%!ied (Fi0ed F 1ariab!e# BBB
+ost of Good 'anufactured BBB
Add H 4%ening Finished Goods BBB
$ess H +!osing Finished Goods #BBB%
+ost of Goods So!d BBB
Add H Under A%%!ied BBB
$ess H4/er A%%!ied #BBB%
+ost of Goods So!d (Ad-usted# #BBB%
Gross .rofit BBB
$ess H 4%erating 60%enses:
Se!!ing o/erhead (Fi0ed F 1ariab!e# BBB
Adinistration o/erhead (Fi0ed F 1ariab!e# BBB #BBB%
4%erating .rofit< Aet .rofit LLL
Aotes:
1" To calculate fi$ed (@?, see formula above.
)" 'apacity will be of two types0 /0 Gudgeted D0 )ormal. Use budgeted capacity. 6f not
given, then use )ormal capacity.
(" @pening (inished Goods ; 'ost of Good >anufactured1"roduction Units P
@pening :toc+ Units
7" 'losing (inished Goods ; 'ost of Good >anufactured1"roduction Units P
'losing :toc+ Units
:" @pening :toc+ Units will be given in the uestion.
=" 'losing :toc+ Units will be calculated as follows0 @pening :toc+ Units O "urchases 3 :ales
>" Gross "rofit ; :ales 3 '@G:
?" Under 1 @ver applied as calculated as per (@? method. Goth (i$ed M Aariable Aariances
will be considered here.


11=

'A3GIAA$<,I36+T<1A3IA;$6 +4STIAG
Sa!e LLL
$ess2 +ost of Goods So!d:
,irect 'ateria! BBB
,irect $abor BBB
Factor& 4/erhead A%%!ied (1ariab!e on!&# BBB
1ariab!e +ost of Good 'anufactured BBB
Add H 4%ening Finished Goods BBB
$ess H +!osing Finished Goods #BBB%
+ost of Goods So!d BBB
Add H Under A%%!ied BBB
$ess H4/er A%%!ied #BBB%
+ost of Goods So!d (Ad-usted# #BBB%
Gross +ontribution BBB
$ess H 1ariab!e se!!ing & adinistration o/erhead #BBB%
Aet +ontribution BBB
$ess H 4%erating 60%enses:
Se!!ing o/erhead (Fi0ed# BBB
Factor& o/erhead (Fi0ed# BBB
Adinistration o/erhead (Fi0ed# BBB #BBB%
4%erating .rofit< Aet .rofit LLL
Aotes:
1" @pening (inished Goods ; Aariable 'ost of Good >anufactured1"roduction
Units P @pening :toc+ Units
)" 'losing (inished Goods ; Aariable 'ost of Good >anufactured1"roduction
Units P 'losing :toc+ Units
(" @pening :toc+ Units will be given in the uestion.
7" 'losing :toc+ Units will be calculated as follows0 @pening :toc+ Units O "urchases 3 :ales
:" Under 1 @ver applied as calculated as per (@? method. @nly Aariable Aariances will be
considered here.
36+4A+I$IATI4A
)et income #Absorption costing% BBB
=essC 2ifference in closing stoc+ BBB
AddC 2ifference in opening stoc+ BBB
Aet incoe ('argina! costing# LLL
,ifference in %rofit under t8o costing s&ste is due to different stock /a!uation ethods use"

11>

+4A+6.TS
A+ K '+ :ame "rofit
A+ U '+ ?igh "rofit
A+ Y '+ =ow "rofit

Tota! +ontribution U F+ "rofit
Tota! +ontribution K F+ )o "rofit M no loss
Tota! +ontribution U F+ =oss

.roduction U +a%acit& @ver applied
.roduction Y +a%acit& Under applied
'A3GIAA$ +4STIAG 1S A;S43.TI4A +4STIAG
A;S43.TI4A +4STIAG 'A3GIAA$ +4STIAG
>arginal cost is the part of the cost of
one unit of product or service which
would be avoided if that unit was not
produced or which would increase if
one e$tra unit were produced.
>arginal cost is the variable cost of
one unit of product or service.
6f volume of sales falls by one unit,
profit will fall by amount of
contribution earned from that unit.
(i$ed production cost are absorbed into the
cost of units M carried forward.
(i$ed production cost are treated as period
cost M written off as incurred.
Absorption costing will report high profit when
stoc+ level increases as fi$ed overhead will be
carried forward to closing stoc+.

'losing stoc+s are valued at full production
cost.
'losing stoc+s are valued at marginal1variable
production cost.
Absorption costing will report low profit when
stoc+ level decreases.

4hen unit of product is made, the e$tra cost
incurred in its manufacture is variable
production costs. (i$ed costs are unaffected M
no e$tra fi$ed costs are incurred when output
is increased.


11?

TH366 TO.6S 4F 36'UA63ATI4A
1" Tie 8ork: 4ages ; ?ours wor+ed P rate of pay per hour
@vertime ; "aid at a premium rate.
a. @vertime premium is e$tra rate per hour which is paid. 6t is not the whole of the
payment for the overtime hours.
b. Gasic rate is ,s; 5per hour and overtime is paid at time and a uarter. &ight hours
of overtime is paid as follows0
/. Gasic "ay #7P5% ; ED
D. @vertime #7P/% ; 7
c. :hift premium is given when employees wor+ for unsocial hours. 6t is similar to
overtime premium. 6t is the e$tra amount paid per hour above the basic hourly
rate.
)" .iece 8ork: 4ages ; Units produced P rate of pay per unit
a. Guaranteed minimum wage rate is given to piece wor+ers.

(" ;onus<incenti/e s&ste

i. ?igh day rate system
ii. 6ndividual bonus scheme
iii. Group bonus scheme
iv. "rofit sharing scheme
v. 6ncentive scheme involving shares
vi. Aalue added incentive scheme0 #Aalue added ; sales 3 cost of
bought in material M services%.
vii. ?asley constant partial sharing scheme
viii. Taylor differential piece rate plan
i$. GA)TT tas+ M bonus plan
$. &merson efficiency bonus plan
$i. ,owan variable sharing plan
$ii. Gedau$ point plan
$iii. Gerth variable sharing plan


11@

F43'U$A6
Has!e& constant %artia! sharing schee 4age rate P -.K P time save
Ta&!or differentia! %iece rate %!an 4age rat e P time save 1 time allowed P time ta+en
Unit "roduction
Tie ?our
Unit $abor +ost =abor 1 Units
Unit 4/erhead +ost (@? 1 Units
+on/ersion +ost .er Unit 2= O (@? 1 Units
.34,U+TI1ITO
1 2 4ut%ut an %er hour Total @utput 1 Total >an hours
) 2 $abor Hour %er unit of %roduction Total =abor ?our1 Total @utput
( 2 60tent of ineffecti/e<$ost tie >an hours =ost 1 "ossible >an ?ours P /..
7 2 Actua! Tie co%ared 8ith
standard tie
Actual Time C :tandard Time

: 2 4ther 'ethods
:ale Aalue 1 )o of wor+ers
2irect 4ages 1 )o of units
Added value of the product 1 Total wages cost

.reiu +osting 'ethods
2irectly charged to production
Treated as overhead element
'harged to income statement as period costs
6ffecti/e .er hour Total 4ee+ly &arnings 1 Total ?ours

$abor Turno/er 'ethods
)umber of employees leaving
Avg number on payroll
43
)umber of employees leaving O joining
43
)umber of employees replaced
Id!e tie foru!a 6dle hours 1 total hours P /..
3o8an /ariab!e sharing %!an
/. Gase wage are generally guaranteed up to tas+. Above such tas+, bonuses are paid
according to a variable share of the time saved.
D. Time saved is the function of standard time allowed whereas in other bonus plan, it is
the function of actual time wor+ed.


1)*

5orker H 1 5orker H )
:tandard time allowed in
hours
7 7
Actual time ta+en in hours 5 F
J bonus #:tandard time
allowed in hours C Actual time
ta+en in hours% 1 :tandard
time allowed in hours
7C517P/.. ; -.K 7CF17P/.. ; D-K
6erson efficienc& bonus %!an
/. &mpirical scale of bonus ratios
D. FFK efficiency ; N&,@ bonus
E. 7I.-K efficiency ; agreed K bonus
Assume normal wage rate I.-.
FFK efficiency N&,@
7I.-K efficiency I.-.O/.K ; 7.D-
/..K efficiency I.-.OD.K ; 8
/./K efficiency I.-.OD/K ; 8..I-
GAATT task & bonus %!an
Standard .roduction ;e!o8 .roduction Abo/e .roduction
"iece "roduced E.. D8/ E5-
"roduction K to standard /..K 8IK //-K
5ages +a!cu!ation
)ormal 4age )ormal 4age )ormal 4age
Gonus C Gonus
C C Additional Gonus
#wage O bonus P K%
;edau0 %oint %!an
/. Time saved ; I-K
D. ,emaining time of D-K to foreman, serviceman, other indirect personnel
E. )ormal performance inde$ ; F.K #not /..K% on assumption that F. units of standard
time can be produced with normal effort in F. minutes of actual time. Technically, one
point ; one minute.
5. (or first F. points, wor+er will get normal wages. (or additional points, say I- 3 F. ; /-
points will be distributed in I-0D- ratio.


1)1

.34,U+TI4A 1S .34,U+TI1ITO
.roduction .roducti/it&
Luantity or volume of output produced. >easure of efficiency with which output has
been produced.
,elative measure of hours actually ta+en M the
hours that should have been ta+en to ma+e
the output.

6mproved productivity is the mean of reducing
total unit costs.

$A;43 +4ST ;6HA1I4U3
1" "ayment in piecewor+ basis ; variable cost
)" =abor cost is often mi$ed costs due to bonus, overtime premium, and commission.
(" "ayment in day rate wage ; pay per wee+ is fi$ed regardless of volume.
,I36+T & IA,I36+T $A;43
;asic %a& of direct 8orker
Direct cost
;asic %a& of indirect 8orker
6ndirect cost unless customer as+s for order which
involve dedicated use of indirect wor+er time
;onus
6ndirect cost
5age of su%%ort staff
6ndirect costs
Id!e tie
6ndirect costs
+ost of 8ork on ca%ita! eBui%ent
Added to cost of euipment
6%!o&ers Aationa! insurance contribution
6ndirect labor costs
4/ertie %reiu to direct or indirect
8orkers

6ndirect costs. &$ceptions are0
@vertime wor+ed at specific reuest of
customer to get his order completed,
direct costs
@vertime is wor+ed regularly by
production deptt in normal course of
operation, overtime premium paid to
direct wor+ers will be direct costs.

I$$UST3ATI4AS
P K Gonus paid under ?asley "lan with -.K of time saved eual bonus paid under ,owan
"lan. 4hen this statement will hold true9
A K ?asley "lan ; ,owan "lan

1))

:tandard wage rate P -.K time saved ; standard wage rate P time saved 1 time allowed P time ta+en
Assuming :tandard wage rate M time saved being common M cancelled each other in =.?.: M ,.?.:,
-.K ; time allowed 1 time ta+en
Time ta+en ; -.K time allowed
Thus time ta+en is eual to -.K of time allowed; bonus under ?asley "lan M ,owan plan is same.
P K Time allowed for job is 7 hours. ?ourly rate is ,s0 71C. :how bonus earn, total
earning M hourly earning under ?asley M ,owan "lan progressively.
A K
Time allowed ; 7 hours
Time ta+en will be ; 7, I, F, -, 5 , E , D , /
Time ta+en will never be greater than time allowed in normal situation.
:tudent should particularly note the language of uestion carefully.
"rogressively indicates that time ta+en will be from 7 to /.
?asley "lan ; :tandard wage rate P -.K time saved
,owan "lan ; standard wage rate P time saved 1 time allowed P time ta+en
4ages ; time ta+en P wage rate
?ourly earning ; earnings1time ta+en
Tie
A!!o8ed
Tie
Taken
Tie
Sa/ed
;ase
5ages
;onus 6arnings Hour!& 6arnings
Has!e& 3o8an Has!e& 3o8an Has!e& 3o8an
7 7 I F5 C C F5 F5 7 7
7 I / -F 5 I F. FE 7.-I 8
7 F D 57 7 /D -F F. 8.EE /.
7 - E 5. /D /- -D -- /..5. //
7 5 5 ED /F /F 57 57 /D /D
7 E - D5 D. /- 55 55 /5.FI /E
7 D F /F D5 /D 5. 5. D. /5
7 / I 7 D7 I EF EF EF /-

P K The management of B[N =td. is worried about the increasing labor turnover in the
factory and before analy<ing the causes and ta+ing remedial steps; they want to have an idea of
the profit foregone as a result of labor turnover during the last year.
=ast years sales amounted to ,s.7, E.E, E.. and the profit1volume ratio was D.K. The total
number of actual hours wor+ed by the direct labor force was 5.5- la+hs. As a result of the

1)(

delays by the "ersonnel department in filling vacancies due to labor turnover, /.., ...
potentially productive hours were lost. The actual direct labor hours included E., ... hours
attributable to training new recruits, out of which, half of the hours were unproductive.
The cost incurred conseuent on labor turnover revealed, on analysis the following.
:ettlement cost due to leaving0 ,s.5E, 7D.
,ecruitment costs0 ,s.DF, I5.
:election costs0 ,s./D, I-.
Training costs0 ,s.E., 58.
Assuming that the potential production lost as a conseuence of labor turnover could have
been sold at prevailing prices, find the profit foregone last year on account of labor turnover.
A K 4e will have to calculate the profit foregone by calculating the amount of contribution
lost and the additional cost that was incurred as a result of the labor turnover. This is done in
the following manner.
6. Actual productive hours0 Actual hours wor+ed 3 unproductive training hours
; 55-, ... 3 /-, ... TE.K of E., ...U ; 5, E., ... actual productive hours.
66. Total hours lost0 /..,... hrs
:ales lost T,s.7, E.E, E.. P /.., ...U15E., ... ; ,s./, 8E/, ...
=oss of contribution 3 D.K of ,s./8, E/, ... ; ,s.E7F, D..

Stateent Sho8ing .rofit Foregone
'ontribution lost 0 ,s.E, 7F, D.. TAs per 66 aboveU
:ettlement cost due to leaving 0 ,s. 5E, 7D.
,ecruitment cost 0 ,s. DF, I5.
:election cost 0 ,s. /D, I-.
Training cost 0 ,s. E., 58.
.rofit foregone 0 3s":, **,***


1)7

G6A63A$ H6A, 4FFI+6

FA+T43O
.urchase of 'ateria!:
>aterial 'ontrol
Aoucher1Account "ayable
(actory =edger
>aterial 'ontrol
General =edger
3eturn of 'ateria!:
>aterial 'ontrol
3eturn of 'ateria!:
(actory =edger
3eturn of 'ateria!:
General =edger
>aterial 'ontrol
'ateria! Issued:
>aterial 'ontrol
4or+CinC"rocess
(actory @verhead

)@ &)T,[ 46== G& ,&'@,2&2
AT ?&A2 @((6'&.
'ateria! Issued:
>aterial 'ontrol
4or+CinC"rocess
(actory @verhead
'ateria! 3eturned:
4or+CinC"rocess
(actory @verhead
>aterial 'ontrol

)@ &)T,[ 46== G& ,&'@,2&2
AT ?&A2 @((6'&.
'ateria! 3eturned:
4or+CinC"rocess
(actory @verhead
>aterial 'ontrol
Factor& 4/erhead:
(actory @verhead
"repaid &$penses
Allowance for 2ep
Aarious 'redits

)@ &)T,[ 46== G& ,&'@,2&2
AT ?&A2 @((6'&.

)@ &)T,[ 46== G& ,&'@,2&2 AT
(A'T@,[ @((6'&.
F4H .a&ent:
Aarious 'redits
Aoucher "ayable
)@ &)T,[ 46== G& ,&'@,2&2
AT ?&A2 @((6'&.
)@ &)T,[ 46== G& ,&'@,2&2 AT
(A'T@,[ @((6'&.
F4H ,is%osa!:
Aoucher "ayable
'ash
)@ &)T,[ 46== G& ,&'@,2&2
AT ?&A2 @((6'&.
)@ &)T,[ 46== G& ,&'@,2&2 AT
(A'T@,[ @((6'&.
F4H A%%!ied:
4or+CinC"rocess
(@? Applied
F4H A%%!ied:
(actory =edger
(@? Applied
F4H A%%!ied:
4or+CinC"rocess
General =edger
,is%osa! F4H A%%!ied:
(@? Applied
(@? 'ontrol
)@ &)T,[ 46== G& ,&'@,2&2
AT ?&A2 @((6'&.
)@ &)T,[ 46== G& ,&'@,2&2 AT
(A'T@,[ @((6'&.
.a&ro!!:
"ayroll
6ncome ta$ with held
"rovident fund
Accrued "ayroll

)@ &)T,[ 46== G& ,&'@,2&2
AT ?&A2 @((6'&.

)@ &)T,[ 46== G& ,&'@,2&2 AT
(A'T@,[ @((6'&.
.a&ro!! .a&ent:
Accrued "ayroll
Aoucher "ayable
)@ &)T,[ 46== G& ,&'@,2&2
AT ?&A2 @((6'&.
)@ &)T,[ 46== G& ,&'@,2&2 AT
(A'T@,[ @((6'&.

1):

.a&ro!! ,is%osa!:
Aoucher "ayable
'ash
)@ &)T,[ 46== G& ,&'@,2&2
AT ?&A2 @((6'&.
)@ &)T,[ 46== G& ,&'@,2&2 AT
(A'T@,[ @((6'&.
.a&ro!! ,istribution:
4or+CinC"rocess
(actory @verhead
:elling @verhead
2istribution @verhead
"ayroll
(actory =edger
:elling @verhead
"ayroll
#(actory ledger will be used
for 46" M (@?%
4or+CinC"rocess
(actory @verhead
General =edger
#General ledger will be used for :@?
M 2@?%
.a&ro!! +ontribution:
4or+CinC"rocess
(actory @verhead
:elling @verhead
"rovident fund
:ocial :ecurity (und
(actory =edger
:elling @verhead
"rovident fund
:ocial :ecurity (und
4or+CinC"rocess
(actory @verhead
General =edger
Finished Goods:
(inished Goods
4or+CinC"rocess

)@ &)T,[ 46== G& ,&'@,2&2
AT ?&A2 @((6'&.
Finished Goods:
(inished Goods
4or+CinC"rocess

+ost 4f Goods So!d:
'ost @f Goods :old
(inished Goods
+ost 4f Goods So!d:
'ost @f Goods :old
(actory =edger
+ost 4f Goods So!d:
General =edger
(inished Goods
+redit Sa!e:
Trade 2ebtor
:ale
)@ &)T,[ 46== G& ,&'@,2&2
AT ?&A2 @((6'&.
)@ &)T,[ 46== G& ,&'@,2&2 AT
(A'T@,[ @((6'&.
Aote: 4e will always use General =edger for ?ead @ffice M (actory =edger for (actory while
recording journal entries.
IAT6G3AT6, A++4UATIAG SOST6'
6n the integrated accounting system, separate set of accounts under cost accounting and
financial accounting systems are not maintained. The accounts are integrated and only a single
set of accounts are maintained. This enables a firm to eliminate separate "rofit and =oss
Accounts under financial accounting and cost accounting systems and only one "rofit and =oss
Account is prepared. Thus there is no uestion of two separate amounts of profits being
disclosed from the two different set of boo+s. The need for reconciliation of profits shown by
cost accounts and financial accounts is therefore is eliminated.


1)=

A4A 2 IAT6G3AT6, A++4UATIAG SOST6'
Under the nonCintegrated system, separate ledgers are maintained for financial transactions
while the cost accounts department is responsible for maintaining cost accounts.

A++4UATIAG 6AT3I6S ( 'ethod R )#
The journal entries under integral and nonCintegral accounting systems are given in the
following table.


1)>

36+4A+I$IATI4A 4F +4ST AA, FIAAA+IA$ A++4UATS
3easons for ,ifference in .rofit
The profit shown by financial accounts and cost accounts differ on account of the following
reasons.
6U It!ms o# Fi"a"cial Natur! "ot r!cord!d i" Cost Accou"ts( The following items are not
recorded in cost accounts as they are of purely financial nature and conseuently the profits
differ as these items are recorded in the financial accounts.

1)?

6nterest received on ban+ deposits.
2ividend, interest received on investments.
,ent received
=osses on sale of assets
Gad debts written off, recovered
Transfer fees received
6nterest on proprietorSs capital
(ines and penalties payable
'ompensation payable.
66U It!ms C*ar6!d to %ro#it a"d Loss Accou"t $ut "ot R!cord!d i" Cost Accou"ts( The following
items are found in the cost accounts but not recorded in the financial accounts.
'orporate ta$es
Appropriations out of profits, such as transfer of profits to reserves
'ertain payments li+e dividend
Additional provisions of depreciation
'ertain amounts written off such as goodwill, patents, preliminary
e$penses, underwriting commission etc.
666U It!ms %!culiar i" Cost Accou"ts( The items described below are peculiar in cost accounts
while their treatment in financial accounts is different. ?ence there is a difference between the
profits shown by both the systems

O0!r*!ads( 6n cost accounts, overheads are finally absorbed in the products by computing the
predetermined rate of absorption. 6n such cases, there may be under1over absorption of
overheads.
This means that the overheads actually incurred will not tally with the overheads charged to the
product. 6n financial accounts overheads are always ta+en at actual basis irrespective of
under1over absorption of the same. 6n such cases the profits shown by both the systems will
differ. ?owever, if the under1over absorbed overheads are charged to the costing profit and
loss account, the profits shown by financial accounts and cost accounts will not differ.
8aluatio" o# Closi"6 toc2 a"d &or29i"9%ro6r!ss( The principle of valuation of closing stoc+
in financial statements is cost price or mar+et price whichever is less. ?owever, in cost
accounts, valuation of closing stoc+ may be made on the basis of marginal costing where only
the variable costs are ta+en into consideration while valuing the closing stoc+. Thus the closing
stoc+ valuation may differ. 4or+CinC"rogress in cost accounts is often valued on the basis of
prime cost and sometimes variable manufacturing overheads are added in the same. @n the
other hand, in financial accounting, wor+CinCprogress may be valued after ta+ing into
consideration administrative e$penses also. 2ue to this difference in valuation, profits shown
by cost accounts and financial accounts differ.
A$"ormal Loss!s a"d Gai"s( 6n cost accounts, abnormal losses and gains are computed and
transferred to the 'osting "rofit and =oss A1c. )o such computation is made in the financial
accounts. This results in difference between the profits shown by cost accounts and financial
accounts.


1)@

'ethodo!og& for .re%aring 3econci!iation Stateent
The following steps are to be ta+en for preparing this statement.
The starting point may be either profit shown by cost accounts or financial accounts.
6f the profit as ta+en in the beginning is reduced due to the various causes given, these items
should be added in the profits.
6f the profit as ta+en in the beginning is increased due to the various causes given, these items
should be deducted from the profits.
After completion of these additions and deductions, we will arrive at the profit as shown by the
other system, i.e. if a profit as per cost accounts is ta+en in the beginning, we will arrive at the
profit as shown by financial accounts and vice versa.


1(*

C4; +4ST SH66T F43'AT
C4; 43,63 +4ST SH66T
Hob d
'ustomer )ame 2ate :tarted 0 BBB
2escription 2ate @rdered 0 BBB
Luantity 2ate 4anted 0 BBB
2ate 'ompleted 0 BBB
,I36+T 'AT63IA$
2ate 2epartment 2escription Unit 'ost Total
BB BB BB BB BB
BB BB BB BB BB
T@TA= BBB
,I36+T $A;43
2ate 2epartment 2escription ?our ,ate Total
BB BB BB BB BB
BB BB BB BB BB
T@TA= BBB
A..$I6, FA+T43O 4163H6A,
2ate 2epartment Gasis ?our ,ate Total
BB BB BB BB BB
BB BB BB BB BB
T@TA= BBB
:U>>A,[
26,&'T >AT&,6A= 0 BBB :elling "rice 0 BBB
26,&'T =AG@, 0 BBB =ess 3 (actory 'ost BBB
A""=6&2 (A'T@,[ @A&,?&A2 0 BBB Admin &$p BBB 0 #BBB%
T@TA= 0 BBB "rofit BBB

,ate Started 46"
,ate Finished (G
,ate So!d '@G:


1(1

;I, .3I+6 < 'IAI'U' SA$6 .3I+6
2irect >aterial BBB
2irect =abor BBB
(actory @verhead BBB
Admin &$p BBB
:elling &$p BBB
@ther &$p BBB
Total 'ost BBB
Allowance for contingency BBB
;id .rice< 'iniu Sa!e .rice LLL

4163TI'6 +AS6S

;ASI+ Hob 'ost Hob 'ost Hob 'ost
4163TI'6
.36'IU'
(@? (@? @ther Hob 'ost

36+TIFI+ATI4A 543N
Aora! Acti/it& 'harge to (@?
Aot Aora! Acti/it& 'harge to H@G

+AS6 R *1
A43'A$ 4163TI'6
+AS6 R *)
4163TI'6 ,4A6 AT +$I6AT
S.6+IA$ 36PU6ST F43 6A3$O
C4; +4'.$6TI4A
+AS6 R *(
4163TI'6 ,4A6 AT +$I6AT
S.6+IA$ 36PU6ST F43
6A3$O +4'.$6TI4A 4F
AA4TH63 C4;

1()

P R 1 Zs%ring H )*11[
A
:ales #/7....P/DP//.% DIEF..
=essC >aterial 3 A #D.D-...P5-% 8//D-
>aterial 3 G #FI-...PE.% D.D-.
=abor #/7...1D.. ; 8.P/7....P/DPD.1F.% F57..
A1(@? #/7....P/D17.K P /-% 5.-..
(1(@? /....
'ost of Goods :old #DDFFI-%
Gross .rofit 7=@):
5orkings:
>aterial0 /7....P/D17.K ; DI..... #>aterial 3 A0 D.D-... O >aterial 3G0 FI-...%
;
:ales #/7....P/DP//.% DIEF..
=essC
>aterial 3 A #/7.....P57% 7F5..
>aterial 3 G #F.....PE.% /7...
=abor #:ee 4or+ing% -5/.7
A1(@? #/7....P/D18.K P /- 3 D.K% D77..
2epreciation #I.- >illion1-% /-..
(1(@? #/.... C/-K% 7-..
'ost of Goods :old #/8IE.7%
Gross .rofit 7*)@)
5orkings:
>aterial0 /7....P/D18.K ; D5..... #>aterial 3 A0 /7..... O >aterial 3G0 F.....%
=abor0 #/7...1D.. ; 8.P/7....P/DP/51F.% ; 5-EF.
#ID....C-.5... ; D/F...P8.P5-K% ; 7I57
:71*?


1((

P R : Zs%ring H )*11[
.A3T 2 A
Sa!es Puantit& K (i$ed 'ost O Target "rofit ; F/...OF-FF. 1D.7 ; F.7.85D units
'1> "er Unit
Target profit0 "rofit of L0 / ; FD-5.
:hortfall of L0 D ; E/D. #FD-5.C-85D.%
=:==*
'1> "er Unit ,evise :ale "rice #7F.C/-% ; 75-
A' ; #FEI%
'1> ; )*?
Aote K 5F55..1-5.... ; 7F.
F4H Se!!ing
-7.... 75FF. DF-..
-5.... 7.-7. D--..
7**** 7*?* 1***
1+ ( .er Unit# 1*) ):
F+ )::** 1)***

A' "er Unit0 >aterial #/7E.F1-5.% ; E5.
=abor #8/.71-5.% ; /I.
(@? ; /.D
:elling ; D-
=(>
Total (' (@? ; D--..
:elling ; /D...
Admin ; DE-..
=1***


1(7

.A3T 2 ;
'iniu Sa!es .rice K
Total Aariable 'ost #F-. P FEI% ; 5/5.-.
Total (i$ed 'ost #F/... O D-..% ; FE-..
Target "rofit ; F-F..
Total :ale Aalue ,euired ; -5ED/.
Sa!e .rice 8i!! be ; -5ED/.1F-.... ; 7E-.I.
P R 7 Zs%ring H )*11[
'ateria!: /-.... units reuire D-... +g P E of >at0 ' ; I-... +g.
>ar+et 2emand ; I-... +g of >at0 '
'apacity0 /..... +g.
"urchase0 -.... #I-...CD-...% from outside.
)ormal =oss0 5K
"roduction0 D-...C/... #D-...P5K% ; D5... +g
'ompany will buy -/... +g of >at0 ' by outside. )ormal =oss is also
there. :o, company will buy -/...1..8F ; -E/D- +g of >at0 ' by outside.
A' #D-...PD..% ; :******
:et up 'ost ; ?****
"urchase cost ; -E/D- P DD- ; 11@:(1):
Tota! K :******F?****F11@:(1): K 1>*((1):
1+: D-.PDE.FD- ; :>=:=):
$abor: =abor rate per hr ; 8...1D.. ; 5-
=abor reuired for this job ; /-....1/..P/-. ; DD-... hrs
)ormal =oss is there. :o more labor hr will be needed.
; $C ...5 ; DD-... Y $ ; DD-...1...5 ; DE5EI-

1(:

DE5EI-CDD-... ; 8EI- is )ormal loss for total production but e inspect
F.K of process, the )ormal =oss will be ; 8EI- P F.K ; -FD- hr.
Total hr ; DD-... O -FD- ; DE.FD-
6dle hr ; D....
=abor hr reuired ; DE.FD- 3 D.... ; D/.FD-
6t will be0 D/.FD- P 5- ; 85I7/D-
D....P5-PF.K ; -5....
1**1?1):
FIL6, F4H: @nly incremental (@? will be charged. 'ompany is running at 7.K
capacity. :pecific order reuires E.K additional capacity. :o 7.K O
E.K ; //.K capacity is needed.
&nhance capacity ; //.K C /..K ; /.K
DD...... for /..K
DD......1/..K ; DD.... for /.K capacity
DD....P/. #for /.K capacity% P /.- ; ((*****
Tota! cost 8i!! be:
>aterial ; /I.EE/D-
=abor ; /../7/D-
A1(@? ; -IF-FD-
(1(@? ; EE.....
(=11=?>:
"rofit is D.K of :ale price
; B 3 ..D$ ; EF//F7I- T..7$ ; EF//F7I- TB ; EF//F7I-1..7 ; 5-/5F.8E.I-
Sa!e .rice K 5-/5F.8E.I- 1 /-.... ; (**"@>


1(=

P R ? ZS%ring H )**1[
Sa!e: :ale #88% ; F-..
:ale #D...% ; F... #ID..1/D.K%
2ecrease in ty ; -..
,atio of fall in ty ; -..1F-.. ; /1/E
'ateria!: 2ecrease in ty is /1/E
th
; A' should decrease to /D1/E
th
.
'ost of #D...% ; EF.. #E8..P/D1/E%
Actual 'ost #D...% ; E5..
,eduction in >' ; D..
Sa!e .rice: :ale #ID..1/D.K% ; F...
Actual 'ost ; ID..
'hange ; /D..
Sa!e 1o!ue: '> #DF..P/1/E% ; D..
@r
(all in sale #F-..P/1E% ; -..
(all in A' #E8..P/1/E% ; E..
(all in '> ; D..
Fi0ed +ost: 6ncrease in (' ; D..
6ffect:
(all in >' ; D..
6ncrease in :" ; /D..
2ecrease in :" ; /...
6ncrease in (' ; D..
)et "rofit ; 1)**


1(>

I!!ustration of abo/e:
Oear: 1
Actual Lty ; /.... unit
'onsumption of 2> ; E +g
2> consume ; E.... +g #/....PE%
A, ; 5
A' ; ,s0 /D.... #/....PEP5%
Oear: )
Actual Lty ; /.K increase #/....O/.K ; //...%
'onsumption of 2> per unit ; -K increase #EO-K ; E./-%
A, ; /-K increase #5O/-K ; 5.F%
A' ; ,s0 /-88E. #//...PE./-P5.F%
1)****21:@@(* K (@(@* (A#
+heck:
"rice 0 D.I8. #A% #/-8E8. P /-1//-% @, E5F-. #5.FC5%
A@= 0 /D... #A% #/D.... P /.K%
Lty 0 FF.. #A% #Galancing figure% @, 5 #E5F-.CEE...% ;FF..#A%
"rice O Aol O Lty ; D.I8. #A% O /D... #A% O FF.. #A% ; E8E8. #A%
&fficiency Aar 0 :, #AL 3 :LA% ; 5#E5F-.CEE...% ; FF..#A%
_: _: _: _: , ,, , Gase year _ 'onsumption _: :tandard per +g _
,
~
'


1(?

P R = ZAutun H )**7[
5ithout ,iscount 5ith ,iscount
>aterial #5DPEI% /--5
#5DPEF.8% /-58.7
2irect =abor 7-. 7-.
2irect >aterial E.. E..
Tota! 1ariab!e +ost )>*7 )=@@"?
:ale "rice D7FD D7FD
+<' 1:? 1=)")
Annual (' F..IED. FE.IED.
;6 Unit (F+ < +' %er unit# (?*)1 (???=

P R = ZS%ring H )**:[
'ain .oint K Ao 1+ is gi/en, then a!! Sa!e .rice 8i!! be assued to be +<'"
3eB R *1
5--.15... 5--.1-...
;6. //E7 8/.
3eB R *)
3e/ise F+ E--. E--.
+<' E... EI-.
;6. //E7 85I

3eB R *(
Aote: &liminate the difference will be indifferent.
Sa/ing in F+ /...1/... #5...PD-K% /...1/D-. #-...PD-K%
Ao of Tickets (for indifferent
%oint#
/... 7..

3eB R *7
/. 2emand 1 good will in mar+et
D. Availability of alternatives
E. )ature of concert
5. Taste of audience
-. Area
F. &$pectation of sale of tic+et


1(@

P R > ZAutun H )**:[
:ale "rice ; /... per unit
@ther A' ; F.. per unit
'ommission M discount ; -K of :ales
)ote for students0
@ther variable cost per unit will remain constant in case for fall in sale price. 4here
commission M discount per unit will also fall if there is fall in sale price.
P R > ZS%ring H )**=[
'omputation of sale price0
2irect >aterial ; /8EF..
2irect =abor ; 8....
@ver ?ead ; 7....
Admin ; E....
Total 'ost #7DK of sales% ; E8EF..
Add 3 'ommission #7K of sales% 0 #E8EF..P7K% ; E75..
)et "rofit #/.K of sales%
P R ) ZAo/ H 1@@=[
There is nothing in the uestion. :tudent will get confused due to >ar+s0 /5 given in the
uestionM wrote lot of irrelevant material M lost precious mar+s M time.
P R ? ZAutun H )***[
)et profit 0 5/D-..
(' ; /DI-..
'ontribution ; -5....
'1> per unit #/-CF% ; 8
:ales #-5....18% ; F....


17*

P R : ZS%ring H )**7[
6t is assume that minimum order ty is purchase order. =imiting factor is availability of funds.
A/ai!ab!e funds:
4or+ing 'apital ; 7.....
,unning (inance ; -....
=ess 3 Admin ; /-DI..
>ar+eting ; ID75D
(inance 'ost #-.....PD5KPF1/D% ; F....
Total ; )?::7)
Total Grand ; /./55-7
Sa!e E/7 5D/ D7.
1+ D57 E5- D.5
+<' I. IF IF
+<' J ( +<' <1+I1**# D7K DDK EIK
3anking ) ( 1
P R > ZS%ring H )**>[
,ress Scraf Handbag
F.K completed //I.. //I.. //I..
/.K dress M scraf /8-. /8-. C
D.K dress M handbag E8.. C E8..
/.K dress only /8-. C C
Tota! Units #/-... P E.K ; /8-..% 1@:** 1(=:* 1:=**
&$isting Units /-... C C
Increenta! Units 7:** 1(=:* 1:=**

6ncremental :ales Aalue

2ress #5-..PD...% 8......
:craf #/EF-.P5..% -5F....
?andbag #/-F..P-..% I7.....
Total :ales DDDF....
6ncremental 'osts

>aterial # 5-..PE.-P/..% /-I-...
'ost of designer /-....
?oo+s # /-F..P7% /D57..

171

,eduction in ,esale value0
&$isting # /-...PD.% E.....
,evised #/8-..P-% #8I-..% D.D-..
'utting 'osts0
2ress # 5-..PE-% /-I-..
:craf # /EF-.PI-% D.5I-.
?andbag #/-F..PD.% E/D... FI5D-.
@ther0
2ress #5-..PD... P 5.K% EF.....
:craf #/EF-.P5..P--K% E..E...
?andbag #/-F..P-..PF.K% 5F7.... //D7E...
Total 'osts #/5..8--.%
6ncremental "rofit

7D-.5-.
P R > ZAutun H )**([
3eB R *1
Sei Auto
Guy 'ost D... D...
Aariable >anufacturing 'ost /-.. /D..
:avings -.. D..
(' -...... /.......
Puantit& to -ustif& (F+ <
Sa/ings#
1**** 1):**

3eB R *)
Sei Auto
Annual ,euirement /-... /-...
:avings -.. 7..
Total :avings I-..... /D......
(' -...... /.......
Aet Sa/ing ):***** )******

3eB R *(
2ifference in A' savings ; E.. per unit
2ifference in (' ; -......
Luantity to justify allocation ; /FFFI #-......1E..%


17)

P R ( ZAutun H )**>[
(inished Goods ; D....18IK ; D.F/8
,aw >aterial ; D.F/8187K ; D/.5.
2irect >aterial ; D/.5. P 5D.E ; 77888D
Assume ; / +g euals / unit.
P R ( ZS%ring H 1@@?[
2uty drawbac+ is an income in case of e$port. 6t is paid on import time M will be refunded later.
P R ? ZS%ring H )**:[
'1> "er unit ; 5-.....1E..... O E. ; 5-
6ffect on %rofit:
a% :titching elimination
=oss of '1> #E.....P/.K ; E....P5-% ; #/E-....%
,eduction of A' #E.....C/.K ; DI....PF% ; /FD...
)et Genefit ; )>****
b% Use of plastic eye
'ost of glass eye #E.....C/.K ; DI....PD18-KP51/..% ; DDIEF7
'ost of plastic eye #E.....C/.K ; DI....PD18.KPE1/..% ; #/7....%
)et Genefit ; 7>(=?
c% (illing material
'ost of synthetic #E.....C/.K ; DI....1D...P/F..% ; D/F...
)et loss of using scrap #E.....C/.K ; DI.... P/% ; DI....
)et Genefit ; (:7***#
A6T 6FF6+T ; )=((=?
P R 7 ZAutun H )*1*[
Aote: This Buestion is a co%& of sae Buestion fro 1** Ps & As b& +hart Fou!k
$&nch


17(

Unit %roduce:
:ale D/...
'losing :toc+ #D/...P/.K% D/..
DE/..
@pening :toc+ #/8...P-K% #8-.%
Unit 'ade ))1:*

Tota! & .er Unit Fi0ed F4H K
Annual (i$ed (@? on E.C.FC// #F......P/..7% ; F57.
Train 'ost ; E..
Total ; FI7.
"er Unit #D.//% ; FI7.1DD/-. ; E.F..8
"er Unit #D./.% ; F...1/7... ; EEE.EE
1+ %er unit on (*2*=211 K
>aterial #- +g P 8-K ; 5.I-PF.P5K% FD.5
>aterial 6nspect #5.I-PD% 8.-.
=abor #5P7-K;E.5PI-P/./% D7..-.
=abor 6ncentive #5P/-K ;..FP7D.-#I-O/.K%PE.K% /5.7-
A1(@? #/-P/..-PE% 5I.D-
Aariable :elling #/. m P E.K 1/8...% /-I.78
Total ?*="(@
1+ %er unit on (*2*=21* for 4%ening Stock K
>aterial #-PF.% E..
=abor #5PI-% E..
A1(@? #/-PE% 5-
Total =7:
.rofit:
>' ; #IF/.7F-% A' ; #ID75I5.%


177

ATT6'.T K ZAUTU'A H )*11[
P R (:
/. "roduction cost budget ; 2> O 2= OA1(@? O (1(@?
D. 2irect =abor will be calculated as follows0
I-...15 ; /7I-. O /.K ; D.FD-1..8F P E ; F55-E.
P R 7:
&", will be calculated as follows ; 46" K P 'ompletion K
-.K P 5.K D.K
D.K P E.K FK
E.K P D5.-K I.E-K
(("(:J

P R =:
/. 4hen variable cost will not be given, then all variable cost is cost of good sold.
D. Average stoc+ level ; >in O >a$ 1 D
ATT6'.T K ZAUTU'A H )*1*[
P R 1:
/. 2irect labor hr will be used to allocate (@?.
D. 'ost per unit ; (@? cost 1 unit produced
P R (: Total input 3 net input 3 loss T /.7C/.FC...8 ; ..//
P R ::
/. 6gnore cost of monthly payroll
D. 6gnore fi$ed (@?.
E. 2irect labor cost is not possible to calculate here.


17:

ATT6'.T K ZS.3IAG H )*1*[
P R 1:
'losing stoc+ ;
i. 4eighted avg 3 @pening stoc+ O purchases
ii. (6(@ ; "urchases
(ormula ; 'ost of purchase P closing stoc+
"urchases
P R ): Average 6nventory ; &@L 1D O :afety :toc+
F-..1DOD... ; -D-.
'arrying 'ost ; Average inventory P /II.. ; 8D8D-... P /K ; 8D8D-..
@rdering cost ; 5DD5...P/.K ; 5DD5..
P R (:
'ateria! +4L is introduced at the start of the %rocess in de%artent A and subseBuent!&
transferred to de%artent ;" Aora! !oss in de%artent A is :J of the units transferred"
Total Transfer O 46" O )ormal =oss
FF5-.. Transfer O D5... O )ormal =oss
FF5-.. 3 D5... Transfer O )ormal =oss
F5.-.. Transfer O )ormal =oss
/.-K /.. K O -K
Transfer to ne$t deptt F5.-.. P /..1/.- ; F/....
)ormal =oss of deptt 3 A F5.-.. P -1/.- ; E.-..
1*J of the units %rocessed are e/a%orated before the ins%ection stage"
This means this is )ormal =oss M is calculated as follows0
Unit received by last deptt P /.K ; F/.... P /.K ; F/...
,uring the &ear, actua! e/a%oration in de%artent ; 8as 1*J higher than the estiated
nora! !osses because of high !e/e! of Su!%her contents in natura! gas used for %rocessing"
Actual =oss ; //.
)ormal =oss ; /..
Abnora! $oss ; /.
Abnormal =oss Amount ; F/...P/.1/.. ; F/..
P R 7:

17=

/. :tandard ty O 'losing (G 3 @pening (G ; "urchases
D. "urchases are calculated as follows0
:tandard Lty #unit made P per hr% BBB
Add 3 Adverse >aterial Usage Aariance #Aariance 1E.% BBB
=ess 3 (avorable >aterial Usage Aariance #Aariance 1E.% BBB
Add 3 'losing (G #:tandard Lty P days given 1EF-% BBB
=ess 3 @pening (G #:tandard Lty P days given 1EF-% BBB

ATT6'.T K ZAUTU'A H )**@[
P R ):
/. Always record actual (@? in (@? distribution sheet.
D. Actual (@? will be found at (@? distribution sheet.
P R (:
/. Total contribution K ; Total contribution 1 total sales P /..
D. G&" ; (' 1 Total contribution K
P R 7:
/. "urchase 'ost ; 2emand P unit price
D. Transport 'ost ; Luantity 1 'apacity P )o of order ; BBB P one trip cost given
E. ?ired 'ost ; ?ighest &@L P third party rate #add in second unit%


17>

,6+ISI4A 'ANIAG
6LA' 3U;3I+: "urchase new euipment which would cost ,s. D5. million and have a useful
life of si$ years with no salvage value. The company uses straightCline method of depreciation.
A++4UATIAG T36AT'6AT: A notion that depreciation on new machine being a fi$ed cost will
be ignored is partially correct. Gut at the same time it is relevant cost as it could, be avoided if
the other euipment were purchased from e$ternal supplier.
6LA' 3U;3I+: (i$ed overhead0 1# 2epreciation ; F. )# General overheads ; E.
A++4UATIAG T36AT'6AT: 6gnore fi$ed overhead of all types unless a direction is given in the
uestion. Another option was to include these but in that case one should give a note
e$plaining their assumption.
6LA' 3U;3I+: :+illed labour can wor+ on other contracts which are presently operated by
semis+illed labour who have been hired on temporary basis at a cost of ,s. ED-,... per month.
The company will need to give them a notice of E. days before terminating their services.
A++4UATIAG T36AT'6AT: :+illed labour reuired for this contract could have been used to
replace the semiCs+illed wor+ers who were wor+ing on other contracts and had been hired on
temporary basis. The amount payable to such semiCs+illed wor+ers was ,s. E.8 million
#ED-,...$/D%. 'onseuently, many students too+ ,s. E.8 million as the opportunity cost. 6n
doing so, they ignored the information that even if the semiCs+illed labour were laid off, E. days
salary would have to be paid to them and conseuently the company will only be saving ,s.
E,-I-,.... @n the other hand, many students erroneously too+ the opportunity cost as ,s.
5,DD-,... i.e. eual to /E months salaries of the uns+illed labour.
6LA' 3U;3I+:
/. 2> rate0 5D.E
D. Unit0 D....
E. ,eject rate0 DK

A++4UATIAG T36AT'6AT:
/. 2> cost will be calculated as follows ; D....P5D.EP/..187
D. (G rejection rate will be calculated as follows ; 'ost 1/..CK P K
6LA' 3U;3I+: "urchase cost plus additional charges
A++4UATIAG T36AT'6AT: 'ost P /..1/..OK

17?

6LA' 3U;3I+: 4hich component to be purchased from supplier
A++4UATIAG T36AT'6AT: =owest cost will be ran+ed higher than highest cost.
6LA' 3U;3I+:
SA$6S L O E
,efined F -.-. I
Unrefined D.-. D.I- 5
A++4UATIAG T36AT'6AT: 4hen two revenue figures are given in the uestion, we will
incremental revenue.
SA$6S L O E
,efined F -.-. I
Unrefined D.-. D.I- 5
Increenta! 3e/enue (": )">: (

;36AN 616A .4IAT
A4T6:
/. 4henever sales increases. All variable cost will increase unless specified.
D. )o Aariable cost, all sales price will be contribution margin.

6LA' 3U;3I+: 'ompute the brea+Ceven point in units if the company offers a discount of /.K
on purchase of D. bottles or more, assuming that D.K of the sales will be to buyers who will
avail the discount.
A++4UATIAG T36AT'6AT: 'orrect discount calculation will be0
/.K discount on D.K of ,s0 /F T /FPD.K ; E.D P/.K ; ..ED paisa per bottle.
6LA' 3U;3I+:
)**= )**>
.roduction /I-... DD-...
Tota! +osts //8..... /F-/7F..

,ate of inflation in D..I0 /-K
,euired0 Aariable cost M fi$ed costs in real terms.
A++4UATIAG T36AT'6AT: ,eal ,ate for current year ; current year cost 1/O inflation rate
; /F-/7F..1/./- ; /5EF5....
.roduction Tota! +osts
)**> DD-... /5EF5...
)**= /I-... //8.....
,ifference :**** )7=7***

17@

Aariable cost per unit ; D5F5...1-.... ; 58.D7
(i$ed cost ; /5EF5... 3 #DD-...P58.D7% ; /5EF5... 3 //.77... ; EDIF...
6LA' 3U;3I+: 4hen per unit cost of sales M variable cost is not given in brea+even mi$ case.
G&" ; (6B&2 '@:T:
'1> P individual ratio
6LA' 3U;3I+: 4hat price per unit to be uoted for the ne$t year if it is desired to earn /.K
profit on sales assuming that the variable cost will increase by /.K, fi$ed cost by /.K M
production by /.K.
Aariable cost ; 55.. T Unit ; //.. T ('; /-8-...
4hen sales increase, variable e$pense increases by same ratio.
:ale ; variable cost O fi$ed cost O profit
)o of unit P sale price per unit ; )o of unit P variable cost per unit O fi$ed cost O )o of
unit P sale price per unit P /.K
//..P: ; //..P55.. O /-8-...O #//..P:% P /.K
//.. : ; 575.... O /-8-... O //.:
//.. : 3 //. : ; F5E-...
: ; F5E-... 1 88.
: ; F-.. units
6AT3I6S
6LA' 3U;3I+: The valuation is carried out by the (inance 2epartment using stores
memorandum record.
A++4UATIAG T36AT'6AT: 6t e$hibits that only uantity is recorded in the stores ledger.
$A;43
6LA' 3U;3I+: bonus hours
A++4UATIAG T36AT'6AT: bonus hours will be compared with direct hours wor+ed.


1:*

6LA' 3U;3I+: 2irect wages per unit, when overtime is wor+ed0
#i% 2ue to labor shortage.
#ii% :pecifically at the customerSs reuest, to e$pedite delivery.
#i% 2ue to labor shortage.
4hen overtime was wor+ed due to labor shortage, the overtime premium should have been
e$cluded from direct wages per unit.
#ii% :pecifically at the customerSs reuest, to e$pedite delivery.
4hen overtime was wor+ed on specific reuest of the customer to e$pedite delivery, the
overtime premium should have been included in direct wages per unit.
6LA' 3U;3I+:
)umber of employees ; /7.
:tandard wor+ing hours #8 hours1day% ; -5
:tandard hours per unit #at /..K efficiency% ; E
:tandard labour rate per hour #,upees% ; E.
An analysis of the employeeSs performance report has revealed that the company is suffering
on account of the following0
/. A tendency to waste time as a result of which appro$imately 8 wor+ing hours are lost
per wee+ per employee.
D. A tendency to wor+ inefficiently, as a result of which the production efficiency is only
I5K.
6n order to meet the increased demand, the management is considering an increase in wages
by ,s. - per hour. The increase is li+ely to motivate the employees and reduce the wastage of
time by - hours and will also improve the production efficiency to 77K. 'alculate labor cost per
unit.
/. At current wages ; E.PEP-515- ; /5-.8D
D. After increase in wages ; E-PEP-5158 ; /E/.58
-515- M -5158 represent the ratio between total hours per wee+ M the actual hours that were
wor+ed.
6LA' 3U;3I+: >ost of the wor+ers have raised objection on the companySs bonus plan. They
are of the view that bonus calculation should be based on daily production instead of wee+ly
production.

1:1

The amount of bonus wor+ed out on daily basis was different from the amount wor+ed out on
wee+ly basis because in the latter case higher production on a particular day will be offset by
lower production on other days.
F4H
6LA' 3U;3I+: 6t is budgeted that the machine will wor+ for D,F.. hours in D..7. The
budgeted hours include0
e 7. hours for setting up the machine; and
e /D. hours for maintenance.
Total hour 3 idle hour T DF.. 3 D.. #/D.O7. ; D..% ; D5..
A+<'+
6LA' 3U;3I+: The cost of opening finished goods inventory determined under the absorption
costing method system was ,s. 5-.,....(i$ed overhead constituted /FK of the total cost last
year.

A++4UATIAG T36AT'6AT: @pening stoc+ value ; ,s0 5-.... C/FK fi$ed overhead cost.
6LA' 3U;3I+: (i$ed overhead cost for the year ,s. /,...,...
Annual budgeted capacity of the plant units 5.,...
A++4UATIAG T36AT'6AT: (i$ed overhead rate will be calculated on annual budgeted capacity
of the plant. 6f budgeted capacity is not given, then use normal capacity.
'AT63IA$
6LA' 3U;3I+: Godown rent of ,s. /.,... per month
A++4UATIAG T36AT'6AT: This will not be included in carrying cost calculation.
6LA' 3U;3I+: 4hat would be the safety stoc+ and reCorder point if the company is willing to
ta+e0
/. a D.K ris+ of being out of stoc+9
D. a /.K ris+ of being out of stoc+9
A++4UATIAG T36AT'6AT: 6f the company is ready to ta+e D.K ris+ of being out of stoc+
meant that it needed to +eep sufficient safety stoc+ to ensure that it would only be out of stoc+

1:)

if the lead time reached /E days or in other words it would need to reorder when /D days stoc+
was left. i.e. the reC order point should be /D days.
The average usage per day was 5-. units #/FD...1EF.%
:ince the usual lead time was // days, safety stoc+ should be eual to /DC//;/ daySs stoc+ i.e.
5-. units M reCordering point was 5-.P/D ; -5.. units
6LA' 3U;3I+:

4rdered Puantit& Unit %rice 3s"
Upto 888 units /F....
/... to /888 units /-7.5.
D... or more units /-F.7.

/. Ta+e lower class boundaries i.e 888, /... M D... as annual demand for calculating &@L.
D. Luantity discount will be calculated as follows0
i. "urchase 'ost ; unit made P cost per unit P #/..K C K given%
ii. @rdering 'ost ; Annual demand P ordering cost 1 &@L
iii. 'arrying 'ost ; &@L P 'arrying 'ost1D P #/..K C K given%
6LA' 3U;3I+: 4hen ne$t order be placed9

/ C (reuency ; EF-1 )o of order
D 3 2ays :upply left ; Unit in inventory 1&@L P (reuency
E 3 :upply left 3 lead time
6LA' 3U;3I+: ?olding cost per year

A++4UATIAG T36AT'6AT: #&@L 1D P safety stoc+% P 'arrying cost
6LA' 3U;3I+: AG' '?A,T


1:(

'ateria! +ode Oear!& Usage Unit +ost Tota! +ost
TB./ /.... ..-. -...
TB.D I/.. ..F- 5F/-
TB.E D... D.-. -...
TB.5 -D-. D... /.-..
TB.- F... /.I- /.-..
TB.F DI-. ..7. DD..
TB.I /-.. /... /-..
TB.7 --.. /.7- /./I-

/. "er unit will decide which unity falls in A, G M '
D. Unit M total cost will be used for calculating A, G M '
E. Unit1usage P per unit ; total cost
'ateria! +ode Oear!& Usage Unit +ost Tota! +ost
TB.E D... D.-. -...
TB.5 -D-. D... /.-..
A >):* (1?"*?J# 1::** ((1"(1J#
TB.- F... /.I- /.-..
TB.I /-.. /... /-..
TB.7 --.. /.7- /./I-
; )*):* (:*"7@J# (>=>: (>="1)J#
TB.F DI-. ..7. DD..
TB./ /.... ..-. -...
TB.D I/.. ..F- 5F/-
+ 7*1** (1**J# 7@7@* (1**J#


1:7

ZPuestion R 1[
A company is considering the closure of its internal printing department. The department prints all of
the companySs publicity material and it also carries out other printing jobs as reuired. An e$ternal firm
has offered to produce all of the companySs printing reuirements for a total cost of ,s0 8,... per
month. The internal printing departmentSs costs are as follows0
#a% A total of 7.,... sheets of customi<ed paper are used each month, at a cost of ,s0 -. per /,...
sheets. The contract for supply of the paper reuires three monthsS notice
of cancellation. The company does not hold stoc+s of the paper but any e$cess can be
sold for a net price of ,s0 D. per /,... sheets.
#b% A total of 5.. litres of fluorescent in+ are used each month, at a cost of ,s0 /.7. per litre. The
contract for supply of this in+ reuires / monthSs notice of cancellation. )o stoc+s of in+ are held but any
e$cess can be sold for ,s0 ..-. net per litre.
#c% @ther paper and materials costs amount to ,s0 D,7-. per month.
#d% The printing machinery is rented for ,s0 5,-.. per month. 6t is operated for /D. hours each month.
The rental contract can be cancelled with D monthsS notice.
#e% The two employees in the department are each paid ,s0 /,... per month. The company has a noC
redundancy policy which means that the employees are guaranteed employment even if the
department closes.
#f% @verhead cost for the printing department is as follows0
#i% Aariable overhead0 ,s0 5 per machine hour.
#ii% (i$ed overhead0 ,s0 E per machine hour.
Aariable overhead varies in direct proportion to the machine hours operated. (i$ed overhead represents
an apportionment of central overheads which would not alter as a result of the printing departmentSs
closure.
3eBuireent
'alculate the longCterm monthly saving or e$tra cost which will result from the closure of the printing
department. 6f you consider that the department should be closed, you are as+ed to advise on the most
appropriate timing for its closure.

ZSo!ution R 1[
The longCterm monthly saving or cost can be calculated by identifying the relevant costs,
ignoring the effect of the notice reuired on certain of the contracts. The labour costs and the fi$ed
overheads are not relevant. They would be incurred even if the department is closed.


1::

3e!e/ant cost of interna! %rinting

,s0 per month
'ustomised paper #7.P-.% 5,...
(luorescent in+ #5..P/.7.% ID.
@ther paper and material D,7-.
>achine rental 5,-..
Aariable overhead #5P/D.% 57.
Tota! re!e/ant cost of interna! %rinting 1),::*
'ost of e$ternal printing services #8,...%
'onth!& sa/ing fro c!osure (,::*
Therefore the offer fro the e0terna! su%%!ier shou!d be acce%ted, resu!ting in a onth!&
sa/ing of 3s: (,::*"

This saving would only be made in the long term, once all of the relevant notice periods have e$pired. 6n
the immediate short term, some costs would still be incurred because of the need to give notice of
cancellation. 6t is possible to demonstrate the effect of this by charting in which month each saving will
be made. 6n the following table, month /S is ta+en to mean one month from nowS.

3e!e/ant sa/ings and re/enues

Mo"t* 1 Mo"t* 2 Mo"t* . Mo"t* /
3s: 3s: 3s: 3s:
'ustomi<ed paper #note /% - - - 5,...
,evenue from sale of e$cess paper /,F.. /,F.. /,F.. -
(luorescent in+ #note D% - ID. ID. ID.
,evenue from sale of e$cess in+ D.. - - -
@ther paper and materials #note E% D,7-. D,7-. D,7-. D,7-.
>achine rental #note 5% C C 5,-.. 5,-..
Aariable overhead #note E% 57. 57. 57. 57.
,elevant savings and revenues -,/E. -,F-. /.,/-. /D,--.
&$ternal cost 8,... 8,... 8,... 8,...
Sa/ing<(e0cess cost# fro c!osure ((,?>*# ((,(:*# 1,1:* (,::*

)ote that the monthly saving settles down at the longCtermS amount of ,s0 E,--. once all of the notice
periods have e$pired.
Aotes
/. The saving on customised paper will not be made until month 5, because E monthsS notice is reuired and the
company is obliged to purchase the paper. ?owever, if printing is ceased immediately the paper could be reCsold
for ,s0 /,F.. per month.
D. The saving on fluorescent in+ will not be made until month D because the company will be obliged to purchase it
for the first month. 6f printing is ceased immediately the in+ could be reCsold for ,s0 D.. for / month.
E. The other material costs and the variable overheads are relevant from month /, because they can be avoided as
soon as the department closes.
5. The machine rental will only be saved from month E onwards, because it must be paid for anyway for the ne$t D
months.


1:=

ZPuestion R )[
(udge =td operates at three factory sites producing a closely related product range. The
D. B 5 budget for (udge =tdSs operations is as follows0

Cro3do" Luto" out*!"d
3s: *** 3s: *** 3s: ***
1ariab!e 5I- D,D.. /,...
Fi0ed (site# EI- /,E.. F-.
Fi0ed (centra!# -. D.. /..
Sa!es /,... 5,... D,...
.rofit 1** (** ):*

The lease of the 'roydon site e$pires at the end of D. B 5. (our alternative options have been identified
for the D.B- operations0

/. ,enew the 'roydon site lease at an additional annual rental of ,s0 -.,....
D. :hut the 'roydon site and franchise 'roydon production to another manufacturer at a
/.- per cent commission on sales.
E. :hut the 'roydon site and switch production to =uton; this would involve an additional
,s0 D-.,... per year fi$ed costs at =uton and additional transport costs on production transferred
amounting to I.- per cent of sales.
5. :hut down the 'roydon site and switch production to :outhend; this would involve additional fi$ed
costs of ,s0 D..,... per year at :outhend and additional transport costs on production transferred
amounting to /. per cent of sales.

3eBuireents
&valuate the options and advise0
#a% 4hich option is most attractive on purely financial grounds9
#b% 4hat strategic factors are relevant which might be beyond the scope of your analysis in #a%.

ZSo!ution )[

Ti%: 6dentify relevant costs and revenues associated with each of the four alternatives.

(a# ,enewal of 'roydon lease gives profit of ,s0 F..,...
(ranchise 'roydon production gives profit of ,s0 -/-,...
Transfer production to =uton gives profit of ,s0 I..,...
Transfer production to :outhend gives profit of ,s0 ID-,...I
I"rofitCma$imi<ing option.
4%tion 1 H 3ene8 +ro&don site !ease
,s0 ...
,enew 'roydon site lease 3 additional rent #-.%
,evised profit #F-. P -.% F..
4%tion ) H Franchise +ro&don %roduction
6f the 'roydon site is shut the central fi$ed costs will not be saved.


1:>

6mpact on sales #/,...%
6mpact on variable costs 5I-
6mpact on fi$ed site costs EI-
'ommission income #/.-K of sales% /-
(1(:#
,evised profit #F-. P /E-% -/-
4%tion ( H Shut +ro&don and s8itch %roduction to $uton
Again, the central fi$ed costs will not be saved, but the fi$ed site costs will be saved and are therefore
relevant to the decision. The assumption is made that the sales revenue and variable cost from 'roydon
will be transferred to the =uton site. Therefore these two items are not affected by the decision and are
not included in the calculation of revised profit.

6mpact on 'roydon fi$ed site costs EI-
Additional costs 3 =uton #D-.%
Transport costs #I.-K of sales% #I-%
:*
,evised profit #F-. P -.% I..
4%tion 7 H Shut +ro&don and s8itch %roduction to Southend
6mpact on 'roydon fi$ed site costs EI-
Additional costs 3 :outhend #D..%
Additional transport costs :outhend #/.K of sales% #/..%
>:
,evised profit #F-. P I-% ID-

#b% ,elevant strategic factors which are beyond the scope of analysis in #a% above include0
impact on wor+force and labour relations;
impact on companySs standing with customers;
reduction in companySs total production capacity;
increased vulnerability to local events at remaining sites.

ZPuestion ([
H" =td produces three joint products 3 A, G and ' 3 which are then further processed. 6t is normal
practice for the company to apportion all preCseparation costs on the basis of weight of output of each
joint product.

2ata for the last period is as follows0
'osts incurred up to separation point ,s0 8,F..

%roduct A %roduct B %roduct C
@utput #+g% 100 60 80
3s: 3s: 3s:
'osts incurred after separation point 2,000 1,200 800
:elling price per +g
After further processing 50 80 60
At preCseparation point #estimate% 25 70 45


1:?

3eBuireents
#a% "repare a statement showing the profit or loss made by each product using the present method of
apportioning preCseparation costs.
#b% 'omment on the method used by H" =td to attribute preCseparation costs to its joint products.
#c% Advise the management of H" =td whether or not, on purely financial grounds, it should further
process any of the three products.

ZSo!ution ([
Ti%s
,emember preCseparation costs are common costs and therefore irrelevant to the decision.
4hen a decision on whether or not to further process is to be made; the relevant costs are
incremental costs and revenue.

(a# .rofit stateent for the three -oint %roducts

A B C Total
3s: 3s: 3s: 3s:
Sa!es -,... 5,7.. 5,7.. /5,F..
$ess22
.re2se%" costs 5,... D,5.. E,D.. 8,F..
.ost2se%" costs D,... /,D.. 7.. 5,...
.rofit< (!oss# #/,...% /,D.. 7.. /,...

(b# C. $td a%%ortions %re2se%aration costs according to the physical measure 3 on the weight of
output of each joint product. Another method available is apportioning according to mar+et value of the
joint products. Goth methods are arbitrary and do not provide management with accurate
apportionment of costs. 6t is impossible to calculate accurately the amount of preCseparation costs to be
charged to individual joint products. They must therefore be loo+ed at in total rather than on an
individual product basis.
(c# The decision on 8hether or not to further %rocess should be based on a comparison of
incremental sales revenue and incremental costs, and not on information that includes an arbitrary
apportionment of costs.

%roduct I"cr!m!"tal
r!0!"u!
I"cr!m!"tal
costs
I"cr!m!"tal
pro#it:;loss7
3s: 3s: 3s:
A D,-.. 2,000 500
; 600 1,200 (600)
+ 1,200 800 400
.00

Therefore, further process A and ' and sell G at the point of separation.


1:@

ZPuestion 7[
">: plc is a large diversified organisation with several departments. 6t is concerned over the
performance of one of its departments 3 department ". ">: plc is concerned that department " has not
been able to meet its sales target in recent years and is considering either to reduce the level of
production or to shut down the department.

The following information has been made available0
Gudgeted sales and production in units -.,...
3s: ***
:ales -..
=ess CC production costs
>aterial A 3 / +g per unit -.
>aterial G 3 / litre per unit D-
=abour 3 / hour per unit /D-
Aariable overhead /..
(i$ed overhead -.
)onCproduction costs -.
Total cost #5..%
;udgeted %rofit 1**

The following additional information has also been made available0

(i# There is -.,... +g of material A in stoc+. This originally cost ,s0 / per +g. >aterial A has no other use
and unless it is used by the division it will have to be disposed of at a cost of ,s0 -.. for every -,... +g
(ii# There are E.,... litres of material G in stoc+. Any unused material can be used by another
department to substitute for an euivalent amount of a material, which currently costs ,s0 /.D- per
litre. The original cost of material G was ,s0 ..-. per litre and it can be replaced at a cost of ,s0 /.-. per
litre.
(iii# All production labour hours are paid on an hourly basis. ,umors of the closure of the department
have led to a large proportion of the departmentSs employees leaving the organi<ation. Uncertainty over
its closure has also resulted in management not replacing these employees. The department is therefore
short of labour hours and has sufficient to produce D-,... units. @utput in e$cess of D-,... units would
reuire the department to hire contract labour at a cost of ,s0 E.I- per hour. 6f the department is shut
down the present labour force will be deployed within the organi<ation.
(i/# 6ncluded in the variable overhead is the depreciation of the only machine used in the department.
The original cost of the machine was ,s0 D..,... and it is estimated to have a life of /. years.
2epreciation is calculated on a straightCline basis. The machine has a current resale value of ,s0 D-,...6f
the machinery is used for production it is estimated that the resale value of the machinery will fall at the
rate of ,s0 /.. per /,... units produced. All other costs included in variable overhead vary with the
number of units produced.
(/# 6ncluded in the fi$ed production overhead is the salary of the manager of department " which
amounts to ,s0 D.,.... 6f the department were to shut down the manager would be made redundant
with a redundancy pay of ,s0 D-,.... All other costs included in the fi$ed production overhead are
general factory overheads and will not be affected by any decision concerning department ".
(/i# The nonCproduction cost charged to department " is an apportionment of the total nonCproduction
costs incurred by the department.
(/ii# The mar+eting manager suggests that either0

1=*

a sales volume of D-,... units can be achieved with a selling price of ,s0 8... per
unit and an advertising campaign of ,s0 D-,...; or
a sales volume of E-,... units can be achieved at a selling price of ,s0 I.-. with an
advertising campaign costing ,s0 E-,....
3eBuireents
#a% As the management accountant of ">: plc you have been as+ed to investigate the following options
available to the organi<ation0
#i% ,educe production to D-,... units
#ii% ,educe production to E-,... units
#iii% :hut down department ".
#b% 2iscuss the relevance of opportunity costs in decisionCma+ing
ZSo!ution 7[
Ti%s
A straightforward uestion with three decision options. &valuate each option using relevant
costs and revenue.
'andidates freuently do not show clear wor+ings for this type of uestion. A large proportion
of the mar+s are awarded for the wor+ings, not the final statement.
(a#
R!l!0a"t sa0i"6s a"d r!0!"u!
21<000 u"its .1<000 u"its *ut do,"
3s: 3s: 3s:
:ales revenue DD-,... DFD,-.. C
>aterial G 6,250 - 7,500
:ale of machinery DD,-.. D/,-.. D-,...
Tota! re/enue<sa/ings ):(,>:* )?7,*** =),:**
R!l!0a"t costs
>aterial A disposal D,-.. /,-.. -,...
"urchase material G C I,-.. C
=abour FD,-.. /..,... C
Aariable overhead #e$cl. depreciation% 5.,... -F,... C
Advertising campaign D-,... E-,... C
>anagerSs salary D.,... D.,... C
,edundancy pay C C D-,...
Tota! re!e/ant costs 1:*,*** ))*,*** (*,***
Aet sa/ings 1*(,>:* =7,*** (),:**

5orkings

R!l!0a"t sa0i"6s a"d r!0!"u!
21<000 u"its .1<000 u"its *ut do,"
3s: 3s: 3s:
1 2 Sa!es re/enue C
)o. of units D-,... E-,...
:elling price ,s0 8... ,s0 I.-.
:ales revenue 3s: )):,*** 3s: )=),:**

1=1

)" Sa/ings ade on ateria! ;
:urplus available -,... C E.,...
:aving per litre ,s0 /.D- ,s0 /.D-
Total saving 3s: =,):* 2 3s: (>,:**
(" Sa!e of achiner&
'urrent mar+et price ,s0 D-,... ,s0 D-,... ,s0 D-,...
,eduction in value ,s0 D,-.. ,s0 E,-.. C
:ale proceeds 3s: ):,*** 3s: )1,:** 3s: ):,***
7" ,is%osa! cost of ateria! A
Luantity to be disposed of D-,... /-,... -.,...
'ost of disposal 3s: ),:** 3s: 1,:** 3s: :,***
:" .urchase cost of ateria! ;
"roduction reuirement D-,... E-,...
)o. of litres to be purchased C -,... C
"urchase cost 3s: >,:**
=" $abour costs
)ormal labour costs ,s0 FD,-.. ,s0 FD,-..
'ontract labour C ,s0 EI,-..
3s: =),:** 3s: 1**,***
>" 1ariab!e o/erhead
\ ,s0 /.F. per unitP
PAariable overhead1unit
,s0 5.,... ,s0 -F,...
Total variable overhead /..,...
less depreciation #D.,...%
?*,***
Aariable overhead1unit P ,s0 7.,...
-.,...
K 3s: 1"=* %er unit
?" 'anagerXs sa!ar& ,elevant
@" 3edundanc& %a& ,elevant
1*" Genera! fi0ed o/erheads and non2
%roduction o/erheads
)ot relevant

#b% An opportunity cost is the value which represents the cost of the ne$t best alternative or the benefit
forgone by accepting one course of action in preference to others when allocating scarce resources.
6f there is only one scarce resource, decisions can be made by ran+ing alternatives according to their
contributions per unit of the scarce resource. ?owever, in reality, there will be many scarce resources,
and different alternatives will use alternative combinations of those scarce resources. 6n these situations
opportunity costs are used to identify the optimum use of those resources.

ZPuestion R :[
2 runs a ceramics company that employs twenty staff. The employees wor+ a basic 5.Chour wee+ for 57
wee+s a year, and are paid on an hourly basis. The average wage per hour is ,s0 /..5D. The fi$ed costs
for the pottery total ,s0 E.,... per annum.

The company ma+es tableware and tiles. A set of tableware sells for ,s0 -.. The costs per set are0

1=)

,s0
2irect materials /.
2irect labour /.
Aariable overheads /.

Tiles sell for ,s0 D.. per /.. tiles and the costs per hundred are0

,s0
2irect materials D.
2irect labour -.
Aariable overheads -.

The normal sales mi$ is F.. tiles to D. sets of tableware. 6n most years the company wor+s close to
normal capacity, but at present the business is operating at F. per cent of capacity. Gecause of this, 2
has assigned two members of staff to refurbish the pottery showroom, which should ta+e those 7 wee+s
to complete. ?e has also recently agreed to redecorate and tile the changing rooms and surround of the
local swimming pool. This is a charitable wor+ and should ta+e three of 2Ss staff half a year to complete.
?owever, 2 has since been offered two large contracts, which he bid for a few months ago.

Fish2and2chi% sho%s contract
The first contract is from a company that owns a chain of up mar+et fishCandCchip shops.
The company needs tiles for five new fishCandCchip shops that it is about to open. 2 has heard from a
reliable source that the company plans to open a further E. new shops over the ne$t D or E years. The
tiles for the five shops are reuired in F monthsS time, and each shop will reuire D.,... tiles at the
normal selling price less - per cent.

E %!c contract
The second potential contract is from a department store, N plc, which reuires 5.,... sets of pastel
colored tableware in one yearSs time. This may lead to further annual orders from N plc. 2 has already
produced designs for the product, which the company has agreed; 2 rec+ons that this too+ ,s0 D,-.. of
his time. The price agreed per set is the normal price less /- per cent uantity discount. 6f he accepts the
contract he will need to have the moulds made, which will cost ,s0 /-,.... 6n order to complete this
contract a considerable amount of production space is reuired to store and dry the moulds and to store
the completed goods ready for dispatch in / yearSs time.

2 owns a warehouse adjacent to the pottery. This warehouse is leased to another business on an annual
basis at a rental of ,s0 /.,... per annum. (ortunately, the lease is due for renewal this month and 2
could use the warehouse to complete the large contract for N plc. ?e estimates that its use would cost
him ,s0 E,... in e$tra fi$ed operating costs per annum.

Staffing and ca%acit& inforation
2 has no difficulty in recruiting staff as reuired, but he feels that he could not absorb more than eight
new employees in the coming year. ,ecruitment costs are ,s0 -.. per employee.
?e also has little difficulty in getting staff to wor+ F hoursS overtime per wee+ at /-. per cent of their
normal rate of pay. ?owever, they could only wor+ at this level for half of the 57 wee+s wor+ed per
annum.


1=(

6f 2 accepted either job he could stop the two members of staff decorating the showroom and hire a
contractor, which would cost ,s0 -,.... 6f he brought the three staff bac+ from the wor+ on the
swimming pool he would feel obliged to ma+e a donation of ,s0 E-,... which would pay for a
contractor to finish the wor+. TwentyCfive per cent of the potterySs output each year is made up of new
oneCoff orders from small outlets. 2 feels that, if he wished to do other, more profitable, wor+, he could
stop supplying these customers without longCterm detriment to his business.
3eBuireents
#a% "roduce calculations that show whether the contracts are feasible and profitable. 4here
appropriate, e$plain your reasoning, and the figures in your calculations. #)( arks%
#b% ,ecommend, with reasons, whether 2 should accept either or both of the contracts. 2escribe the
longerCterm implications of the actions you recommend. #> arks%

ZSo!ution :[

Ti% K This answer shows different ways of calculating the answer H of course, only one is reuired.
The answer presents only one view0 some items could be treated differently, so other solutions would
be acceptable in an e$amination.

(a# +urrent %otter& data

=ours
?ours wor+ed per person per fourCwee+ month #5. hours P 5 wee+s% /F.
?ours wor+ed per person per annum #5. hours P 57 wee+s% /,8D.
Total hours available per annum #D. staff P /,8D. hours% E7,5..
'apacity currently not being used per annum C 5.K /-,EF.
:taff wor+ing elsewhere CD-K
:taff currently available for use per annum 3 /-K -,IF.

Co"tri$utio" #rom "ormal productio"(

Ta$l!,ar! p!r s!t Til!s p!r 100

3s: 3s: 3s: 3s:
:ales price 50 200
>aterial cost 10 20
=abour cost 10 50
Aariable overhead 10 50
0 120
'ontribution 20 >0
)o. of hours to produce
0 ,s0 /.1,s0 /..5D
0 ,s0 -.1,s0 /..5D
*"@=

7"?*


1=7

A0!ra6! co"tri$utio" p!r *our $as!d o" sta"dard mi+(

=ours Co"tri$utio" Co"tri$utio" p!r *r
3s: 3s:
Tiles 3 F.. 28.8 480 16.67
Tableware C D. sets 1!.2 400 20.8
Total />)0 >>0

A"erage contr#$ut#on per hour ; ,s0 77.157 ; ,s0 .7.EE

Fish2and2chi% sho%s contract

)o. of batches ; - shops P D.,... tiles V /.. tiles ; /,...
=ours =ours
?ours reuired ; /,... batches P 5.7 hours 5,7..
:upplied by0
?ours currently available in ne$t F months0
-,IF. P D5157 D,77.
"lus two men decorating showroom
#/F wee+s available to wor+%0 #D P /,8D.% P /F157 /,D7.
5,/F.
Hours sti!! needed =7*

The F5. hours can be found by stopping the two staff decorating the showroom #D P #/,8D. hours P 7157
wee+s% ; F5. hours% and getting in a contractor, costing ,s0 -,.... The salaries of the two staff amount
to F5. hours P ,s0 /..5D ; ,s0 F,FF8. Gy employing a contractor 2 will save ,s0 /,FF8. #As the salaries
are included in the contribution calculation that follows, only the net saving is included.%
3s:
'ontribution ; /,... batches P T,s0 7. C #-K P ,s0 D..%U I.,...
Add0 cost saving /,FF8
Aet gain >1,==@

'ontribution per hour ; ,s0 I/,FF8 V 5,7.. ; ,s0 /5.8E
'ontribution per hour in a normal year ; ,s0 I.,... V 5,7.. ; ,s0 /5.-7
#The other option of paying overtime is possible but this will generate an additional cost and so is not
calculated.
Alt!r"ati0! tr!atm!"t
'ost of F5. hours using overtime0
@vertime possible0 /- staff P F hours P D5 wee+s ; D,/F. hours
@vertime needed for contract for F months, i.e. F5. hours.
'ost of overtime ; F5. hours P overtime rate ,s0 /..5D P /-.K ; ,s0 /.,..E
'ontribution generated without the F5. hours under uestion0
3s: 3s:
:ales revenue /,... batches P #,s0 D.. C -K% /8.,...
=ess0
>aterials and variable overhead0

1=:

/,... batches P ,s0 I. I.,...
4ages0 5,/F. hours P ,s0 /..5D 5E,E5I
#//E,E5I%
IF,F-E
4%tion 1 H contractor for sho% to gain e0tra =7* hours:
'ontribution as above less payment to contractor0 ,s0 IF,F-E C ,s0 -,... ; ,s0 I/,F-E
4%tion ) H 8ork o/ertie to gain e0tra =7* hours:
'ontribution as above less overtime0 ,s0 IF,F-E C ,s0 /.,..E ; ,s0 FF,F-.

E %!c contract

'ost of wor+ on swimming pool0 #E staff P 5. hours P D5 wee+s% P ,s0 /..5D ; ,s0 E.,./.

This is cheaper than ma+ing a donation.
The opportunity cost of giving up small contracts is ,s0 /7.EE per hour #after charging labour cost%. The
cost of hiring new labour is only ,s0 /..5D per hour #e$cluding hiring cost, which is only ,s0 -..%. The
cost of wor+ing overtime is ,s0 /-.FE per hour. Therefore hiring new staff is the cheapest option,
followed by wor+ing overtime. This also helps to +eep the e$isting products1business going.

1#
%ours
5.,... sets P ..8F hours E7,5..
?ours available this year if all staff wor+ing in pottery 15,60
&ight new staff P /,8D. hours /-,EF. #E.,ID.%
Therefore, hours still reuired I,F7.
=ess0
@vertime 3 e$isting staff #D. P F hours P D5 wee+s% D,77.
new staff #7 f F hours f D5 wee+s% /,/-D #5,.ED%
,emainder must be ta+en from small contracts (,=7?
)#
+ontribution: 3s: 3s:
5.,... sets P #,s0 D. C #/-K P ,s0 -.% ; ,s0 /D.-.% -..,...
Add0 saving on contractor for showroom /,FF8
-./,FF8
=ess C additional costs0
,ent forgone /.,...
&$tra fi$ed costs E,...
>oulds /-,...
'ontractor for swimming pool E-,...
,ecruitment costs for eight staff 5,...
@vertime premium 5,.ED hours P ,s0 /..5D P -.K D/,..I
=ost contribution on small contracts0 ,s0 /7.EE P E,F57 hours FF,7F7
#/-5,7I-%
Aet gain (7=,>@7
;oth contracts are feasib!e and %rofitab!e"


1==

(b# E %!c contract
%ours
>a$imum available hours without overtime #D7 staff P /,8D.% -E,IF.
=ess C N plc contract E7,5..
Hours a/ai!ab!e for nora! %roduction H on!& 1:,(=*
,s0 ,s0
'omparable contribution in a normal year -..,...
=ess0 fi$ed costs E,...
,ent forgone /.,... #/E,...%
7?>,***
57I,... V E7,5.. hours ; 3s: 1)"=?

3ecoendation
Assuming that 2 e$pects that normal sales will pic+ up in the future, and that he is comfortable with the
present si<e of the pottery, it is suggested that he accepts the fishCandCchip shop contract. The following
points need to be considered0

Til!s #or #is* ? c*ip s*ops
This is a profitable contract which can be met without e$ceeding the potterySs e$isting capacity.
2 would actually save money by getting a contractor in to decorate.
The additional profit generated is ,s0 I/,FF8 and the contribution per hour is ,s0 /5.8E,
compared with an average contribution on normal production of ,s0 /7.EE per hour.
4hether 2 will wish to accept further contracts in future years will depend on whether there is
sufficient spare capacity. The contribution per hour ne$t year will be ,s0 /5.-7. This is less than
the contribution on e$isting wor+ and so should be pursued only if there is spare capacity.
' plc co"tract
This generates a net gain of ,s0 E5F,I85. This is a considerable amount, but the e$tra amount of
wor+ that it places on 2 must be considered.
There is also the possibility that 2 may not be able to reClet the premises immediately the
contract is completed. ?owever, the rent lost is small in comparison to the gain on the contract.
6f further contracts were available, 2 would be unwise to accept them 3 assuming that the
pottery was wor+ing near capacity by this time 3 as the business does not have adeuate
capacity to meet the normal production and the contract. The contribution per hour on the
contract in a normal year would be only ,s0 /D.F7.
Acceptance of the very large N plc contract would have an effect on the nature of 2Ss business.
The company would change into a manufacturer for a department store and would have little
say over future designs, etc.
There is also the worry that the pottery might become reliant on N plc at some stage because of
the large volume of wor+ done for the company. 6f, in future, N plc withdrew the contract or
reduced the price it was willing to pay, 2Ss business could be in considerable difficulty.

ZPuestion =[
N manufactures three joint products #>, ) and "% from the same common process. The following
process account relates to the common process last month and is typical of the monthly results of
operating this process0


1=>

Commo" %roc!ss Accou"t
Litr!s Rs( Litr!s Rs(
@pening wor+ in process /,... -,ED. )ormal loss /.,... D.,...
>aterials /..,... D-.,... &utput - ' D-,... /5/,7I-
'onversion costs0 &utput - ( /-,... 7-,/D-
Aariable /..,... @utput " 5-,... D--,EI-
(i$ed /7.,... 'losing wor+ in process 7.. E,-EE
Abnormal loss -,D.. D8,5/D
1*1,*** :(:,()* 1*1,*** :(:,()*

&ach one of the products can be sold immediately after the common process, but each one of them can
be further processed individually before being sold. The following further processing costs and selling
prices per litre are e$pected0

%roduct !lli"6 pric! a#t!r commo"
proc!ss 3s:litr!
!lli"6 pric! a#t!r #urt*!r
proc!ssi"6 3s:litr!
Furt*!r 0aria$l!
proc!ssi"6 cost 3s:litr!
' F.D- 7.5. /.I-
A -.D. F.5- ..8-
. F.7. I.5- ..7-

3eBuireent
#a% :tate the method used to apportion the common costs between the products >, ) and " and
comment on its acceptability. &$plain why it is necessary to apportion the common costs between each
of the products.
#b% &valuate the viability of the common process, and determine the optimal processing plan for each of
the three products showing appropriate calculations.

ZSo!ution =[
#a% The cost per litre is the same for all three joint products therefore the basis of the common cost
apportionment is the number of litres output. This is an acceptable method for the purposes of e$ternal
financial reporting since it is based on the cost incurred in the common process, however its usefulness
for internal reporting is limited given that there is one process that is common to all three outputs.
6t is necessary to apportion the common costs between the different products so that inventory values
can be derived for each form of output in order to match sales with cost of sales for the purposes of
e$ternal financial reporting.

#b% The sales values of the outputs from the common process total g-5.,D-. and the total costs
attributed to the outputs from the process total g57D,EI- therefore the common process is viable since
it generates revenues in e$cess of costs. 4ith regard to the viability of each individual product a
comparison must be made between the incremental revenue from further processing and the further
processing costs that are incurred. Thus0

%roduct I"cr!m!"tal r!0!"u! p!r litr! I"cr!m!"tal cost p!r litr!
' D./- /.I-
A /.D- ..8-
. ..F- ..7-

1=?

Thus it can be seen that products > and ) should be further processed whereas product " should be
sold at the point of separation #i.e. after the common process%. All three products are viable if this
course of action is ta+en, however it is not viable to further process product ".

Z60a%!e: >[
A company is considering whether to do a special job for a customer. The job will need D.. units of
direct materials. These are already held in inventory, but they are used regularly for other wor+ that the
company does. These D.. units were purchased for gE per unit, but their purchase cost has recently
been increased to ,s0 E.D. by the supplier. 6f the decision is ta+en to do the job for the supplier, the D..
units already held will be used. ?owever, because the materials are used regularly for other wor+,
additional replacement materials will have to be purchased. These will cost ,s0 E.D. per unit, which is
the relevant cost. The relevant cost of using the D.. units of materials is therefore ,s0 F5. #D.. unitsS
J,s0 E.D.%.

Z60a%!e: ?[
A company has been as+ed to uote a price for a oneCoff contract. The contract would reuire -,...
+ilograms of material B. >aterial B is used regularly by the company. The company has 5,... +ilograms
of material B currently in inventory, which cost ,s0 D per +ilogram. The price for material B has since
risen to ,s0 D./. per +ilogram. 4hat are the relevant costs of the material B for the contract9

Ans8er

This is in regular use. Any units of the material that are held in inventory will have to be replaced for
other wor+ if they are used for the contract. The relevant cost is their replacement cost. ,elevant cost ;
replacement cost ; -,... +ilograms J,s0 D./. ;,s0 /.,-...

Z60a%!e: @[
A company has been as+ed to uote a price for a oneCoff contract. The contract would reuire D,...
+ilograms of material [. There are /,-.. +ilograms of material [ in inventory, but because of a decision
ta+en several wee+s ago, material [ is no longer in regular use by the company. The /,-.. +ilograms
originally cost ,s0 I,D.., and have a scrap value of ,s0 /,7... )ew purchases of material [ would cost ,s0
- per +ilogram. 4hat are the relevant costs of the materials for the contract9

Ans8er

This is not in regular use. There are /,-.. +ilograms in inventory, and unless they are used for the
contract they will be sold as scrap. The contract would need D,... +ilos, so an additional -.. +ilograms
would have to be purchased. The relevant cost of material [ for the contract would be as follows0
,s0
>aterial held in inventory #scrap value% /,7..
)ew purchases #-.. J,s0 -% D,-..
Total relevant cost of >aterial [ 7,(**

The scrap value of the /,-.. +ilos already purchased is their scrap value. This is the benefit that would
be lost if the materials are used for the contract instead of using them for the ne$tCmost beneficial use
#which is to sell them as scrap%.

1=@

Z60a%!e: 1*[
6n order to carry out some wor+, a company would need to use -.. +ilos of >aterial >. 6t already has
sufficient uantities of the material in inventory, but due to the recent closure of a business operation,
the materials are no longer in regular use. The material > has a scrap value of ,s0 E per +ilo after selling
costs. ?owever, they could also be used as an alternative material in another operation, where it could
be used instead of the same uantity of material ". >aterial " is in regular use and costs ,s0 5 per +ilo to
buy. 4hat are the relevant costs of the material >9

Ans8er

This is not in regular use. There are -.. +ilograms in inventory, and if they are not used for the wor+,
they will either by sold as scrap #for ,s0 E per +ilo% or used in a different operation, which would save
purchases of -.. +ilos of material " at ,s0 5 per +ilo. The relevant cost is the higher of these two values 3
-.. +ilos J,s0 5 ;,s0 D,... 3 because this is how the materials should be used if they are not used for
the wor+ under consideration.

Z60a%!e: 11[
A company has been as+ed by a customer to carry out a special job. The wor+ would reuire D. hours of
s+illed labour time. There is a limited availability of s+illed labour, and if the special job is carried out for
the customer, s+illed employees would have to be moved from doing other wor+ that earns a
contribution of ,s0 5. per labour hour. :+illed labour is paid ,s0 E. per hour. 4hat is the relevant cost of
the labour9

Ans8er
:+illed labour is in restricted supply and using labour for the job will mean that other wor+ that earns ,s0
E. per hour will be lost.
,s0
'ost of labour hours #D. hours J,s0 E.% F..
'ontribution forgone 3 an opportunity cost0 #D. hours J,s0 5.% 7..
Total relevant cost of s+illed labour 1,7**

Z60a%!e: 1)[
A company has been as+ed to do a special job for a customer. This would reuire 7 hours of Grade A
labour and F hours of Grade G labour. Grade A labour is paid ,s0 D. per hour and Grade G labour is paid
,s0 /- per hour. The Grade A labour would have to be ta+en off other wor+ that earns a contribution of
,s0 5. per hour. There is sufficient Grade G labour available0 if the Grade G employees do not wor+ on
this job, they will be paid but will have no other revenueCearning wor+ to do. 4hat are the relevant
costs of the labour for the job9

Ans8er
Grade A labour is in restricted supply. Grade G labour time is available and would otherwise be paid for
as idle time. The relevant labour costs are therefore as follows.
,s0
Grade A labour0 basic pay #7 hours J,s0 D.% /F.
Grade A labour0 opportunity cost #7 hours J,s0 5.% ED.
Grade G labour0 no incremental cost .
,elevant cost of labour 7?*

1>*

Z60a%!e: 1([
A company is considering a contract that will reuire labour time in three departments.
,e%artent 1" The contract would reuire D.. hours of wor+ in department /, where the wor+ force is
paid ,s0 /. per hour. There is currently spare labour capacity in department / and there are no plans to
reduce the si<e of the wor+force in this department.
,e%artent )" The contract would reuire /.. hours of wor+ in department D where the wor+force is
paid ,s0 /D per hour. This department is currently wor+ing at full capacity. The company could as+ the
wor+ force to do overtime wor+, paid for at the normal rate per hour plus -.K overtime premium.
Alternatively, the wor+ force could be diverted from other wor+ that earns a contribution of ,s0 5 per
hour.
,e%artent (" The contract would reuire E.. hours of wor+ in department E where the wor+force is
paid ,s0 D. per hour. =abour in this department is in short supply and all the available time is currently
spent ma+ing product N, which earns a contribution of ,s0 /. per hour. 4hat is the relevant cost for the
contract of labour in the three departments9

Ans8er
,e%artent 1" There is spare capacity in department / and no additional cash e$penditure would be
incurred on labour if the contract is underta+en. ,elevant cost ;,s0 ..
,e%artent )" There is restricted labour capacity. 6f the contract is underta+en, there would be a choice
between0
@vertime wor+ at a cost of ,s0 /7 per hour #g/D plus overtime premium of -.K% 3
this would be an additional cash e$pense, or
2iverting the labour from other wor+, and losing contribution of ,s0 5 per hour 3
cost per hour ;,s0 /D basic pay O contribution forgone ,s0 5 ;,s0 /F per hour.
6t would be better to divert the wor+ force from other wor+, and the relevant cost of labour is therefore
/.. hours J,s0 /F per hour ;,s0 /,F...
,e%artent (. There is restricted labour capacity. 6f the contract is underta+en, labour would have to be
diverted from ma+ing product N which earns a contribution of ,s0 /. per labour hour. This is an
opportunity cost of labour if the contract wor+ is underta+en. The relevant cost of the labour in
department E is0
,s0
=abour cost #E.. hours J,s0 D.% F,...
'ontribution forgone #E.. hours J,s0 /.% E,...
Total relevant cost, 2epartment E 8,...
Suar& of relevant costs of labour0
,s0
2epartment / .
2epartment D /,F..
2epartment E 8,...
1*,=**
Z60a%!e: 17[
A machine was purchased eight years ago for ,s0 D.,... and is depreciated at the rate @f ,s0 D,... per
year. The net boo+ value of the machine is ,s0 5,... and its net disposal value is ,s0 E,.... A similar
machine would cost ,s0 5-,... today. The machine is not due to be replace for another two years, but
as it has developed a fault which cannot be repaired, the company must replace the machine
immediately. 4hat is the relevant cost of the machine9

1>1

Ans8er

The machine is obviously in regular use. The relevant cost of the machine is therefore its replacement
cost ,s0 5-,....

)ote the following points.

The purchase price of ,s0 D.,... is not a relevant cost. 6t is a sun+ cost that was incurred in the
past.
)et boo+ values are not relevant costs. They do not represent cash flows or disposal values. 6n
this e$ample the )GA of ,s0 5,... is not a relevant cost.
The net disposal value of ,s0 E,... is only relevant if the machine will not be replaced and has
no alternative use.

Z60a%!e: 1:[
A company manufactures a product in a process production system. There is some wastage in
production, and normal loss is /.K of the number of units input to the process. The standard price per
unit of direct material is ,s0 5.-. per unit.
4hat would be the standard direct material cost per unit of output0
#a% 6f an ideal standard is used, and the standard does not provide for any loss in process9
#b% 6f the standard cost allows for a loss of /.K of input materials in producing each unit of output.

Ans8er
#a% Idea! standard
)o loss; therefore standard cost ; / unit of direct materials at ,s0 5.-. per unit of material ; ,s0 5.-. per
unit of output.
#b% Attainab!e or current standard: a!!o8 for 1*J !oss
:tandard input to produce one unit of ; /1..8 units ; /./// units. Therefore standard cost ;
/./// units of materials at ,s0 5.-. per unit ; ,s0 - per unit of output.
Z60a%!e: 1=[
A company produces sandwiches. &ach sandwich reuires two slices of bread and a loaf of bread
contains D5 slices. &ach loaf of bread costs ,s0 F. it is estimated that currently D.K of bread is wasted.
>anagement would li+e to reduce this wastage to /.K.
'alculate a standard material cost for a sandwich based on
a% 6deal conditions
b% 'urrent conditions
c% Attainable conditions

Ans8er
:tandard cost per slice of bread ; ,s0 F1D5 slices ; ,s0 ..D-
#a% 6deal standard0 D slices J ,s0 ..D- ; ,s0 ..-.
#b% 'urrent standard0 D1..7. slices ; D.- slices at ,s0 ..D- ; ,s0 ..FD-
#c% Attainable or target standard0 D1..8 ; D.DD slices at ,s0 ..D- ; ,s0 ..---.
)ote that the current and attainable standard costs include an allowance for wastage, and a material
usage variance will occur only if the actual wastage rate differs from the standard wastage rate.


1>)

Z60a%!e: 1>[
A 'ompany budgets for a production of /-.... units. The variable cost per unit is ,s./5 and fi$ed cost
per unit is ,s.D per unit. The company fi$es the selling price to fetch a profit of /-K on cost.
,euired,
A. 4hat is the brea+C even point9
GU 4hat is the profit1volume ratio9
'U 6f the selling price is reduced by -K, how does the revised selling price affects the Grea+ &ven "oint
and the "rofit1Aolume ,atio9
2U 6f profit increase of /.K is desired more than the budget, what should be the sales at the reduced
price9

olutio"(
A[ Grea+ &ven "oint ; (i$ed 'ost 1'ontribution "er unit
; ,s.D P / -. ... units ; ,s.E, .., ... 1,s./7.5. 3 ,s./5...
; ,s.E, .., ... 1 ,s.5.5. ; F7, /7D units.
)ote0 'ontribution per unit is computed as shown below.
:elling "rice per unit ; Total 'ost O /-K "rofit on cost ; ,s./F T,s./5 variable cost O ,s.D fi$ed costU O
,s.D.5. T/-K of ,s./FU ; ,s./7.5.
'ontribution ; :elling "rice 3 Aariable 'ost ; ,s./7.5. 3 ,s./5 ; ,s.5.5.
;[ "rofit1Aolume ,atio0 'ontribution "er Unit1:elling "rice "er Unit P /..
,s.5.5. 1,s./7.5. P /.. ; DE.8/K
+[ ,eduction in selling price by -K0 ,educed selling price ; ,s./7.5. 3 -K of ,s./7.5. ; ,s./I.57, revised
contribution ; ,s./I.57 3 ,s./5... ; ,s.E.57
Grea+ &ven "oint ; (i$ed 'ost 1'ontribution "er Unit ; ,s.E, .., ... 1,s.E.57 ; 7F, D.I units
,[ 2esired profit ; ,s.D.5. O /.K of ,s.D.5. ; ,s.D.F5 per unit
Total "rofits ; ,s.D.F5 P / -. ... units ; ,s.E, 8F, ... O Total (i$ed 'osts ; ,s.E, .., ... Total
'ontribution ; ,s.F, 8F, ...
Luantity to be sold ; Total 'ontribution O ,evised 'ontribution "er Unit
,s.F, 8F, ... 1 ,s.E.57 ; D, .., ... units
:ales Aalue ; D .. ... units P ,s./I.57 ; ,s.E5, 8F, ...
Z60a%!e: 1?[
:elling price per ton ,s.F8.-.
Aariable cost per ton ,s.E-.-.
(i$ed 'ost ,s./7..D la+hs
6f this volume represents 5.K capacity, what is the additional profit for an added production of 5.K
capacity, the selling price of which is /.K lower for D.K production and /-K lower than the e$isting
price, for the other D.K capacity9

olutio"(
&$isting Grea+ &ven :ales ; (i$ed 'ost1'ontribution per unit
,s./7..D la+hs1,s.F8.-. 3 ,s.E-.-.
,s./7..D la+hs1,s.E5 ; -E ... units
:ales Aalue ; -E, ... P ,s.F8.-. ; ,s.EF, 7E, -..
6t is given in the problem that 5.K capacity represents -E, ... units
?ence 7.K capacity will represent / .F ... units


1>(

(or additional D.K capacity, selling price falls by /.K
,evised :elling "rice ; ,s.F8.-. 3 ,s.F.8- ; ,s.FD.--
=ess0 Aariable 'ost ; ,s.E-.-.
'ontribution ; ,s.DI..-
D.K capacity ; -E, ... units1D ; DF, -.. units
"rofit if sale price is ,s.FD.-- ; 'ontribution per unit P :ales units
,s.DI..- P DF, -.. units ; ,s.I, /F, 7D-

'ontribution by D.K capacity for which selling price falls by /-K
,evised :elling "rice ; ,s.F8.-. 3 ,s./..5D- ; ,s.-8..I-
=ess0 Aariable 'ost ; ,s.E-.-.
'ontribution ; ,s.DE.-I-
"rofit is sale price is ,s.-8..I- ; 'ontribution per unit P :ales units
,s.DE.-I- P DF, -.. units ; ,s.F, D5, IEI
Additional profit by 5.K sales ; ,s.I, /F, 7D- O ,s.F, D5, IEI ; ,s./E, 5/, -FD
Z60a%!e: 1@[
A retail dealer in garments is currently selling D5, ... shirts annually. ?e supplies the following details
for the year ended E/st >arch D..I.
:elling price per shirt 0 ,s.7..
Aariable cost per shirt 0 ,s.F..
(i$ed 'ost0
:taff salaries 0 ,s.D, 5.., ...
General @ffice 'ost 0 ,s.7.., ...
Advertising 'ost 0 ,s.7.., ...
As a 'ost Accountant, you are reuired to answer the following each part independently0
/. 'alculate Grea+ &ven "oint and margin of safety in sales revenue and number of shirts sold.
D. Assume that E., ... shirts were sold during the year, find out the net profit of the firm.
E. Assuming that in the coming year, an additional staff salary of ,s./., .., ... is anticipated, and price
of shirt is li+ely to be increased by /-K, what should be the brea+ even point in number of shirts and
sales9

olutio"(
1" Grea+ &ven "oint0 TunitsU ; (i$ed 'ost 1 'ontribution "er Unit ; ,s.5, ..., ...1,s.D.. ; D. ... number
of shirts
)ote0 'ontribution per units is selling price 3 variable cost per unit ,s.7.. 3 ,s.F.. ; ,s.D..
Grea+ &ven "oint Tsales valueU ; D.... units P ,s.7.. ; ,s./F, ..., ...
>argin of safety ; Actual :ales 3 Grea+ &ven :ales
D5, ... shirts P ,s.7.. ; ,s./8, D.., ... 3 ,s./F, ..., ... ; ,s.E, D.., ...
>argin of safety TunitsU ; D5, ... shirts 3 D., ... shirts ; 5... shirts
)" Amount of profit if E., ... shirts are sold0
:ales TunitsU ; (i$ed 'ost O "rofit 1 'ontribution "er Unit
E., ... ; ,s.5, ..., ... O "rofit 1,s.D.. ; "rofit ; ,s.D, ..., ...
(" ,evised Grea+ &ven "oint if fi$ed cost rise by ,s./, ..., ... and selling price increase by /-K
)ew selling price ; ,s.7.. O /-K ; ,s.8D., new fi$ed cost ; ,s.5, ..., ... O ,s./, ...,
... ; ,s.-, ..., ...
,evised Grea+ &ven "oint Tnumber of shirtsU ; ,s.-, ..., ... 1 ,s.8D. 3 ,s.F..

1>7

Grea+ &ven "oint ; /-, FD- shirts and /-, FD- P ,s.8D. ; ,s./, 5E, I-, ...
Z60a%!e: )*[
AG' =td. maintains a margin of safety of EI.-K with an overall contribution to sales ratio of 5.K. 6ts
fi$ed costs amount to ,s.-, ..,.... 'alculate the following0
/. Grea+ &ven :ales
D. Total :ales
E. Total Aariable :ales
5. 'urrent "rofits
-. )ew >argin of :afetyS if the sales volume is increased by I.-K

olutio"(
/. Grea+ &ven :ales ; (i$ed 'ost 1 "rofit1Aolume ,atio ; ,s.-, ..,...15.K ; ,s./D, -., ...
D. Total :ales ; Grea+ &ven :ales O >argin of :afety
>argin of :afety ; Actual :ales 3 Grea+C&ven :ales
=et the actual sales be /.., >argin of :afety is EI.-K
?ence Grea+ even sales will be ,s.FD.-
)ow, if the Grea+ even sales are ,s.FD.-, actual sales are ,s./.., hence if Grea+ even sales are
,s./D.- la+hs, actual sales will be /..1FD.- P /D.- ; ,s.D. la+hs
E. 'ontribution ; :ales 3 Aariable 'ost. As the contribution is 5.K of sales, the variable cost is F.K of
sales and so variable cost will be F.K of ,s.D. la+hs, i.e. ,s./D la+hs.
5. 'urrent "rofits ; :ales 3 T(i$ed 'ost O Aariable 'ostU ; ,s.D, ..., ... 3 T,s./, D.., ... O ,s.-.., ...U ;
,s.E.., ...
-. )ew >argin of :afety is the sales volume is increased by I.-K
)ew :ales Aolume ; ,s.D, ..., ... O I.-K of ,s.D, ..., ... ; ,s.D, /-., ...
?ence, )ew >argin of :afety ; ,s.D, /.., ... 3 G&" :ales ,s./, D-., ... ; ,s.8.., ...

Z60a%!e: )1[
A company manufactures a single product with a capacity of / -. ... units per annum. The summari<ed
profitability statement for a year is as under0
.articu!ars Aount Aount
3s" 3s"
:ales0 / .. ... units \ ,s./- per unit /, -..,...
=ess0 'ost of :ales
2irect materials E..,...
2irect labor D..,...
"roduction overheads 3 variable F.,...
"roduction overheads 3 fi$ed E,..,...
Administrative overheads 3 fi$ed /-.,...
:elling and distribution overheads 3 variable 8., ...
:elling and distribution overheads C fi$ed /-.,...
Total cost of sales #/, D-.,...%
.rofit ):*,***

[ou are reuired to evaluate the following options0
/% 4hat will be the amount of sales reuired to earn a target profit of D-K on sales, if the pac+ing is
improved at a cost of ,e./ per unit9

1>:

D% There is an offer from a large retailer for purchasing E., ... units per annum subject to providing a
pac+ing with a different brand name at a cost of ,s.D per unit. ?owever, in this case there will be no
selling and distribution e$penses. Also this will not in any way affect the companySs e$isting business.
4hat will be the brea+ even price for this additional offer9
E% 6f an e$penditure of ,s.E.., ... is made on advertising, the sales would increase from the present
level of /..... units to /D.... units at a price of ,s./7 per unit. 4ill that e$penditure be justified9
5% 6f the selling price is reduced by ,s.D per unit, there will be /..K capacity utili<ation. 4ill the
reduction in selling price be justified9

olutio"(
4or+ing )ote )o. /

Stateent Sho8ing Tota! +ontribution and +ontribution .er Unit
.articu!ars Aount Aount
3s" 3s"
:ales0 / .. ... units \ ,s./- per unit /, -..,...
=ess0 Aariable 'osts0
2irect materials E..,...
2irect labor D..,...
"roduction overheads 3 variable F.,...
:elling and distribution overheads 3 variable 8., ...
Total Aariable 'ost #F-.,...%
+ontribution ZSa!es H Tota! 1ariab!e +ost[ ?:*,***

Aariable 'ost "er Unit ; F-.,... 1/, ..,... ; ,s.F.-.
'ontribution "er Unit ; 7-.,... 1/, ..,... ; ,s.7.-.

4or+ing )ote )o. D
Total Fi+!d Cost(
"roduction overheads 0 ,s.E.., ...
Administration overheads 0 ,s./-., ...
: M 2 @verheads 0 ,s./-., ...
Total fi$ed costs 0 ,s.F.., ...
1# Aount of sa!es reBuired to earn a target %rofit of ):J on sa!es after i%ro/ing the %acking:
"resent variable cost per unit T4or+ing )ote )o./U ; ,s.F.-.
Additional cost of improvement in pac+ing ; ,e./...
,evised variable cost per unit ; ,s.I.-.
,evised contribution per unit ; ,s.I.-.
"rofit1volume ratio ; ,s.I.-.1,s./- P /.. ; -.K
=et B is the amount of sales to earn desired profit, the amount of sales will be computed with
the help of the following formula
: ; (i$ed 'ost O 2esired "rofit 1"rofit1Aolume ,atio
Therefore ; ,s.F.., ... O .D-1-.K ; ,s.D, 5.., ...
)ote0 Total fi$ed cost is given in 4or+ing )ote )o.D
Amount of sales reuired to earn the profit is ,s.D, 5.., ... and the amount of profit is ,s.F..,
.. TD-K of salesU

1>=

)# 6/a!uation of %urchase offer b& a !arge retai!er: (* *** units, additiona! %acking cost of 3s") %er unit
"resent variable cost per unit 0 ,s.F.-.
=ess0 : M 2 @verheads 0 ,s...8.
Add0 "ac+ing e$penses 0 ,s.D...
3e/ised /ariab!e cost %er unit : 3s">"=*
The current selling price is ,s./- per unit and after considering the revised variable cost, the
contribution per unit wor+s out ,s./- 3 ,s.I.F. ; ,s.I.5.. :ince the fi$ed costs are not going to increase,
there will be additional contribution of E. ... units P ,s.I.5. ; ,s.DDD, ... which will the additional
profit and hence the offer can be accepted. The brea+ even price for this offer will be ,s.I.F. per unit,
which is eual to the variable cost per unit.
(# 6/a!uation of %ro%osa! of incurring additiona! ad/ertising e0%enses of 3s"(, **,***
.articu!ars Aount Z3s"[
,evised :elling "rice per unit /7...
=ess0 variable cost Twor+ing note no./U per unit F.-.
'ontribution per unit //.-.
Total contribution 0 /D., ... P ,s.//.-. ; /, E7., ...
=ess0 (i$ed cost0 'urrent ,s.F.., ...
Addl. &$penditure on Advertising ,s.E.., ... #8.., ...%
.rofit 7?*,***
:ince the amount of profit has increased from the present ,s.D-., ... to ,s.57., ... the e$penditure
on advertising is justified.
7# 3eduction in se!!ing %rice for increasing ca%acit& uti!i9ation to 1**J
.articu!ars Aount 3s"
)ew selling price per unit /E...
=ess0 variable cost per unit F.-.
'ontribution per unit F.-.
Total 'ontribution /-.,... units P ,s.F.-. ; 8I-, ...
=ess0 (i$ed cost #F.., ...%
.rofit (>:,***
6t can be seen that the e$isting profit can increase by reducing the selling price up to ,s./E per unit and
thus increasing the capacity utili<ation to /..K and hence the proposal is justified.

Z60a%!e: ))[
A company produces E., ... units of product A and D., ... units of product G per annum. The sales
value and costs of the two products are as follows0
:ales value ,s.IF., ..., (actory overheads0 ,s./8., ..., 2irect material0 ,s./5., ..., Administrative and
selling overheads0 ,s./D., ..., 2irect labour0 ,s/8., ...
-.K of the factory overheads are variable and -.K of the administrative and selling overheads are fi$ed.
The selling price of A is ,s./D per unit and ,s.D. per unit for G.
The direct material and labour ratio for product A is D0E and for G is 50-. (or both the products, the
selling price is 5..K of direct labour. The factory overheads are charged in the ratio of direct labour and
administrative and selling overheads are recovered at a flat rate of ,s.D per unit for A and ,s.E per unit
for G. 2ue to fall in demand, of the above products, the company has a plan to diversify and ma+e
product ' using 5.K capacity. 6t has been estimated that for ' direct material and direct labour will be

1>>

,s.D.-. and ,s.E per unit respectively. @ther variable costs will be the same as applicable to the product
A. The selling price of product ' is ,s./5 per unit and production will be E. ... units.
Assuming F.K capacity is used for manufacture of A and G, calculate,
6U "resent cost and profit
66U 'ost and profit after diversification
666U Give your recommendations as to whether to diversify or not.
olutio"(
I[ Stateent sho8ing .resent +ost and .rofit
.articu!ars .roduct A .roduct ; Tota!
"roduction and :ales TunitsU E.... D.... -....
:ales value EF.... 5..... IF....
Aariable 'osts0
2irect material F.... 7.... /5....
2irect labor 8.... /..... /8....
(actory overheads 5-... -.... 8-...
Administrative M selling overheads E.... E.... F....
Total variable costs DD-... DF.... #57-...%
+ontribution 1(:*** 17**** )>:***
(i$ed 'osts #/--...%
.rofit 1)****

II[ Stateent sho8ing +ost and .rofit after ,i/ersification
.articu!ars .roduct A .roduct ; .roduct +
'apacity levels =*J =*J 7*J
"roduction and :ales TunitsU /7... /D... E....
:ales value D/F... D5.... 5D....
Aariable 'osts0
2irect material EF... 57... I-...
2irect labor -5... F.... 8....
(actory overheads DI... E.... 5-...
Administrative M selling overheads /7... /7... E....
Total variable costs #/E-...% #/-F...% #D5....%
+ontribution ?1*** ?7*** 1?****

.articu!ars Aount
'ontribution0
"roduct A 0 ,s.7/, ...
"roduct G 0 ,s.75, ...
"roduct ' 0 ,s./7., ...
Tota! contribution (7:, ***
R!comm!"datio"( The 'ompany should implement the proposed diversification as it has resulted into
increase in the profit from ,s./, D., ... to ,s./, 8., ...

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