Concepts

ADVANCED MANAGEMENT
ACCOUNTING

Contents
Chapter No. Chapter Name Page No.
1 Assignment Techniques 1–4
2 Transportation Techniques 5–9
3 Linear Programming 10 – 15
4 CPM & PERT 16 – 21
5 Learning Curve 22 – 23
6 Simulation 24 – 24
7 Activity Based Costing 25 – 26
8 Service Sector Costing 27 – 27
9 Standard Costing 28 – 36
10 Budgetary Control 37 – 38
11 Marginal Costing 39 – 40
12 Relevant Costing 41 – 42
13 Transfer Pricing 43 – 44
14 Pricing Decisions 45 – 46

C.A. Mohit Arora

© Mohit Arora
All rights reserved. No part of this publication may be reproduced or transmitted, in any form or by any means
of electronic, mechanical & photocopying or otherwise, without the prior permission from the Author.
 Advanced Management Accounting CA. Mohit Arora Classes

ASSIGNMENT TECH
TECHNIQUES

MEANING:
Assignment technique is a procedure ure used for solving special kind of Linear programming
ing problems having
one to one relationship.
With the above definition following ththree things have been arisen:
gramming technique.
(i) It is an extension of linear progra
rogramming problems can be solved with the help off this
(ii) Only special kind of Linear prog th technique. (i.e.
work assignment)
(iii) One to One relationship is a n necessity for application of Assignment technique.. (each
( job is to be
assigned to workmen on one to one basis i.e. jobs cannot be separated in otherr wordswo a single job
cannot be done by more than an one workman as well as a workman cannot do more m than one job
simultaneously).

SOME IMPORTANT FACTS TO

OBBE KNOWN BEFORE USING ASSIGN
NMENT TECHNIQUE

(i) What we will exactly do in assissignment technique:

Standard model of assignmentt is designed for work allocation. It says that if we have
ave a number of jobs
to do say J-1; J-2; J-3; and J-4;
4; and on the same time we have a number of workme men also say A-1; A-
workman can do each job then our task in assignment problem
2; A-3; and A-4; and every workm pr is to assign
ssignment.
these jobs to above workmen so that we can gain optimum benefit out of such assign

(ii) Objective:
Our objective while assigning
g th
these jobs to different workmen is optimization of benefit
b out of this
assignment. Here optimization
nmmeans minimization of cost or maximization of profi
rofit according to the
facts given in the problem.

(iii) Conditions to be fulfilled:

One to One Relationship.

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PROCEDURE FOR SOLVING ASSIGNMENT PROBLEMS:

(May 2013)
Procedure of solving assignment problems can be understood with the help of flow chart given below. This
flow chart shows the procedure for solving simple assignment problems:

START

MINIMISATION CONVERT
NO
YES

BALANCED INSERT DUMMY

NO
YES

INITIAL SOLUTION
Have at Least one “0” in each row and
each column.
Say Row & Column Operations.

Draw minimum number of lines (whether

horizontal or vertical) to cover maximum
possible zeros.

IF No. of lines =
IMPROVE
order of matrix
NO

YES

FINAL SOLUTION
ASSIGN

END
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1. Row Operations And Column Operations Steps:

 Row Operations
(i) Locate smallest value given in each row.
(ii) Deduct this smallest value of each respective from every element of such row.
(iii) Now we will have at least one “0” in each row.

 Column Operations
Repeat the above steps with columns also, to get at least a single “0” in each column.

2. Assignment steps

(i) Locate any row or column having only single “0”

(ii) Make it assigned by putting a box over it.
(iii) Cancel all the “0” in any row or column corresponding to this assigned cell.
(iv) Repeat the above steps with the remaining cells, until complete assignment is over.

3. Maximization problem i.e. instead of cost data, profit data is provided.

Solution: Conversion
Procedure: Steps
(i) Locate maximum value from the entire matrix
(ii) Deduct each value of the matrix from this value.
(iii) Resulting matrix will be a minimization matrix.
(iv) Now apply normal procedure to solve this matrix.

4. Unbalanced problem i.e. No. of workmen and No. of Jobs is not same.

Solution: Insert dummy Row or Column.

5. Improvement where no. of lines drawn is not equal to the order of matrix Solution:

Steps
(i) Locate minimum value from uncovered cells.
(ii) Deduct it from the value of every uncovered cell.
(iii) Add it to the value of cells at intersection of lines.

With the above procedure we can improve the matrix and after improvement we will repeat all the steps
from drawing the lines again until we get no. of lines equal to the order of matrix.

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SOME SPECIAL CASES IN ASSIGNMENT PROBLEMS

(1) Prohibited Assignment: Sometimes in assignment problems there may be a restriction that may
require as a particular work cannot be assigned to a particular person. In those problems one should
put “M” in the cell of the prohibited assignment so that the cell should not be considered while making
final solution. (November 2009)

(2) Particular Assignment: Sometimes an assignment problem may require that a particular type of
work should be given to a particular person. In these problems all the rows and columns related to
specific assignment should be deleted from the matrix, and above process of solving assignment
problems should be done with remaining matrix.

(3) Multiple Solutions: Sometimes while assigning jobs from the final matrix we may not find any row or
column with single “0”. In these cases we can choose any one “0” for the purpose of assignment, but
sometimes in these situations there may be clashes of “0”. This type of situation is called multiple
optimal solution case, and in these situations, there exist more than one optimal solution having equal
answer, though internal assignments may change.

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TRANSPORTATIO
ATION TECHNIQUES

MEANING:
Transportation technique is a proce
ocedure used for solving special kind of Linear progra
gramming problems
having one to many relationship.

With the above definition following ththree things have been arisen:
(i) It is an extension of linear progra
gramming technique.
(ii) Only special kind of Linear prog
rogramming problems can be solved with the help off this
th technique. (i.e.
Transportation between factories
ries and warehouses)
(iii) One to Many relationship is a n necessity for application of Transportation technique.
ue. (transportation is
done on one to many basis i.e. from a factory there may be transfers to many warehouses
war and vice
versa).

SOME IMPORTANT FACTS

STTO BE KNOWN BEFORE USING TRAN
ANSPORTATION
TECHNIQUE

1. What we will exactly do in trans

ransportation technique:
Standard model of transportatirtation is designed for making schedules of transpo sportations between
factories and warehouses. It says that if we have to transport some items from a num
umber of factories to
a number of warehouses or sa sales centers by meeting their demand and supply y restrictions
re and by
taking different costs of transpo
sportation between various places in to consideration,
ion, then our task in
transportation problem is to tran
ransport these items in such a way so that we can gain
gai optimum benefit
out of such transportation.

2. Objective:
Our objective while transporting
ing these items is optimization of benefit out of this
s transportation.
tra Here
optimization means minimization
tion of cost or maximization of profit according to the
he facts given in the
problem.

3. Conditions to be fulfilled:

One to Many Relationship.

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PROCEDURE FOR SOLVING TRANSPORTATION PROBLEMS:

Procedure of solving transportation problems can be understood with the help of flow chart given below:

START

INSERT DUMMY
BALANCED
NO
YES

MINIMISATION CONVERT
NO
YES

INITIAL SOLUTION
(i) North West Corner Rule
(ii) Least Cost Method
(iii) Vogel Approximation Method (VAM)

Rows + Columns – 1= REMOVE

No. of allocations NO DEGENERACY

YES

(i) Calculate Ui & Vj for transported cells, such as cost of

transported cell = (Ui + Vj) of that cell
(ii) Calculate ∆ij for untransported cell, such as
∆ij of untransported cell = cost of that untransported
cell - (Ui + Vj) of that cell

NO
IMPROVE All ∆ ij’s are positive

YES

FINAL SOLUTION

END

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1. Initial Solution: ( This is not supposed to be final solution)

 North West Corner Rule (Ad-Hoc Rule)

(i) Start making allocations from the top left corner of the matrix by following demand and supply
restrictions. Cost figures given in the question are not relevant for arriving at initial solution under
this method.
(ii) Gradually eliminate the rows or columns for which demand or supply exhausted, and repeat the
above steps with remaining cells.
(iii) By following above steps we can arrive at the initial solution under North West corner rule.

 Least Cost Method (Based On Cost Approach)

(i) Start making allocations from the cell having least cost in overall matrix by following demand and
supply restrictions.
(ii) Gradually eliminate the rows or columns for which demand or supply exhausted, and repeat the
above steps with remaining cells.
(iii) By following above steps we can arrive at the initial solution under least cost method.

 Vogel’s Approximation Method (Based On Opportunity Cost Approach & Preferable For Exams)
(i) Calculate difference between minimum and second minimum (i.e. penalty) value for each row and
each column.
(ii) Select maximum overall penalty value and make an allocation at the cell having minimum cost,
corresponding to row or column having such highest penalty.
(iii) Gradually eliminate the rows or columns for which demand or supply exhausted, and repeat the
above steps with remaining cells.
(iv) By following above steps we can arrive at the initial solution under VAM.

NOTE:
 Tie between Penalties: Criteria for selection, minimum cost cell from the rows or columns having
equal maximum penalties.
 Tie between Minimum costs: Criteria for selection, Cell having maximum number of
transportations from the cells having equal minimum costs.

2. Maximization problem i.e. instead of cost data, profit data is provided.

Solution: Conversion
Procedure: Steps
(i) Locate maximum value from the entire matrix
(ii) Deduct each value of the matrix from this value.
(iii) Resulting matrix will be a minimization matrix.
(iv) Now apply normal procedure to solve this matrix.

3. Unbalanced problem i.e. Demand units and supply units are not same.

Solution: Insert dummy Row or Column with “0” costs and having balance demand or supply.

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4. Removal of Degeneracy
Steps:
(i) Locate a cell having minimum cost from untransported cells.
(ii) Make sure that there is not any loop possible from that cell.
(iii) Make it transported by putting an insignificant value “e” nearer to “0”.
(iv) Degeneracy will be removed.

5. Improvement where any ∆ ij value is ‘ –ve’:

Steps:
(i) Select maximum ‘- ve’ ∆ ij value.
(ii) Make a loop from this cell.
(iii) Put +, - signs alternatively on the corners of loop, start with (+) at maximum ‘-ve’ ∆ij value corner
of the loop.
(iv) Select minimum value of transportations from the corners having ‘-ve’ signs and add this value in
the value of transportations having positive sign, and deduct it from the value of transportations
having negative sign.
(v) Resulting matrix will be the improved matrix.

SOME SPECIAL CASES IN TRANSPORTION PROBLEMS

(1) Prohibited Routes: Sometimes in transportation problems there may be a restriction that may require
as from a particular factory, there cannot be any transportation to a particular warehouse. In those
problems one should put “M” near to “∞ ” in the cell of the prohibited transportation so that the cell
should not be considered while making final solution. (November 2013)

(2) Particular Transportation: Sometimes a transportation problem may require that there should be
some transportation from a particular factory to a particular warehouse. In these situations we have to
use following steps:
(i) Direct Specific: Allocate the required no of units to that particular cell. Deduct these units from
both (demand and supply) sides in the matrix. Solve the remaining matrix by applying VAM. For
checking optimality (Calculation of Ui and Vj & ∆ij ) do not consider specifically allocated cell. Insert
this specifically allocated cell into the solution only.

(ii) At Least case: Don’t make the required cell transported with the “at Least Qty.” Only deduct this
qty. Deduct these units from both (demand and supply) sides in the matrix. Solve the matrix by
applying VAM. For checking optimality (Calculation of Ui and Vj & ∆ ij ) do not take “at Least qty.
cell” in to consideration, if there is not any allocation other than at least allocation in that particular
cell. Insert this specifically allocated cell into the solution only.

(iii) Maximum case: Solve the matrix by applying VAM, if specific maximum cell got no allocation, or
allocations which are less than such maximum limits, no problem, but if this cell have allocations
more than maximum allocations allocate only the maximum units suggested by the question, and in
later situation do not take this cell into consideration during optimality check .

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(3) Multiple Solutions: Sometimes in final solution we may find one or more ∆ij values equal to “0” this
indicates the problem have more than one optimum solution having equal answers. No. of alternative
solutions will always be equal to no. of “0” ∆ij values in the final solution. Steps to arrive at alternative
solution from the final solution:
(i) Select any ‘0’ ∆ ij value cell.
(ii) Make a loop from this cell.
(iii) Put +, - signs alternatively on the corners of loop, start with (+) “0” ∆ij value corner of the loop.
(iv) Select minimum value of transportations from the corners having ‘-ve’ signs and add this value in
the value of transportations having positive sign, and deduct it from the value of transportations
having negative sign.
(v) Resulting matrix will be the alternative solution.

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LINEAR PROGRAM
RAMMING

MEANING:
Linear Programming is a mathemat atical technique. It is used to solve inequations havin
aving more than one
is technique is used to solve the problems having more
variable. In operations research this ore than one limiting
factor (Key factor). In these typess oof problems generally we see “Many to Many” relationship
rela between
int of view of examination we can broadly classify
different variables. From the point y the
t question in to
following two parts:

Linear Programming Problems

Formulation Solution

FORMULATION:
Formulation of linear programming gpproblems is quite easy. One should know basic fund
undamentals of class
10 regarding formulation of linearr eq
th equations for formulating linear programming problem
ems. We can broadly
classify tasks of formulation into three
ree different parts.

(i) Objective Function: In this functi

nction we identify the objective for a linear programmin
ming problem. It may
be maximization of profit or minim
inimization of costs. Objective function is denoted with
th alphabet
a “Z”.

(ii) Constraints: These functions rest

restrict the scope of linear programming problems. These
The functions show
sources. We have to follow these restrictions in the course
the limited availability of resour co of achieving
objective of the problem. Genera
erally we find inequations as constraints function.

(iii) Non negative restriction: This rest

restriction limits the scope of solution of a linear progra
gramming problem. It
says that solution of a linear pro
programming problem cannot be negative. It can be “0” or more than “0”,
but it can not be in negative.

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SOLUTION:
We can find out the solution of liner
er p
programming problem by using following three metho
thods:

Solution of L.P.P.

Graphical Trail & Error Simplex

GRAPHICAL METHOD:
We can solve with this method onlyly tthe problems having two variables or a problem with
th three
t variables
and having at least one “equal to” rest
restriction.

STEPS:
(i) Draw lines for each inequation noof constraint functions.
(ii) Shade the appropriate region acco
according to “less than” or “more than” restriction.
(iii) Find extreme points of the shad
aded region.
(iv) Find values of X and Y at differe
ferent points located above.
(v) Put these values in objective fun
function one by one.
(vi) Select the maximum or minimu imum value of the objective function as per requiremen ment of the objective
function.
(vii) Values of X and Y giving highest
hest/ least value of the objective function will be the answe
nswer.

TRAIL & ERROR METHOD

OD:
We can solve with this method only
ly tthe problems having two variables.

STEPS:
(i) Insert Slack or surplus variablele as per the requirements of the question.
(ii) Put any two values equal to “0” in each of the constraints function, and compute other
ot two values by
solving the equations.
(iii) Repeat above trail (problem havi
having two variables will have 6 such trails)
(iv) Put the values so computed in e each trail in the objective function consecutively.
(v) Trail giving the highest/ least ou
outcome will be the answer of the problem.

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SIMPLEX METHOD:
 Slack Variable: This is also can be termed as idle resource or unused capacity. This variable is introduced
with “less than or equal to” restrictions to convert it into “equal to” restriction. This variable is useful in
solving LPP with “Simplex” and “Trail & Error” Method. We generally denote this variable by using “S”. This
variable will have ‘+’ sign coefficient.

 Surplus Variable: This is also can be termed as extra benefit or additional gain. This variable is introduced
with “More than or equal to” restrictions to convert it into “equal to” restriction. This variable is useful in
solving LPP with “Simplex” and “Trail & Error” Method. We generally denote this variable by using “S”. This
variable will have ‘-’ sign coefficient.

 Artificial Variable: This is a variable having no existence. This variable is introduced only to start solution
under simplex method. This variable is with “Surplus variable” in the problems having “More than or equal
to” and “Equal to” restrictions. We generally denote this variable by using “A”. This variable will have ‘+’ sign
coefficient in constraint functions and in objective function, It will have “M” or “-M” in minimization and
maximization problems respectively. When artificial variable becomes outgoing variable it will not come
again in the simplex table.

FORMAT OF INITIAL SIMPLEX TABLE:

Objective Function

Cj
Basic variable Quantity X1 X2 S1 S2 Ratio
S1
S2
Zj
Cj - Zj

Constraint Function

STEPS SIMPLEX METHOD: (MAXIMISATION PROBLEMS)

(i) Introduce Slack variables (Generally Maximization problems have “less than or equal to restrictions.)
(ii) Set up initial simplex table.
(iii) Calculate Zj Row: Zj for each column =∑ ( Cj column X values of respective column)
(iv) Calculate (Cj - Zj)Row = Cj Row - Zj Row
(v) Select MAXIMUM POSITIVE value from (Cj - Zj)Row.

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(vi) Column corresponding to this value will be “Key Column”.

(vii) Variable of Key column will be incoming variable.
(viii) Calculate ratio = Quantity column / Key column.
(ix) Select MINIMUM POSITIVE ratio.
(x) Row corresponding to such minimum positive ratio will be “Key Row”.
(xi) Variable of key row will be outgoing variable.
(xii) Intersection point of key row and key column will be “Key Element”.
(xiii) Prepare II simplex table.
(xiv) New Row for Key Row = ( Old row for key row) / (Key element)
(xv) New row for Non Key Row = (Old row for non key row) – [(New row for key row) X (Element
corresponding to key element in non key row)]
(xvi) Repeat step (iii) & (iv) again
(xvii) Check is there any positive value in (Cj - Zj )Row (excluding ‘0’)
(xviii) If answer to above question is ‘no’ then it is a final solution
(xix) If answer is ‘yes’ then Repeat steps (v) to (xvii) again and again until answer to question in step (xvii)
above is ‘yes’.

STEPS SIMPLEX METHOD: MINIMISATION PROBLEMS

(i) Introduce Surplus variables & Artificial Variables (Generally Minimization problems have “more than
or equal to restrictions.)
(ii) Coefficient of artificial variable will be “M” in the objective function.
(iii) Set up initial simplex table.
(iv) Calculate Zj Row: Zj for each column =∑ ( Cj column * values of respective column)
(v) Calculate (Cj - Zj )Row = Cj Row - Zj Row
(vi) Select MAXIMUM NEGATIVE value from (Zj - Cj)Row.
(vii) Column corresponding to this value will be “Key Column”.
(viii) Variable of Key column will be incoming variable.
(ix) Calculate ratio = Quantity column / Key column.
(x) Select MINIMUM POSITIVE ratio.
(xi) Row corresponding to such minimum positive ratio will be “Key Row”.
(xii) Variable of key row will be outgoing variable.
(xiii) If any artificial variable is an outgoing variable, then it will not be incoming variable in
subsequent simplex tables. So we will not do any further calculation for such variable in next
table. We will delete this variable from next and subsequent simplex tables.
(xiv) Intersection point of key row and key column will be “Key Element”.
(xv) Prepare II simplex table.
(xvi) New Row for Key Row = ( Old row for key row) / (Key element)
(xvii) New row for Non Key Row = (Old row for non key row) – [(New row for key row)* (Element
corresponding to key element in non key row)]
(xviii) Repeat step (iv) & (v) again
(xix) Check is there any negative value in (Cj - Zj )Row (excluding ‘0’)
(xx) If answer to above question is ‘no’ then it is a final solution
(xxi) If answer is ‘yes’ then Repeat steps (vi) to (xix) again and again until answer to question in step (xix)
above is ‘yes’.

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SOME SPECIAL CASES IN LINEAR PROGRAMMING PROBLEMS

1. Inequations In Reverse Direction:
Generally we see in linear programming problems, “Maximization” problems have “less than or equal to”
restrictions and, “Minimization problems” have “More than or equal to” restrictions. Where These conditions
do not exists we will say it as inequations in reverse or wrong direction (i.e. “Maximization problems with
more than or equal to restrictions”, or “Minimization problems with less than or equal to restrictions”). In this
case all steps of simplex method will apply in solution except coefficient of artificial variable will be “-M”
instead of “M” in maximization problems.

2. Unbounded Solution:

In graphical method where we are not able to identify extreme

points to arrive at solution due to absence of upper bounds of
the shaded region we can say, the problem is having
unbounded solution. We can understand this problem with the
help of graph alongside. In simplex method where, all values
in the ratio column are negative than we can say that the
problem have unbounded solution. We have to insert upper
bounds in the problem if we want to solve the problem. But it
there is not any upper bound, then the problem cannot be
solved further.

3. Not Feasible Solution:

In graphical method where, there is not any common feasible

area which can satisfy all the constraint function, we can say
there is not any feasible solution for the problem. In simplex
method where artificial variable remains in the final solution,
the problem will not have any feasible solution. (i.e. the
problem cannot be solved altogether.)

4. Multiple Solutions:
It is a case where a problem has more than one optimal solution (i.e. answer will be same under all the
alternatives). In graphical method we can easily identify alternate solutions, as answer will be same at two
or more extreme points. In simplex method where (Cj - Zj ) Row value is “0” for “Non- basic variable”,
alternate solutions exist. We will arrive at this alternative solution by considering, the column having (Cj - Zj)
Row value “0” as key column and thereafter preparing the next simplex table by repeating the steps of
simplex table.

5. Degeneracy:
Where there is tie between two minimum values in the ratio column of a simplex table and we are unable to
choose minimum positive value, this type of a problem is regarded as degeneracy. Unlike transportation

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problems we need not to remove this degeneracy, but here we can choose any value arbitrarily from
abovementioned values and the degeneracy will be removed automatically from the problem.

6. Primal Dual Relationship:

All linear programming problems can be reformulated by an another way also. In this situation the solution
of both the problems will be same. Here the main problem will be said as primal problem and the
reformulated problem will be said its dual problem. By applying following rules we can restate the primal
problem as dual problem:
(i) Maximization problem will become minimization problem and vice versa
(ii) Objective function will become constraint function and vice versa
(iii) Rows will become columns and vice versa
(iv) “less than or equal to” restrictions will become “more than or equal to restrictions” and vice versa.

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CPM & PERT

CRITICAL PATH ANALYSI

SIS (MEANING):
Critical Path analysis is a technique
ue used for project planning, monitoring and control. This
Th technique helps
ing, Control and Management (such as estimation off the
us in different areas of Cost planning th project duration,
monitoring the flow of the project,
ct, p
planning the requirement of resources, and make ke sure
su whether such
resources are being used efficiently
tly o s for different projects.
or not, etc.) by creating simple Network diagrams
Now, we should discuss something gaabout Project and Network diagrams.

1. Project: It is any task or workk tha s known

that can be subdivided into smaller tasks or modules kn as activities,
in such a way so that each activi n of
ctivity can be performed independently and completion o each activity will
show certain stage of completiontion of the project.

2. Network: Network is diagrammic mic presentation of the project. In the network diagra gram we present the
flow of project (from starting to
oe end), as well as the flow of individual activities and their
the correlation with
other activities, with the help off a
arrows and nods, called as activities and events respespectively.

Not
Notations used in a Network Diagram

Event

Activity Duplicate Activities

Act Sequential
ctivities
acti

Network Diagram

Initial Event Termin

minal Event

nt activities
Concurrent

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Tail event Head event Dummy Activity

Burst Event Merge Event

RULES OF PREPARING NETWORK DIAGRAM

(1) Path flows from left to right.
(2) Time flows always forward and not backward.
(3) Activities are shown by using Arrows and Events are shown by using Nods.
(4) Curves should not be used while presenting activities, banded lines can be used instead of curves.
(5) Duration of activity has not any connection with the length of line representing such activity.
(6) There should be only one initial event and one terminal event.
(7) Head event should have greater numeric value than tail event.
(8) There should not be any looping in the network diagram. i.e.

This network is incorrect.

(9) Crossing should be avoided in network, if unavoidable use bridge.
For example: prepare network diagram.

Activity Preceding Activity

A --
B --
C --
D A, B
E B
F B
G F, C
H B
I E, H
J E, H
K C, D, F, J
L K

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K
D 7 8
3 J L
A
E 6 I
B
1 2 H 4 9

F
C G
5

(10) Use of dummy Activity.

In the following situations we will introduce dummy activity:

 To connect loose ends.

Incorrect figure Correct figure

 To remove duplicity.

Incorrect figure Correct figure

 For correct successor & predecessor relationship.

Activity Preceding activity

A --
B A
C A
D B
E C
F C, D
G D

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D
B 3 5
G
A 2
1 6 F
C 7

4
E

Note: Number of dummies should be kept minimum.

OTHER IMPORTANT TERMS OF NETWORK DIAGRAM
1. Critical Path
This is the minimum time required to complete the project.
In a project network, we have to find out various ways (paths) to reach the terminal event from the initial
event.
Then add the durations of activities falling at each path to find out the duration of each path separately.
The path having longest duration, from the durations of all the paths calculated above, will be the critical
path.

2. Earliest Occurrence Time (EOT) & Latest Occurrence Time (LOT) for events.

EOT: For calculating EOT for a particular event, (forward pass computations)
 Identify all the paths approaching to that event from the initial event.
 Calculate duration of each of such path.
 Maximum from the above durations, will be the EOT of that particular event.

LOT: For calculating LOT for a particular event, (backward pass computations)
 Identify all the paths approaching to that event from the terminal event. (reverse way)
 Calculate duration of each of such path.
 Deduct these durations from the LOT of the immediate preceding event. (reverse way)
 Minimum from the above values, will be the LOT of that particular event.

3. Earliest Start Time (EST), Latest Start Time (LST), Earliest Finish Time (EFT) & Latest Finish Time
(LFT) for activities.

EST = EOT of tail event.

EFT = EST + Duration of the activity for which EFT is to be calculated.
LFT = LOT of head event.
LST = LFT – Duration of the activity for which LST is to be calculated.

4. Floats:
 Total Float: Total time lag available at a particular activity.
TF = LST – EST or LFT – EFT
 Free Float: That part of total float, that can be used without affecting the float of succeeding activity.
FF = TF – Slack of head event or “0” whichever is higher.

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CA. Mohit Arora Classes Advanced Management Accounting

 Independent Float: That part of total float, that can be used without affecting the float of preceding
activity.
IF = FF – Slack of tail event or “0” whichever is higher.
 Interfering Float: That part of total float, that will hamper the float of other activities, if used for an
activity.
INF = TF – FF.

Note: Critical Path has no floats.

PERT
Since PERT is a Probabilistic Model, we will be provided with different estimates of the duration of project
completion. We have to identify estimated duration with different, to arrive at the critical path. Following
formulae are generally used in PERT:

 Te (Estimated duration) = To + 4Tm + Tp

6
 Variance of an Activity = [(Tp - To ) / 6]2

 Ϭ of an activity = √(variance of the activity)

 Variance of a Project = Total of all the Variances of the Activities on critical path.

 Ϭ of the Project =√(variance of the Project)

 Value of Z = X–X
Project Ϭ
From the value of Z calculated with the help of above formula we can easily find out the probability of
completion or non completion of a project at a given time.

PROJECT CRASHING
Project crashing is a technique of shortening the duration of the project. With this technique we can arrive
at the optimum duration and minimum duration of the project. We generally use following terms in project
crashing:
 Normal Time (NT): It is the time required for completing an activity without crashing.
 Crash Time (CT): It is the time required for completing an activity after crashing.
 Normal Cost (NC): It is the direct cost relating to an activity without crashing.
 Crash Cost (CC): It is the direct cost relating to an activity after crashing.
 Indirect Cost: It is the cost of Project relating to the duration of the project. i.e. It increases and
decreases with the length of the project. Our aim in project crashing is to reduce these indirect costs by
way of project crashing.
 ∆T = NT – CT
 ∆C = CC – NC
 Cost slope (cost of crashing per day) = ∆C / ∆T

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STEPS FOR CRASHING:

(i) Calculate∆T, ∆C and Cost slope for each activity.
(ii) Identify critical path of the network. We will gain the benefits of crashing only by the way of shortening
the length of critical path only. So we have to crash the activities o critical path.
(iii) We will select the activity having least cost slope, from the activities on critical path.
(iv) Crash the activity selected above in such a way that critical path should remain critical path.
(v) By this way we will be able to cut the duration of the project. We can also have benefits of crashing as
initially direct cost incurred due to crashing will always be less than the indirect cost saved.
(vi) We should repeat the abovementioned steps until saving in indirect cost is stopped, if the crashing is
self initiated, but where the crashing is due to pressure of meeting deadlines, than we will continue with
crashing until minimum duration is reached. At minimum duration total cost of the project may increase
instead of decreasing.
(vii) If there are two or more critical paths in the questions, we will crash all the critical paths simultaneously
by making suitable combinations of the activities on different critical paths.

RESOURCE SMOOTHING & RESOURCE LEVELING

This concept is directly related with efficient utilization of resources. In resource smoothing, although we
have a plenty of resources but we want to smoothen their use, so that wastage of resources can be
minimized. In resource leveling we want to smoothen the usage of resources certainly, but not at the cost of
project delay and compromising with the quality. So we will not increase the duration of the project.
On the other hand in resource leveling we have resources in limited quantities and we have to complete the
project with these limited resources. So in resource leveling the ultimate impact will be on project duration,
the project will get delayed due to non availability of resources.

STEPS:
(i) Convert network diagram into time scaled diagram.
(ii) Try to shift concurrent activities by using the floats available on each activity, without delaying the
project. If it is possible than the case will be the resource smoothing case.
(iii) If it is not possible to complete the project on time due to unavailability of resources than we have to
increase the duration of the project, this situation will be termed as resource leveling.

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LEARNING CURVE

MEANING:
Learning curve concept says when n we start a new work, we are not familiar to the process,
cess, so that the cost
initial level, but gradually it falls down. So the concept
and time involved is very high at ini cept says while doing
sion making we should take in to consideration these reduced
costing, pricing, control and decision re costs also.
Learning curve concept applies in the following situations:

(i) Work is new.

(ii) Workman is new.
(iii) Process (method) is ne
new.

It applies only on manual labour ur and not on mechanical labour. (Machines do not n have learning
nu
tendencies). It generally applies on unskilled labour and not on skilled labour (exception:
on: If the work is new
or the process in new then learningg cu
curve can apply on skilled labourers also.)

oduction is doubled a learning rate applies.

Concept: When every time produc

Learning curve ratio (LCR) = Average

age time or cost for producing first 2N units / batches
Averag
rage time or cost for producing first N units / batches

STEPS:
1. With The Help Of Learning Curve ve Series:
In this case problem is given in such
ch a way, so that solution can be arrived at within the
e series
se only. We just
only need a certain learning curve ve series (i.e. No. of units or batch size) and learnin
rning curve ratio. By
applying learning curve ratio in thee se
series we can arrive at the desired solution. Format at of learning curve
table is given below:

Units/ Batches (i) Average time p.u/ Total time / total cost Marginall time /
Average cost p.u. (ii) (iii) Marginall cost
co (iv)
Initial Unit Initial time/
e/ ccost P.U. Initial time/ cost P.U. Initial time/
e/ cost P.U.
Previous entry x 2 Previouss en
entry x LCR (i) x (ii) (iii) – Previ
evious entry

22 Concept Book
 Advanced Management Accounting CA. Mohit Arora Classes

2. With The Help Of Formula:

If it is not possible to compute the desired value with the help of formula, as the desired value is not within
the learning curve series, then we can use following formula to solve the problem:

Yx = K (X)s

Where,
Yx = Average cost/ time p.u. for producing X units/ batches
K = Average cost/ time p.u. for producing first unit/ batch
S = Log LCR
Log 2

Some other useful formulae in log

(i) Log (ab) = Log a + Log b
(ii) Log (a/ b) = Log a – Log b
(iii) Log (a)b = b Log a

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CA. Mohit Arora Classes Advanced Management Accounting

SIMULATION

MEANING:
Simulation means to create and testest a small prototype of a large population to identifntify the behavior of
ns relating to such large population can be made easi
population so that various decisions asily with the help of
ototype or sample. In operations research we generall
such relatively small simulated proto rally use probabilistic
model of simulation called Monte CaCarlo simulation, which is very helpful for solving prob
roblems in uncertain
situations.

STEPS:
(i) Determine the objective for the simulation. There may be some objectives like maxi aximization of return
on investment (ROI), or minimiimization of inventory holding cost, stock out of situation
tions etc.
(ii) Indentify the variables that hahave significant influence on the objective e.g. variabl
iables of ROI can be
Sales, cost of sales and Invest
estment etc.
(iii) Determine probabilities of occuoccurrence of various events or factors that may y affect
af the result of
simulation.
(iv) Set up Random No. table.
• Write down the situationss tthat may occur as a result of simulation and their rela elative probability.
• Compute cumulative proba obability for every event or situation.
• Set up range for random om nos. on the basis of such cumulative probability ity computed above.
Range for random nos. ma may vary from 0 – 99 depending upon the cumulative ve probability
p for each
event or situation.
(v) Set up simulation table.
• Identify the size of trailss to be taken for predicting the behavior of population..
• Select Random Numbers rs ffor each such trail.
• Locate the random nos. s. in the range set up in the random no. table drawn above
bove.
• Take the value related to th the range of random nos. identified above as a value ue of trail.
• Take any measure of cent central tendency (i.e. Mean, Median, Mode) as per the e requirement
r of the
situation, for predicting the behavior of population.
• Validate the result find out in the simulation table.

24 Concept Book
 Advanced Management Accounting CA. Mohit Arora Classes

ACTIVITY BASED COSTING

MEANING:
Activity based costing is a new technique for overheads distribution. In traditional costing system concept of
departmentalization of overheads is generally used to distribute overheads amongst various products. In
traditional system of overheads distribution we consider various departments as cost centers and compute
all the overheads related to the departments by allocating and apportioning various overheads between the
departments. Then we use some recovery base such as machine hrs. and labour hrs. etc. for absorbing
overheads between various products. But sometimes this method does not give correct results as it takes a
single recovery rate for absorbing various kinds of overheads within the department. Activity based costing
has been invented to overcome this drawback of traditional costing system. It states that various rates for
overheads absorption should be used instead of using single recovery rate for arriving at correct amount of
cost.
For this purpose we try to identify relatively small cost centers (called activities) within the departments,
for which different absorption base (called cost drivers) can be identified separately. Then we calculate
different recovery rates for the purpose of calculating cost of production.

STEPS:
Following steps are used for absorbing overheads under activity based costing:
(i) Identify different independent activities within the organization for which cost can be identified
separately.
(ii) Compute the cost related to each activity.
(iii) Identify the cost drivers related to each kind of activity.
(iv) Compute the total no of cost drivers for which cost in (ii) above has been incurred.
(v) Compute cost per driver Such as:

Cost per driver = Cost related to a particular activity computed in (ii) above
Total no. of cost drivers related to the activity computed in (iv) above

(vi) Now compute No. of cost drivers consumed by each product individually.
(vii) Calculate cost of different activities for different products by using the following formula:

Activity related cost for each product line =

Cost/ driver computed in (v) above X No. of cost drivers used by respective product line

Concept Book 25
CA. Mohit Arora Classes Advanced Management Accounting

Some examples of different types of activities and their cost drivers are given below:

Activity Cost Driver

Unit Level Activities

(i) Inspection Units produced / Inspected
(ii) Packing Units packed

Batch Level Activities

(i) Set-up costs No of set ups / production runs
(ii) Purchasing Purchase orders/ Requisitions raised
(iii) Selling Batches produced / Sold
(iv) Materials handling Materials movements
(v) Inspection Batches produced / Inspected

Product Level Activities

(i) Advertisement No. of units to be sold

Facility Level Activities

(i) Machining cost Machine hours
(ii) Machine operation and maintenance Machine hours
(iii) Engineering service Engineering hours
(iv) Canteen Meals Provided

26 Concept Book
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SERVICE SECTOR COSTING

MEANING:
Service sector costing or operating costing is used for calculating cost of providing different services like
hotels, transportation, hospitals, canteen, professional consultancy etc. Costing of Service sector is
different from that of manufacturing in many areas. One of which is, unlike manufacturing, service industry
has not any defined cost unit for which cost of production can be identified easily. In service sector we have
to find out some composite cost units (like tonne km., passenger kms., room days etc.) for calculating the
cost of provision of different services. In service industry cost of labour and overheads is dominating factor,
cost of materials is almost negligible, that’s why we generally classify cost related to service industry as
standing (fixed) costs, and operating (running) costs. In this chapter we will learn how to calculate the cost
of provision of different services.

STEPS:
Following steps are used for calculating cost under service sector costing:
(i) Compute the cost related to provision of an each independent service, indicating standing charges and
running charges separately.
(ii) Identify the composite cost unit related to each kind of service.
(iii) Compute the total no of cost units for which cost in (i) above has been incurred.
(iv) Compute cost per cost Such as:

Cost per cost unit = Cost related to a particular service computed in (i) above
Total no. of cost units related to the service computed in (iii) above

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CA. Mohit Arora Classes Advanced Management Accounting

STANDARD COSTI
STING

MEANING:
Standard costing is an efficientt te technique for cost control. Standards are basical cally the measures,
parameters, scales or yardsticks, wh which we set up for controlling different elements off cost
co like, Materials,
Labour or Overheads etc. In standard ard costing, standards are set up and actual performanance is evaluated on
the basis of these pre fixed standardards. Then the deviation of actual performance from the standards (called
variance) is calculated. Then we try ry tto find out reasons for aforesaid variances and try to eliminate them by
oncerned persons so that cost control can be applied
fixing responsibilities of different con d in
i the organization
effectively.

ndards:
Factors important for fixing standa
 Past performance or experience ce
 Current condition or present scen
scenario
 Future expectations

Types of standards:

Standards

Cost Sales
Let us now learn how to compute var
variances.

28 Concept Book
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MATERIAL VARIANCES:

Material Cost Variance (MCV)

(SR x SQ for AO) x (AR x AQ used)

Material Price Variance(MPV) Material Usage Variance(MUV)

(SR - AR) x AQ used (SQ for AO - AQ used) x SR

Material Mix Variance (MMV) Material Yield Variance(MYV)

(S. Mix - AQ used) x SR (SQ for AO - S. Mix) x SR

 Material Purchase Price Variance (MPV) = SR - AR) x AQ purchased

Where:
SR = Standard rate p.u. of input
SQ = Standard Quantity
AR= Actual rate p.u. of input
AQ = Actual Quantity
AO = Actual Output
S. Mix = Actual Qty. in Std. Ratio

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LABOUR VARIANCES:

Labour Cost Variance (LCV)

(SR x ST for AO) x (AR x AT paid)

Labour Rate Variance (LRV) Labour Volume Variance (LVV)

(SR - AR) x AT paid for (ST for AO - AT paid) x SR

Labour Efficiency Variance (LEV) Labour Idle Time Variance (LITV)

(ST for AO - AT used) x SR Idle Time x SR (Always Adverse)

Labour Gang Variance (LGV) Labour Sub Efficiency Variance (LSEV)

(S. Mix - AT used) x SR (ST for AO - S. Mix) x SR

Where:
SR = Standard rate p. hr. of labour
ST = Standard Time (hrs.)
AR= Actual rate p. hr. of labour
AT = Actual time (hrs.)
AO = Actual Output
S. Mix = Actual hrs. in Std. Ratio

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 Advanced Management Accounting CA. Mohit Arora Classes

VARIABLE OVERHEAD VA
VARIANCES:

Variable OH Cost Variance (VCV)

(SR x ST for AO) x (AR x AT paid)

Variable OH Exp. Variance(VEV) Variable OH Volume Variance (VVV)

(SR - AR) x AT paid (ST for AO - AT paid) x SR

Varaible OH Efficiency Variance (VEFV) Variable OH Idle Time Variance (VITV)

(ST for AO - AT used) x SR Idle Time x SR (Always Adverse)

Where:
SR = Standard rate p. hr. of labour
ST = Standard Time (hrs.)
AR= Actual rate p. hr. of labour
AT = Actual time (hrs.)
AO = Actual Output
S. Mix = Actual hrs. in Std. Ratio

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 CA. Mohit Arora Classes Advanced Management Accounting

FIXED OVERHEADS VARI

RIANCES:
[ABS
[ABSORPTION COSTING METHOD]

Where,
FOH Cost Variance
[FO5 - FO1]

FOH Expenditure Variance FOH Volume Variance / Activity Ratio

[FO2 - FO1] [FO5 - FO2]/ [FO5 / FO2 x 100]

Calendar Variance / Ratio Capacity Variance / Ratio Efficiency Variance / Ratio

[FO3 - FO2] [FO4 - FO3] [FO5 - FO4]
/ [FO3 / FO2 x 100] / [FO4 / FO3 x 100] / [FO5 / FO4 x 100]

Idle Time Variance

[Idle time x SR]

Sub- Eff. Variance

[Eff.var - I time var]

Where,
FO1 FO2 FO3 FO4 FO5
Actual FOH Budgeted FOH Standard FOH for Standard FOH for Stan
tandard FOH for
incurred the the actu
ctual production
[time available] [time used]
OR OR
[Capacity [Capacity used]
available]

NOTE: Use days in case of Calendar

dar Variance

NOTE: budget ratios were asked in ttheory in June 2009

32 Concept Book
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SALES VARIANCES:

Sales Variance

Revenue Approach Profit Approach

(Total Approach) (Margin Approach)

Sales Value Variance Sales Margin Value Variance

(SM x BQ) - (AM x AQ sold)
(SR x BQ) - (AR x AQ sold)

Sales Price Value Sales Volume Varience Sales Margin Price Variance Sales Margin Volume Varience
(SR - AR) x AQ sold (BQ - AQ sold) x SR (SM - AM) x AQ sold (BQ - AQ sold) x SM

Sales Mix Varience S.Mar. Mix Varience

(S. Mix - AQ) x SR (S. Mix - AQ) x SM

Sales Quantity Varience S. Mar. Qty. Varience

(BQ - S. Mix) x SR (BQ - S. Mix) x SM

Market Size Variance = Market Share Variance =

Budgeted Market Share % of the firm x Actual Industry Sales Qty x
[Budgeted Industry Sales Qty - Actual [Budgeted Market share % - Actual
Industry Sales Qty] x SM Market Share %] x SM

 Std. Margin = Std. Sales Price Std. Cost,

 Actual Margin = Actual Sales Price Std. Cost

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Where:
SR = Standard rate p.u. of output
BQ = Budgeted Quantity (Sales)
AR= Actual rate p. u. of output
AQ = Actual Quantity Sold
SM = Standard Margin p.u.
AM = Actual Margin p.u.
S. Mix = Actual hrs. in Std. Ratio

SPECIAL VARIANCE:

Basic Standards Current Standards Actual

Uncontrollable Variance Controllable Variance

[Due to external forces]
(Basic Std. – Current Std.) x Std. Qty for Actual Output

OTHER CLASSIFICATION OF VARIANCES

Price Recovery Variance

Productivity Variance Sales Activity Variance
= Sales Price Variance
= MUV + LUV + OHVV) = Sales Volume Variance
(MPV + LRV +OHRV)

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RECONCILIATION:

MARGINAL COSTING ABSORPTION COSTING

Starting Point Budgeted Profit Budgeted Profit Standard Profit For
Actual Output
Material Variance
- Price   
- Usage   
Labour Variance   
- Rate   
- Volume   
Variable OH Variance   
- Expenditure   
- Volume   
Fixed OH Variance   
- Expenditure   
- Volume   
Sales Variance   
Price   
Qty. [Revenue Approach] Sales Qty Variance X Sales Qty Variance 
P/V Ratio X N/P Ratio
Qty. [Margin Approach]   
End Point Actual Profit Actual Profit Actual Profit

 Note: All favourable variances should be added and adverse variances should be deducted.

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BOOKING & DISPOSITION OF VARIANCES:

Booking of
variances

Single Plan: Partial Plan: Dual Plan:

Accounting entries related
to variance booking are
passed at the respctive
stage where variance
arises
All accounting entries In this plan all varinces are classified in
related to variance two sections, first is variations from basic
booking are passed at to current standards and second is
the work-in-process variations from current standard to actual
account only cost

Disposition of
Variances

(iii) Tranfer all volume / efficieny

(ii) Distribute all the
variances between work-in-
(i) Transfer to Costing P/L progress, finished goods
and cost of goods sold in
the ratio of their values
variances to costing P/L and
Distribute all Rate
variancesbetween work-in-
progress, finished goods and cost
of goods sold in the ratio of their
values

36 Concept Book
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BUDGETARY
Y CONTROL

MEANING:
Budgetary control is also a techniquique of controlling. In this technique we try to set up p control on various
tasks within the organization by draft
rafting different types of budgets for all these activities
s in advance, so that
actual performance can be monitored red easily and the responsibilities of the persons conce cerned can be fixed.
Budget is basically a statement prep
repared in advance for a specified task or activity that at is
i to be performed
within a specific period of time. We set control over cost and other activities within the th organization by
preparing various kinds of budgetsts in this technique. Here we take total approach for control
con point of view,
instead of taking per unit approach
ch unlike standard costing. In this chapter we will learn arn how the various
types of budgets are drafted.

Types of Budgets

Based on Time Based on Based on Based on

Period Conditions Capacity Coverage
(i) Long term (i) Basic (i) Fixed (i) Functional
(ii) Short term (ii) Current (ii) Flexible (ii) Master

STEPS: FUNCTIONAL BUD

UDGETS
(i) Sales Budget: This budget is b basically based on various factors like demand, availaailability of resources,
product mix requirement, desire
ired profit etc. This is the basic budget in budgetary contro
ntrol because all other
functional budgets are depende
dent on this budget only. This budget is generally given n in the question if not
so then conditions related to
o th
this budget are given in the question so that this bud udget can be drafted
easily.
(ii) Production Budget:
Required quantity of sales as per sales budget + Closing stock of finished goods
s – opening stock of
finished goods

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(iii) Materials Requirement Budget:

Production quantity as per production budget X Std. Raw materials requirement for per unit of output.
(iv) Materials Purchase Budget:
Total Raw Materials requirement as per materials requirement budget + Closing stock of raw materials
required–opening stock of raw materials held.
(v) Labour Requirement and Cost Budget:
Total time required (Hrs.) = Production quantity as per production budget X Std. Labour requirement (Hrs.)
for per unit of output.
Number of workers required = Total Hrs. Required computed above / (available hrs. per worker in the
period)
Labour cost = Total Hrs. required X Std. Hrly. Rate.
(vi) Overheads Budget: For variable overheads, budget can be drafted on the basis either on the basis of
production quantity or on the basis of labour hours required. On the other hand fixed overheads are
estimated in total for the whole period. if question requires p.u. rate of the fixed overheads then we can
absorb fixed overheads on the basis of budgeted production or budgeted labour etc.
(vii) Cash Budget:
Cash Surplus or requirement for the period = Total cash inflows for the period–Total cash outflows for the
period
Here cash inflows and outflows can be predicted on the basis of budgeted sales and receipts from
customers, payment to suppliers and for expenses etc.
(viii) Master Budget: It is a summary of all functional budgets discussed above. In this budget we try to
ascertain the budgeted outcome of all the activities in the organization i.e. Profit or loss etc.

STEPS: FLEXIBLE BUDGET

(i) Identify various costs such as Fixed costs, Variable costs and Semi variable costs related to a level of
activities.
(ii) Segregate all semi variable costs into variable and fixed costs by using level of activity method.
(iii) Now we can prepare flexible budget for different activity levels separately. For this purpose all variable
costs including variable portion of semi variable cost will vary according to level of activity (i.e. sales or
production), and all fixed costs including fixed portion of semi variable costs will not change at different
levels of activity.

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MARGINAL COSTING

MEANING:
Marginal costing is a technique for decision making. Generally we use Absorption costing technique for
product costing purpose, where we absorb all fixed costs to the cost of production using some recovery
base like labour hours, machine hrs., units produced etc. But actually it is not so, i.e. fixed costs do not vary
with the level of production or sales. They remain static up to a certain level of activity. So this techniques
states that we should consider all the fixed costs as a period cost or capacity costs for decision making and
evaluation purposes, and should not take them into consideration until they are additionally incurred for a
certain decision Marginal costing is very useful in internal control and decision making.

SOME USEFUL FORMULAS IN MARGINAL COSTING:

(i) Contribution per unit = Sales price per unit – Variable cost per unit
(ii) Contribution total = (Contribution per unit X No. of units sold) or ( Total Sales – Total variable cost)
(iii) P/ V Ratio (Price Volume Ratio)
= (Contribution / Sales)
OR
= 1 – (Variable cost / Sales)
OR
= Change in contribution / Change in sales
OR
= Change in profit / Change in sales
OR
= Fixed cost / Break even sales
OR
= Profit / Margin of Safety

(iv) Break Even point (Where Fixed costs = Contribution)

(v) Break Even point (in units) = Fixed costs / contribution per unit
(vi) Break Even point (in ` ) = Fixed costs / PV Ratio
(vii) Combined Break point = Fixed Cost / Average contribution per unit
OR
= Fixed cost / Combined PV ratio
(viii) Margin of Safety (in ` ) = Sales – Break even sales
OR
= Profit / PV Ratio

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CA. Mohit Arora Classes Advanced Management Accounting

(ix) % Margin of safety = (Margin of Safety / Sales) X 100

OR
= (Profit / Contribution) X 100
(x) Sales to earn a desired profit (in units) = (Fixed cost + Desired profit) / Contribution per unit
(xi) Sales to earn a desired profit (in ` ) = (Fixed cost + Desired profit) / PV Ratio
(xii) Profit = Margin of Safety X PV Ratio
(xiii) Cost Indifference point = Change in total fixed cost / Change in variable cost per unit
Shut down point = (Avoidable fixed costs – shut down costs) / Contribution per unit

40 Concept Book
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RELEVANT COSTING

MEANING:
Relevant costing approach is used in decision making. This technique states that all the costs that are used
for product costing purposes are not necessarily important for decision making also. There are some costs
that should be ignored or taken additionally while decision making. In this chapter we will learn to identify all
the costs that are important for decision making.

RELEVANT MATERIALS COST:

Cost Relevant cost
(i) Materials in Stock
Regular use Materials Replacement Price
Materials not in use but having alternate use Opportunity cost
Materials not in use but having resale value Resale price
Materials not in use to be scrapped Scrap Value
Materials not in use not having any value Nil
Any of the above materials to be modified for use Respective cost from above costs + modification
costs

(ii) Materials not in stock to be purchased Purchase price

RELEVANT LABOUR COST:

Cost Relevant cost
(i) Labour part of permanent labour force
Remaining idle Nil
Not idle Contribution forgone
Idle but having alternative use Opportunity cost

(ii) Labour not part of permanent labour force

Available freely Wages Paid
In short supply Wages Paid + Opportunity costs

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CA. Mohit Arora Classes Advanced Management Accounting

RELEVANT OVERHEADS COST:

 Variable Overheads are always relevant.
 Any type of Fixed overheads are not relevant. Fixed overheads can be relevant only when it have to be
incurred additionally for specific decision.
 Depreciation being a fixed overhead is not relevant but fall in value is always relevant. Where fall in
value = Opening resale value – closing resale value.

SOME OTHER IRRELEVANT COSTS:

(i) Sunk Costs: This is a cost incurred in past and do not have any impact on future decision making.
(e.g. Research & Development Cost)
(ii) Committed Cost: All these costs are to be incurred in future due to any past commitment. These costs
also do not impact future decision making. (e.g. Rent)
(iii) Common cost: All those costs that are common for different decisions are also irrelevant cost
although they can be variable and future costs also.

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 Advanced Management Accounting CA. Mohit Arora Classes

TRANSFER
FER PRICING

MEANING:
Transfer pricing technique is a maj ajor issue in the current business world. As the scopesco of business is
increasing day by day, it is not possi ssible for upper level mangers to manage such a large rge organization. So
for the purpose of better manageme ment and control organizations are divided in to small aller divisions, each
having an independent divisional ma manger. Sometimes, performance of divisional mangers ers is linked with the
profits earned by their respective divi divisions. In such a situation each divisional manager er wants to increase
profits of his respective division. Now a problem arises where output of a particular divisio vision can be the input
for a particular division, in this situatio
ation the problem is to decide proper transfer price as s improper
im price may
impact the profitability of both the di divisions and give birth to various conflicts. divisional
nal mangers may not
be interested to transfer goods inter ternally, instead they can choose to deal with externa rnal parties and may
adversely impact the profitability of o organization as a whole. That’s why it is very imporportant to decide fair
transfer prices.
Transfer Pricing plays a very imp important in international taxation also, as by fixing fair
ir transfer
t prices one
can avoid a lot of tax burden. That at is the reason we are having specific tax laws on tran ransfer pricing issue.
Now we learn how to decide fair tran ransfer prices.

Methods of fixing Transfer Price

At Cost At Market Price At Negotiated Price

(Minimum Transfer Price) (Maximum Transfer Price) (Bargained Transfer Price)
From the point of view of From the point of view of From the point of view of
Transferor Transferee organisation

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MINIMUM TRANSFER PRICE:

Conditions Transfer Price
(i) Goods accumulated in stock
Not in demand or Perishable Any Price
In demand Resale Price
Any of the above but modification required Any of the above price as the case may be +
modification cost
(ii) Goods to be manufactured
Transferor having idle capacity V/ Cost
Transferor not having idle capacity V/ Cost + Contribution forgone
Any of the above but modification required Any of the above price as the case may be +
modification cost

MAXIMUM TRANSFER PRICE:

Conditions
(i) Transferor supplying same goods
(ii) Transferor supplying different goods
Transfer Price
Market price at which the goods is available to
transferee
Market price at which the goods is available to
transferee – Modification Cost

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 Advanced Management Accounting CA. Mohit Arora Classes

PRICING
NG DE
DECISIONS

MEANING:
This Chapter deals with the matter, r, o
of deciding, fair prices for different products and service
rvices. To decide
price is a very crucial decision for any organization because this depends on various facto ctors such as the
mpetition, restrictions imposed by government etc. in this
cost of production, profitability, comp thi chapter we will
rent situations.
learn how to decide prices in differen
Here are some techniques used to o de
decide prices.

COST PLUS PRICING:

In this technique we decide pricess b
by adding cost of production with certain desired profit
pro called mark-up.
Meaning of cost and mark-up in diffe
ifferent situations is explained with the help of following
ng diagram.

Cost Plus Pricing

Cost Mark - up
Where the cost can be:
(i) From past experience.
(i) Total cost
(to maintain profitability)
(ii) Variable cost
(ii) Industry average.
(iii) Relevant cost
(to be in competition)
(iv) Marginal cost
(iii) Some other mathods
(v) Standard cost
( to cover risk associated etc.)

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CA. Mohit Arora Classes Advanced Management Accounting

PRICING FOR DIFFERENT

NT MARKETS:
It is explained with the help of followi
wing diagram:

Pricing for Different Markets

Pure Competition
There are many sellers
Monopoly in the market selling
same product and the
Only one seller in the
price will be decided by
market and it can
market itself.
decide the price as it
[Example: Normal
wishes.
market / Bids and
tendors (Sealed bid
Pricing) ]
Monopolistic
Competition
Oligopoly Few sellers in the
market and product
Few sellers in the differentiation is
market selling same possible. Each one can
products. They can decided different
decide the price with price for its products
majority as everyone by applying product
depends on others differentiation but the
price. prices cannot be
increased or
decreased beyond a
certain limit.

DIFFERENT PRICING STR

TRATEGIES:
Following are the different market str
strategies:

Pricing Strategies

Penetration Pricing Skimming Pricing Price Discriminnation

(initially low price later high
price, to beat the
competition. objective is to
increase demand and reap
profits later on by
increasing prices. it is also
called 'stay out pricing')
(initially high price and later low
price, objective is to skim the
market in early stage as later due
to competition it will not be
possible to increase prices. It is
very helpful to recover high R & D
cost in early stages.)
Different prices on the basis of:
(i) different persons
(ii) different time
(iii) different places,
(iv ) different product features

46 Concept Book