COSTING CONCEPT

{I}- While attempting a question on cost management, it is the most essential to read the requirement of
the question carefully.

{II}- After reading the requirement of the question , concentrate whether the requirement is related to
decision-making or to profit and loss statement .

{III}- If the requirement is related to decision-making we will have to follow Relevant cost concept.
Decision-making will always show effect on profit ascertained by working out relevant gain and
relevant cost.

{IV}- If the requirement is related to profit and loss statement, we will have to follow total cost concept.
Profit and loss statement will always show the profit or loss which is ascertained by working total
revenue and total cost.

{V}- In some questions, some times requirement are given by number a, b,c, & so on.Then in such
requirements we should always preassume that each & every requirement are independent unless &
until information are interlinked with each other. Solve these requirements independently with
information given in question.

{VI}- In some questions, it may happen that all the information given in the question are not required to be
used at the same time. Some information may be useful in requirement number(b) or (c) or so on. The
thought on this information shall be given only when we are going to attempt that requirement.
{VII}- Sometimes many information are given in the question, but these information are not required to be
used in the light of requirement of the question. We should identify these information as
irrelevant/useless/ baseless and keep ourselves away from them.

{VIII}- We always have to follow the instruction of management blindly even if sometimes the instruction is
contrary to our conceptual understanding. Under no circumstances we have any right to disregard the
management instruction.

{IX}- It should always he kept in mind that each and every information is to be read carefully. Casual
approach or idea approach plain reading is very dangerous in most of the cases.

{X}- If the question is silent on some point whose interpretation is required for solving the question, we
should always follow the most acceptable practice.

{XI}- Advise/ recommendation to the management should be always specific and unconditional but if
these appears to be some ambiguity in the information, give the advise/ recommendation subject to
qualifying remarks.

{XII}- Presentation can vary from student to student. It is not at all a cause of worry but it has to be ensured
that the presentation should be up to acceptable norms ( if not the best) with working notes (only
essential working notes).

{XIII}- One of the most essential part while attempting a question on costing is to ensure proper planning.
Before we start the paper, the entire paper has to be first read carefully so that the proper planning to
 attempt the paper can be formulated. Selection of right a question at right time is the vital key for
grand success in this paper which can be ensured through proper planning.

{XIV}- Ensure proper time management through effective planning choosing the sequence of attempting
the question in such a manner so that time management may not go out of control.( For example
choosing one lengthy question with some light weight question so that time spent over in one question
should be set off against another question). Since the Costing paper is quite lengthy, it is generally not
advisable to target 100 marks attempt. We should target around 90 marks attempt and put our sincere
efforts to achieve the same through proper and effective planning. If we are able to achieve higher than
our own designed benchmark, it will be a bonus for us.

RELEVANT COST (SUMMARY ONLY)

Material Labour Overhead Machines Profit Center Cost Center

1:- Out of stock-Rpl.cost 1:- Casual 1:- Variable= 1:- If Offers does not consume a Variable Cost
2:- In Stock a: Cost -Labour cost Cost to be incurred substantial part of the-Nil
a:- Regular use-Replacement Cost b: Busy=Lab. Cost 2:- Fixed Machine
b:- Obsolete: slow moving: (Short supply)+ Cont.Cost a:- Unavoidable- Nil 2:- If the offer consumes VC + Contribution :Lost
b: Avoidable - cost to be substantial part of the
(i) Sale price Higher is 1:- Permanent incurred machine
OR the Relevant a:- Idle=Nil a:- Regular use - Difference
(ii) Substitute Cost b: Busy:- Cont.Cost of Replacement cost
use Ignoring labour Cost b:- Obsolete Machine - Difference Of Resale value

1:- LABOUR: In Following cases the nature of labour Should be considered as permanent . 2:- Pre assumptions
1:- If Laborers can’t be retrenched, can’t be reduced , can’t be terminated. 1:- Material:- Non moving
2:- Idle Wages 2:- Labour: Casual
3:- Unutilized 3:- Overhead: Fixed (unavoidable)
4:- Center: Cost Centre
Note: if Labourers are busy, We should preassume that extra labour cant be appointed. 5:- Machine: Idle

RELEVANT COST:- RS.

RELEVANT COST:- 1:- Future Cost, Different in each alternative Cost to be incurred due to acceptance of offer XX
SUNK COST:- Cost incurred & remain same in each alternative course of action
+ benefit to be loosed due to acceptance of offer XX
OPPORTUNITY COST:- Benefit to be lost - Benefit to be achieved due to acceptance of offer XX
Minimum Price XX
It is important to consider the contribution to Income forgone by
Choosing a particular alternative & rejecting other.
Opportunity Cost is the benefit forgone that could have been realized from the next best
Alternative use of resources.

SUMMARY OF MAKE OR BUY –“Apply when we have a choice for mfr./Purchase.

Alt 1:- STATEMENT OF COMPARTIVE COST W2:- Benefit from Released Capacity
Manufacturing Cost Purchasing Cost Revenue from Released capacity (sale) XX
Rs. Rs. (Less) - Cost XX
Cost to be Net benefit from release capacity XX
Incurred PC XX *if we have more than one alternative to utilize the release capacity,
Material XX select the alternative which have higher benefit.
Labour XX
Variable O.head XX
Avoidable Fixed Cost XX
Benefit to be loosed (W1) XX

XX XX
OR
Alt2:- STATEMENT OF COMPARTIVE COST 2:- STATEMENT OF COST BENEFIT
A1 Manufacture A2; Purchase Loss on purchase XX
Cost to be Purchasing Cost XX Benefit from
Incurred XX release capacity XX

2:- Unavoidable Fixed Cost - Sunk Cost

3:- Cost indifference point TCA = TCB i.e. Change in FC Alt2:- We should prepare Two Statements.

Change in VC Alt1;- We should prepare only one statement.

to be applied where we have two option
one have lower variable cost & Higher Fixed Cost
other have Higher variable cost & lower Fixed Cost

4:- MAKE OR BUY + KEY FACTOR (1)Statement of Ranking (Comparison of manufacturing cost No Condition
with purchase cost , limiting factor). Exist
(2) Statement of Optimum Component Mix.

Condition Exist ( only one component is to be purchased )

1: Statement of Ranking (loss in purchase over mfr in terms of L.F.)
2:- Statement of Combination.

Batch wise Cost:- (1) Cost per batch remain constant

(ii) Cost as No of batch (Increase)
as No. of batch (Decrease)
(iii) Cost Per unit batch size increase

MAKE OR BUY + KEY FACTOR AVERAGE STOCK = ½ EOQ (When lead period not exist)
EOQ = 2AO Average Stock = Minimum Stock + ½ EOQ (When lead period exist)
C.S.
If A product consumed more than one component & its not possible to produce all the component in house due to limiting factor (Labour
Hour, Machine Hour, Material )
1:- We should produce that component which provides maximum saving in manufacturing over purchase in terms of Limiting factor.
2:- We should purchase the component which provides maximum saving in purchase over manufacture interim of Limiting Factor.

STATEMENT OF RANKING STATEMENT OF COMPONENT MIX

Component A B C D QUANTITY LABOUR HOUR LABOUR HOUR
Manufacturing Cost (Rs.) X X X X A 1 X X
Purchase Cost (Rs.) X X X X B 2 X X
Saving in manufacturing X X X X C 3 X X
Labour Hour/ units X X X X D 4 X X
Saving per Hour X X X X TOTAL LHR XX
Ranking I II III IV ___________________Available____________
SUB CONTRACTING
Sub Contracting

Out Sourcing / Purchase & Sale of finished Goods

1:- Sub Contracting relates to be decision of finished goods
When the company has sufficient resources to meet the maximum demand of all the products , than Sub- Contracting decision ( Purchase & Sale of
finished goods) not to be applied.
(Quantity is more important even if purchasing item is cheaper).
2:- Sub Contracting is a short term decision. It may be called stand by arrangement of Limiting Resources.
3:- SUB CONTRACTING decision arises only due to limited resources.
4:- Sub Contracting to be introduced to restrict the development of competitors.

STEPS:-
In sub-Contracting we have 3 steps:-
1:- Prepare statements of RANKING
(A Comparison of Purchasing Cost with Manufacturing Cost)
2:- Prepare statement of optimum Product mix ( How much qty of each Finished Goods to be produced)
3:- Statement of Profit
STATEMENT OF RANKING

A B C
Manufacturing Cost (Rs.) 40 X 50 X 60 X
Purchasing Cost (RS.) 50 X 60 X 55 X
Saving in mfg Purchase Cost 10 10 ( 5)
Hours /Unit (Over/Hour) 5 10 5
Saving in terms of limited factors 2 1 ( I)
Ranking for Manufacturing I II Purchase
If Co. Have sufficient Labour Hours to meet entire Demand of A& B but partially for “C” Than Its Not better to utilize such
balance resource for “C” because “C” has low purchase cost as component its variable Cost.
INDEPENDENT PRODUCT IF SELLING PRICE < PURCHASING COST
Never Purchased
SELLING PRICE > PURCHASING COST
Purchasing Cost – Manufacturing Cost compare & Ranking](Refer to Q3)
DEPENDENT PRODUCT (1) IF SELLING PRICE < PURCHASING COST, (Refer to Q.No. 1)
CONBINED Use Combination method
(2) IF SELLING PRICE > PURCHASING COST.
 RANKING method should be applied.

SUMMARY

I II
When the product are independent Dependent Product (like Sofa Set)
A,B,C,D.
(a) If the Selling Price < Purchasing Cost of a product a:- If the Selling Price of the complete sofa ser < the
Than that particular product not to be purchased Purchase Cost, than apply combination method
Purchasing Cost > Selling Price
(b) IF the Selling Price > Purchasing Cost of Products (b) If Selling Price > Purchasing Cost them always apply
Than ranking concepts to be applied ranking method.
STATEMENT OF OPTIMUM PRODUCT MIX
Ranking Quantity Hour/Unit Hour
I X X X
A
B II X X X(B/F)
C XX
Total hrs avoidable
STATEMENT OF PROFIT Rs.
REVENUE XX
- Cost
A : Manufacturing cost
B : Manufacturing Cost
C : Purchase cost XX
- FIXED COST XX

PROFIT ___

SUMMARISED CONCEPT
If the resources are limiting factor, than –
(1) Produce that product in house ,which provides the max saving in manufacturing over purchase in terms of limiting factor.
 (2) Purchase that Product:-
(3) (a) Which provides saving in purchasing over manufacturing (Purchase Cost < Material Cost)
(4) (b) Which Could not be produced in house due to limiting factor (as per ranking).

KEY FACTOR
Limiting Factor means the factor of Production(Material, Labour hours, Machine Hours) which are in short supply. Short supply means
1:- The availability of which could not be increased in short period of time (Period < 3 years) .
2:- The availability of which are not sufficient to meet the 100% requirement of all the products.
From costing point of view we should utilize the limited resource in optimum manner.
Optimum manner means utilize the resource in producing that product which provides the maximum contribution in terms of limiting factor.
In Key factor concepts we have Z steps:-
1:- Prepare statement of Ranking.
2:- Prepare statement of optimum product Mix & profit statement.
(Not component (with component it is called (MOB + Key Factor)
STATEMENT OF RANKING
PRODUCT A B C
Cont/Unit(Rs.) 100 200 1000
Material(Kg/Unit) 10 10 200
Contribution/Kg. 10 20 5
Ranking II I III
Maximum Demand 1000 1000 1000
Material Required 10,000 1,000 1,000
Material Available =2,00,000

STATEMENT OF OPTIMUM PRODUCT MIX

Qty Required Material/Unit Material Quantity
Manufacturing
AII 1,000 10 10,000 1,000
BI 1,000 10 10,000 1,000
CIII 1,000 200 1,80,000 900
2,00,000 (limit per
period)
1 or 2 Key Fact More than 2

Costing Linear Simplex

Teach Programming Graphic

Points to be remembered
1:- If minimum quantity of each of the product either of the product to be produced as per the restriction by the management, then first of all
utilize the limited resource in producing that minimum special requirement and Balance resource to be utilized as per ranking.
2:- If any goods to be produced in a accounting period as a production then such fractional part not to be ignored , such fractional part to be
considered as Work In Progress for performance evaluation.(It will be completed Balance part in next period.)
3:- Basis of Ranking:-
Limiting Factor Basis
1:- Labour Hour Contribution/Labour Hour
2:- M Hour Contribution/ M Hour
3:- Material(Kg.) Contribution/Kg(unit of Material)
4:- Selling Price (Rs.) Contribution /Selling Price Per Rs. Of Selling Price)
( Per unit – Selling Price)
5:- Sales Quantity Contribution /unit Quantity

IF we have 2 Key factors with 3 products then following steps to be applied.

1:- Prepare Statement of Ranking as per first, key Factor and as per second key factor.
2:- Prepare statement of minimum possible unit for all the 3 products after considering both the key factors individually.
(i.e. Optimum product mix with both key factor independently)& identify Minimum possible unit.

3:- SUMMARY OF KEY FACTOR

I II
ONE KEY FACTOR TWO KEY FACTOR
With Different product
1:- If the Resource can be exchange 1:- One product :Possible unit X contribution Per unit

Statement of Ranking
Statement of Optimum product Mix
2:- If Resource Can’t be exchange 2:- Two Product:- Apply Equation Method.
3:- Statement of Combination 3:- Three Product.
+ Contribution in term of L.F.
+ LF 1:- Short supply Contribution
2:- Can’t meet 100% requirement
of all product.

“ IF We have one Product , which is to be produced with two key factor, than no need to prepare Ranking”.
4:- Calculate the balance resources these Bal resources to be utilized for Balance 2 product (remaining) with the application of equation method.
5:- Calculate Final Total Production
= Minimum Production + Extra Production.
Prepare statement of Profit
=Total Contribution – Fixed Cost
Contribution = Total Final production X Contribution per unit.

TRANSFER PRICE
1:- Transfer Price is a price to be placed on the goods and services which are to be transferred from one department to another department within
the same organization.
2:- Transfer price is always different from selling price because in transfer price, the title of goods is not to be transferred while in sales, the title
of goods is to be transferred.
3:- Transfer Price becomes revenue for the supply division transfer Price becomes the cost for the receiving division.
4:- Transfer Price is a Notional price means the total profit of the company remains the same.
HOW TO CALCULATE TRANSFER PRICE.
TYPE 1:-
When Transfer Price is already fixed by Management (decision has been taken) Now we should follow /apply: Calculation

TYPE 2:-
Transfer Price is to be fixed /arrived by management Accountant for decision-making.
By Top Management Management Accountant
1:- Based on Market Price 1:- Transfer Price always to be fixed in such a manner so
(Risk Free +Risk) that the overall profit of the Co. is not to be reduced.
2:-Based on (Fair rate of return) on capital employed. 2:- TP = Relevant cost
(FA +CA) = C Employed = cost to be incurred due
+ Any Benefit Cost
- any Benefit achieved
3:- Based on Fix % of markup (TC + %)
4:- If the component produced by supply deptt, transfer price (In Relevant cost when we apply Transfer Price than
should be based on cost Ratio Method. Make or Buy is automatically apply).
TYPE III DECISION MAKING
Case I When the supply division has surplus enough spare capacity to provide the services to the receiving department (no other alternatives use exists)
The Minimum Transfer Price = Relevant Cost
= Cost to be incurred due to transfer – Variable Cost
+ Benefit lost due to transfer.

A B
Variable Cost = 8/- Purchasing Cost = 12/-
Eg I
Factory Cost = 10/-
Quantity = 2,000
Minimum Transfer Price = Relevant Cost = 8.
1:- Fixed Cost of the deptt is always to be termed as “ Sunk Cost”.
2:-As per “Make or Buy”. Decision its better to produce in house & transfer, hence we should fix a proper transfer price , so that the receiving department
is interested to purchase the component from outside Market.
Hence Transfer Price:- Relevant Cost
i.e. Variable Cost (Cost to be incurred )
when the supply division have spare capacity to produce the goods & transfer it to receiving dept & some other alternative uses exists for the released
capacity of supply division.
As per make or Buy Decision its better to purchase the component fro outside market, hence we should fix the transfer price so that B deptt. Is interested
To purchase the component from outside max.
TRANSFER PRICE =Variable i.e. cost to be incurred 8.00
(+) Benefit lost due to transfer 2.50
10. 50
How to identify the nature of capacity in the supply division.
1:- When the component produced by the supply division are heavy demand in the market . Comparative Market)
Then we should always presume no spare capacity exists in supply division.
Total Capacity = 10,000 unit - Heavy demand
VC = 6 PC = 10
SP = 10 Qty = 1,000
VC = 6 PC = 10
+ Cont 4 ---
10 Identified
2:- When the nature of supply division are mentioned as profit center. Then always we should presume no spare
capacity exists in supply division.
Now ever if the supply division in a profit center but the capacity utilization is given (Say 80%)
Then we should always presume for the utililsed capacity (20%) no other alternative uses exist.
Deptt A ( Profit center) means regular profit when producing (BE Output)
Mentioned (80% cap offer
VC = 8 , PC = 10
SP = 10 , Qty = 3,000
Total Capacity = 10,000
Profit Center
Total Capacity = 10,000 hrs.
Product A B C D
Max Demand XX XX XX XX = 12,000 hour
C/Hour 4 5 6 7
Transfer = 100 Hour
Transfer Price Variable Cost + Benefit lost
(4/- hour is minimum)
Transfer Price to be Minimum
3:- If the nature of capacity for the supply division are silent then always presume supply Division have excess spare capacity.

TWO TYPE OF QUESTION

1:- Only Transfer rice is to be calculated.
Rs.
- Prepare statement of transfer price
i.e. Relevant cost = Cost to be incurred XX
+ Benefit lost XX
2:- Decision Making:- Will the Co. as a whole benefit in purchasing component from outside Market.
A:- When the Selling Price of Final Product is given
Then Calculate the profit (benefit) when the Component to be purchased from the market/ when the component to be produced transformed.
Select the alternative which given higher (Maximum) Benefit.
B:- When the SP of Final Product is not given then always prepare “Statement of cost Analysis”

DECISION Make OR BUY (When Transfer Price is given)

TYPE II
A B C
Spare Capacity
Variable Cost 10 Variable Cost 25 60/55
Fixed Cost 5 (Sunk) Fixed Cost 5 ( Sunk) Mfg Purchasing Cost
Total Cost 15 30
Rel Cost/Purchasing Cost
+ Profit 5 ( Notional) Hrs 20
 Total Cost 50
+ Profit 10( Notional)
60
Purchasing Cost should be compared with Relevant Cost instead of Transfer Price.
If A has no spare Capacity
Relevant cost A contribution Cost = Fixed Cost + Profit = 5 + 5 = 10
Variable Cost = 10
= 20
If transfer Price of the goods and services are given and the decision is either to produce or purchase from the market ( Make or Buy)
(1) The Decision , Make or Buy to be applied by preparing statement of comparative cost.
In this statement we should compare Purchasing Cost of the component with relevant cost of that component.
Relevant cost means only the cost to be incurred (Variable Cost) when the supply division has sufficient spare capacity.
Relevant cost means cost to be incurred (variable Cost) + Contribution lost when supply division does not have any spare capacity.
Important for Theory also.

Cost Ratio Method to be applied when:-

1:- Component of supply division are not marketable.
2:- When other methods (return on investment ) are not feasible.
3:- When the standard Cost of there deptts could be arrived.
STEPS:- Under cost ratio method the following steps are to be applied.
1:- Calculate Total Profit of the Company.
2:- Calculate supply divisions state of profit.
= Total Profit
---------------- X Supply Division Total Cost
Total Cost
 Transfer Price = Share of profit + Total Cost.
A B C
Quantity 1,000 1,000 Sales1,00,000
SC(VC +FC) 10,000 50,000

Step :- Statement of company Profit

Sale Value 1,00,000
-A 10,000
-B 50,000 60,000
40,000 (Ratio SC is
1:5)
Contribution lost = non Recovery of profit + Loss of profit)
In other words, we can say If Transfer Price is given and the decision’s either to produce or purchase.

The Fixed Cost + Profit of the supply division always to be ignored when spare capacity exists in supply division.

ACTIVITY BASED COSTING

In ABC we have 2 Steps:-
1:- Prepare a “ Statement of Cost Pool”
2:- Prepare “Statement of Cost” / “Statement of Overhead cost” as per requirement of question.
Statement of Cost (ABC Technique)
Product A Rs. B Rs. C Rs. Total Rs.
Material (identified) COST POOL
Labour (identified)
Overheads Amount Activity No. Of activity Cost activity
Material Rent (10,000
Rs. X 0) (10,000 X 8) (10,000 X 2) 1,00,000
Machine Rent nil
XX No. of times80,000
wages XX 20,000 10,000 purchase usage
10(0+8 +2)
Set up Cost (5,000 X 10)= 50,000 (5,000 X 5) = 25,000 (5,000 X 5) = 25,000 1,00,000
Setup Cost XX No. of Setup/Setup hour 20(10 + 5 + 5) 5,000 set up
Stores XX No. of Required 20(10+5+5) 10,000/- slip
2,00,000 Slip/Material Cost/Qty.
Inspection Cost XX No. of Set up 20 (10+ 5 + 5)
2,00,000 Production Rent
Packing Charges XX No. of livery XX
Others XX Method of absorption XX
Cost Driver
Cost Pool means a statement in which all the overheads to be analysed into 2 parts :-
1:- Activity oriented over heads.
2:- Non activity oriented Overheads
so that all the overheads called be identified with the product can the basis of their respective activities.

Cost Driver means the allocation base with the application of which the overheads can be identified with the product.

DIRECT MATERIAL:- 1:- Directing Traced with production

2:- Final Quantity Increase.

3:- Integral & major part

INDIRECT MATERIAL:- Used to produced Finished Good with Raw Material.