Management Accounting

Prof.
Naveen Sharma
Module – 1
Management Accounting: Definition, Functions, Objectives, Roles

Management accounting is the provision of financial and non-financial decision-making information to
managers. In management accounting or managerial accounting, managers use the provisions of
accounting information to inform themselves better before they decide matters within their organizations,
which allows them to manage better and perform control functions.
The part of accounting that helps managers in making decisions providing accounting information is called
management accounting.
Management accounting is a special branch of accounting. It is a modern and scientific innovation of

accounting. Management accounting is accounting for effective management.
Meaning and Definition of Management Accounting

Management accounting is the process of identification, measurement, accumulation, analysis,
preparation, interpretation, and communication of information that assists executives in fulfilling
organizational objectives.
It helps the management to perform all its functions, including planning, organizing, staffing, direction, and
control. In other words, the field of accounting that provides economic and financial information for
managers and other internal users is called management accounting.
Some beautiful definitions of management accounting are mentioned below:
The Institute of Chartered Accountants of England and Wales defines, “Management Accounting is that
form of accounting which enables a business to be conducted more efficiently.”
According to R. N. Anthony, “Management Accounting is concerned with accounting information that is

useful to management.”
Professor J Batty defines, “It is the term used to describe the accounting methods, systems, and
techniques, which, coupled with special knowledge and ability, assist management in its task of maximizing
profits or minimizing losses.”
The Institute of Cost and Management Accountants London has defined, “Management Accounting as
the application of professional knowledge and skill in the preparation of accounting information in such a
way as to assist management in the formulation of policies and the planning control of the operation of the
undertakings.”
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From the above definitions, we can say that the part of accounting that provides information to the
managers for use in planning, controlling operations, and decision making is called management
accounting.
Characteristics/Nature of Management Accounting

The nature/characteristics of management accounting may be summarized as under:
 Management accounting is a technique of selective nature. It does not use the whole data
provided by financial records. It selects and picks up only that information form different
financial records (such as profit and loss account or balance sheet), which are relevant and useful
to the management to arrive at important decisions on different aspects of the business.
 Management accounting is concerned with the future. It collects and analyses data to plan the
future. The primary function of management is to decide bout the future course of action.
Management accounting, with the help of different techniques, formats the future course of
action.
 Management Accounting makes available useful information which helps the management in
planning and decision-making. It can only provide information but cannot proscribe. It is up to
management to what extent it. It can make use of the information depending upon its efficiency
and wisdom.
 Management accounting studies the relation between causes and effects. Financial accounting
does and analyses the causes responsible for profits or losses. Management accounting
attempts to study the cause-and-effect relationship by analyzing the different variables affecting
the profits and profitability of the business.
 Management accounting is no bound by the rules of financial accounting. Financial accounting

procedures are designed based on GAAPs.
Functions of Management Accounting

The basic function of management accounting is to assist the management in performing its functions
effectively. The functions of the management are planning, organizing, directing, and controlling.
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Management accounting is a part of accounting. It has developed out of the need for making more use of
accounting for making managerial decisions.
Management accounting helps in the performance of each of these functions in the following ways:
1. Provides data
Management accounting serves as a vital source of data for management planning. The accounts and
documents are a repository of a vast quantity of data about the past progress of the enterprise, which is a
must for making forecasts for the future.
2. Modifies data
Management accounting modifies the available accounting data rearranging in such a way that it becomes
useful for management.
The modification of data in similar groups makes the data more useful and understandable. The accounting
data required for management decisions is properly compiled and classifies.
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For example, purchase figures for different months may be classified to know total purchases made during
each period product-wise, supplier-wise, and territory-wise.
3. Communication
Management accounting is an important medium of communication. Different levels of management (top,

middle, and lower) need different types of information.
The top management needs concise information at relatively long intervals, middle management needs
information regularly, and lower management is interested in detailed information at short-intervals.
Management accounting establishes communication within the organization and with the outside world.
4. Analyses and interprets data
The accounting data is analyzed meaningfully for effective planning and decision-making. For this purpose,
the data is presented in a comparative form, Ratios are calculated, and likely trends are projected.
5. Serves as a means of communicating
Management accounting provides a means of communicating management plans upward, downward, and
outward through the organization.
Initially, it means identifying the feasibility and consistency of the various segments of the plan. The later
stages it keeps all parties informed about the plans they have been agreed upon and their roles in these
plans.
6. Facilitates control
Management accounting helps in translating given objectives and strategy into specified goals for
attainment t by a specified time and secures the effective accomplishment of these goals efficiently. All this
is made possible through budgetary control and standard costing, which is an integral part of management
accounting.
7. Uses also qualitative information
Management accounting does not restrict itself to financial data for helping the management in decision
making but also uses such information that may be capable of being measured in monetary terms. Such
information may be collected from special surveys, statistical compilations, engineering records, etc.
8. To assist in planning.
Management Accounting assists the management in planning as well as to formulate policies by making
forecasts about the production, selling the inflow and outflow of cash, etc.
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Not only that, but it may also forecast how much may be needed from alternative courses of action or the
expected rate of return from that place and at the same time decides upon the programmed of activities to
be undertaken.
9. To assist in organizing.
By preparing budgets and ascertaining specific cost centers, it delivers the resources to each center and
delegates the respective responsibilities to ensure their proper utilization.
As a result, an interrelationship grows among the different parts of the enterprise.
10. Decision-Making
Management accounting furnishes accounting data and statistical information required for the decision-
making process, which vitally affects the survival and the success of the business.
Management accounting supplies analytical information regarding various alternatives, and the choice of
management is made easy.
11. To assist in motivation.
By setting goals, planning the best and economic courses of action, and also by measuring the
performances of the employees, it tries to increase their efficiency and, ultimately, motivate the
organization as a whole.
12. To Coordinate
It helps the management in coordination the whole activities of the enterprise, firstly by preparing the
functional budgets, then co-coordinating the whole activities of the enterprise, firstly, by preparing the
functional budgets, then co-coordinating the whole activities by integrating all functional budgets into one
which goes by the name of ‘Master Budget.’
In this way, it helps the management by con-coordinating the different parts of the enterprise. Besides,
overall coordination is not at all possible without budgetary control.’
13. To Control
The actual work done can be compared with ‘Standards’ to enable the management to control the
performances effectively.
Purpose and Objectives of Management Accounting
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The primary objective of Management Accounting is to enable the management to maximize profits or
minimize losses.
The fundamental objective of management accounting provides information to the managers for use in
planning, controlling operations, and decision making.
Main purpose and objectives of management accounting may be summarized as under:
1. Uses of Information
The primary functions of management are the uses of information. It presents accounting information in a
form that enables the management, investors, and creditors to analyze the financial statements.
2. Planning and Policy Formulation
Planning is deciding in advance what is to be done. It helps the management of ineffective planning. It
provides costing and statistical data to be utilized in setting goals and formulating future policies.
3. Decision Making
All management work is accomplished by decision making.
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Decision making is defined as the selection of a course of action from among alternatives. It helps the
management in decision-making. It uses accounting data to solve various management problems.
Management accounting techniques like cost-volume-profit analysis, standard costing, budgetary control,
capital budgeting, funds flow analysis, etc. Assist the management in arriving at the correct decision.
4. Motivating
Motivation means individuals need, desires, and concepts that cause him or her to act in a particular
manner. Delegation serves as a motivation device because it increases the job satisfaction of employees
and encourages them to look forward.
By setting goals, planning the best and economic courses of action, and also by measuring the
performances of the employees, it tries to increase their efficiency and, ultimately, motivate the
organization as a whole.
5. Controlling
Management accounting helps management in controlling the performance of the organization.

Actual performance is compared with operating plans, standards, and budgets, and deviations are reported
to the management so that corrective measures may be taken.
6. Reporting
One of the primary objectives of management accounting is to keep the management fully informed about
the latest positions of the concern. The facilitates management to take proper and timely decisions.
The object of management accounting is to provide data. It presents the different alternative plans before
the management in a comparative manner. The performance of various departments is also regularly
communicated to the top management.
7. Help in Organizing
Organizing is the process of allocating and arranging human and nonhuman resources so that plans can be
carried out successfully.
Tools or Techniques of Management Accounting

Management Accountant applies many of the financial and cost accounting systems, as techniques, to assist
the management. Management accounting is concerned with accounting information that is useful to
management.
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Management accounting, like accounting, as an accounting service to management through its .various
functions, has to employ several tools, techniques, and methods. Now one technique can satisfy managerial
needs.
These are placed here in brief to have some idea about those.
1. Financial Planning
A business requires finance. Financial planning involves determining both long-term and short-term
financing objectives of the firm. Every firm has to decide on the sources of raising funds.
The funds can be raised either through the issue of share capital or through raising loans. Again a decision
is to be taken about the type of capital, equity share capital, or preference share capital.
When it decides to raise funds through loans, management is to decide the extent of borrowing, long-term,
or short term. All these decisions are important for financing planning.
2. Budgetary Control
There are a number of the device which help in controlling. The most widely used device for management
control is “Budget.”
Budgetary control is a system that resorts to budget as a means of planning and controlling and coordinating
different types of activities, like the production and distribution of goods and services as designed.
3. Marginal Costing
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Marginal costing is helpful for the measurement of profitability of different lines of production. This
technique helps in identifying the nature of costs like marginal costs (variable) and fixed costs.
This is a method of costing which is concerned with changes in costs resulting from changes in the volume
of production.
4. Historical Cost Accounting
The statement of actual costs after they have been incurred is called Historical cost accounting.
Historical cost accounting is a system of accounting that records all transactions at costs incurred as soon as
they take place or on a date immediately after their occurrence.
5. Decision Accounting
One of the most important functions of top management is to make decisions. Decision making involves
a choice from several alternatives.
The decision is taken after studying the alternative data in terms of costs, prices, and profits furnished by
management accounting and exercising the best choice after considering other non-financial factors. The
objective is to maximize profit through the use of the best alternative method.
The management accounting uses Marginal Costing techniques, Capital Expenditure Budget, and separation
of production costs to achieve this end.
6. Standard Costing
Standard costing is an important tool of cost control, which is one of the main objectives of management
accounting.
Standard costing techniques compare the standard costs of materials, labor, and expenses incidental
to production, which is predetermined, with the actual costs that have occurred in the course of carrying
out production.
It is the most effective technique available for controlling performances and costs.
7. Analysis of Financial Statement
The technique of financial analysis includes comparative financial statements, ratios, fund flow
statements, Cash flow statements, and comparative financial statement analysis tools to management for
decision making.
The financial statements reveal the past performances of business in respect of dividend-paying capacity,
nature of debts services, profit-earning capacity, and solvency position.
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Based on these past events, the future course of action is projected.
8. Revaluation Accounting
This is an important tool for management accounting.
Revaluation or Replacement accounting revere to the maintenance of capital in real terms. This term is used
to denote the methods employed for overcoming the problems connect with fixed asset replacement in a
period of rising prices.
It is a fact that a problem arises in connection with the replacement of fixed assets in terms of rising prices.
It ensures the maintenance of the capital of the firm.
9. Control Accounting
It is not a separate accounting system. It consists of techniques of standard costing, budgetary control,
control reports and statement, internal check, internal audit, and reports.
It is in this field that the management has scope to display ingenuity in the’ analysis, interpretation, and
presentation of information at all levels of management.
10. Management Information System
It has already been stated that the management accounting of an enterprise is to provide management and
other operations as a basis of protective and constructive to management.
The management accountant provides all these data and information relevant to the enterprise for the
purpose.
With the development of electronic devices for recording and classifying data, reporting to management
has considerably improved. Feed-back of information can be used as control techniques.
11. Statistical Techniques
There is a large number of statistical and graphical techniques that are used in management accounting.
Some common examples are the master chart, chart of sales and earnings, investment chart, etc.
12. Ratio Accounting
Ratio accounting signifies the technique and methodology of analysis and interpretation of financial
statements using accounting ratios derived from such statements.
Ratio accounting included trend analysis, comparative financial statements, ratio analysis, fund flow
statements, etc.
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Limitations of Management Accounting

Though management accounting in helpful too to the management as it provides information for planning,
controlling, and decision making.
Still, its effectiveness is limited by several reasons. Management Accounting is a recent discipline, and
therefore, it is in the process of development.
Hence, it suffers from all the limitations of a new discipline. Some of the limitations of management
accounting follow:
1. Management Accounting is only a tool.
Management accounting should never be considered as an alternative or substitute for management. The
tools and techniques of management accounting provide only information and not decisions.
Decisions are to be taken by management, and implementation of decisions is also done by management.
2. Evolutionary’ Stage
Management accounting is still in its initial stage. Management accounting is only in a developmental stage
that has not reached the final stage.
The techniques and tools used by this system give varying and deferring results.
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3. Limitations of Basic Records
Management accounting is mainly concerned with the rearrangement or modification of data. It derives its
information from financing accounting, cost accounting, and other records.
The correctness of management accounting depends upon the correctness of these basic records: that is,
their limitations are also the; limitations of a management accountant.
4. Lack of knowledge
The use of management accounting requires knowledge of several related subjects.
Deficiency in knowledge in related subjects like accounting principles statistics, economics, principles of
management, etc. will limit the use of management accounting.
5. Persistent Efforts
The conclusions and decisions drawn by the management accountant are not executed automatically. Thus,
there is a need for continuous and coordinated efforts of each management level to execute these
decisions.
He has to convince people at all levels. In other words, he must be an efficient salesman in selling his ideas.
6. Intensive Decision
Decision making based on management accounting that provides scientific analysis of various situations will
be a time-consuming one.
As such, management may avoid systematic procedures for making a decision and arrive at a decision using
intuitive and intuitive limits the usefulness of management accounting.
7. Costly Installation
It is very costly. The installation of a management accounting system needs a very elaborate organization
and numerous rules and regulations. This results in heavy investment, which only bill concerns can afford.
8. Personal Bias
The interpretation of financial information depends on the capacity of an interpreter as one has to make a
personal judgment, personal prejudices and bias affect the objectivity of decisions.
9. Resistance
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The installation of management accounting involves a basic change in an organizational setup.
New rules and regulations are also required to be framed, which affects many personal, and hence there is a
possibility of resistance from some quarters or the other.
10. Top-heavy Structure
The installation of a management accounting system requires high costs on account of an elaborate
organization and numerous rules and regulations. It can, therefore, be adopted only by big concerns.
11. Provides Only Data
The main function of management accounting is to provide data and not decisions. It can only inform, not
prescribe.
12. Broad-Based Scope
Management accounting has a very wide scope incorporating many disciplines. Management requires
information from both accounting as well as non accounting sources.
This creates many problems and brings a degree of inexactness and subjectivity in conclusion obtained
through it.
13. Not an alternation to administration
Management accounting is a tool of management, not an alternative to management. It cannot replace the
management or administration.
14. Opposition to Change
Management accounting demands a break away from traditional accounting practices.
It calls for a rearrangement of the personal and their activities, which is generally not like by the people
involved.
Importance or Roles of Management Accounting in the

Decision-Making Process in a Business Organization.
The objective of decision making is to maximize profit through the use of the best alternative method.
Management accounting helps management in deciding financial affairs. It uses accounting data to solve
various management problems.
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Every organization has to decide at the right time. Management accounting played a vital role in
the decision-making process in a business organization.
The importance/role of management accounting can be stated as follows:
1. Efficient Planning
Management accounting plays a vital role in taking an efficient plan providing necessary information.
Through the capital budget, sales budget, Cost-volume-profit analysis, management accountants provide
information for making plans.
2. Increasing Efficiency to Business Operations
Management accounting also plays an important role in increasing efficiency in business operations
through budgeting, ratio analysis, variance analysis, standard costing, etc.
3. Efficient Control
Management accounting takes pan inefficient control through JIT philosophy and total quality control
system.
4. Increase Labor Efficiency

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Management accounting helps to increase labor efficiency through standard labor costing, linking bonus
with productivity and budgeting.
5. Achieve Management Efficiency
Management accounting contributes a lot to increase the management efficiency of the organization
providing managers with the correct information.
6. Help Management Function
We know that the main functions of management are planning, organizing, leading, and controlling
management accounting helps management personnel to perform the functions properly, providing
necessary accounting information.
7. Communicating
For performing the functions efficiently and effectively, managers need to communicate with the various
parties and parts of the organization.
Management accounting helps in this respect preparing various reports.
Last of all, we can say that the activities of management accounting are occurred only to perform a vital role
in the decision-making process in an organization.
Scope of Management Accounting

The main aim is to help management in its functions of planning, directing, and controlling.
The scope of management accounting is so wide broad-based that it includes within its fold an analysis of
all the aspects of modern accounting, which emphasis the common denominator of the functions of both
management and accounting the making of an effective decision based on appropriate information.
Some of the areas of specialization included within the ambit of management accounting:
1. Financial Accounting
Financial accounting is the general accounting which accounting relates to the recording of business
transactions in the books of prime entry, posting them into respective ledger accounts, balancing them
preparing a trial balance.
Accounting for revenues, expenses, assets, liabilities, and net worth, together with the production of
summary financial reports.
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Hence management accounting can not obtain full control and coordination of operations without a well
designed financial accounting system.
2. Cost Accounting
Costing is a branch of accounting. Accounting for current, standard and prospective costs; analysis and
communication of cost data at all levels of management with the organization. It is the process and
technique of ascertaining cost. Planning, decision-making, and control are the basic managerial
functions.
The cost accounting system provides the necessary tools such as standard costing, budgetary control,
inventory control, marginal costing, etc. for carrying out such functions efficiently.
3. Budgeting Forecasting
Budgeting means expressing the plans, policies, and goals of the enterprise for a definite period in the
future. Assembly and consolidation of budget; assistance to management personnel in translating
operating plans into financial budgets; reporting and analysis of budget variances.
Forecasting, on the other hand, is a prediction of what happened as a result of a given set of circumstances.
Targets are set for different departments, and responsibility is fixed for achieving these targets.
4. Data Processing
Recording accounting data, performing repetitive operations with these data, and preparing reports to form
recoded data.
5. Internal Auditing
Review and appraisal of accounting procedures and records to ascertain their reliability, conformity to
prescribed practices, and adequacy to protect against loss of assets by fraud, waste, and other causes.
Internal audit helps the management in fixing the responsibility of different individuals.
6. Tax Reporting
This necessitates the computation of income by the Income Tax Act, preparing return statements and
making payment of taxes when due Income statements are prepared, and tax liabilities are calculated.
The management is informed about the tax burden from the central Government, State Government, and
Local Authorities. This includes the computation of taxable income as per tax law, filing of returns, etc.
7. Financial Analysis
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Interpretation of accounting reports, analysis in financial terms of proposed projects, plans, and procedures;
assistance to the management in interpretation and evaluation of financial data of all types.
8. Inventory Control
It includes control over inventory from the time it is acquired until its final disposal.
9. Revaluation Accounting
This is concerned with ensuring that capital is maintained intact in real terms, and profit is calculated with
this fact in mind.
10. Statistical Methods
Graphs, charts, pictorial presentations, index numbers, and other statistical methods make the information
more impressive and intelligible.
Other tools, such as time series, regression analysis, sampling technique, etc. are highly useful for planning
and forecasting.
11. Taxation
This includes the computation of income following the tax laws, filing of returns, and making tax payments.
12. Method and Procedures
This includes maintenance of proper data processing and other office management services, reporting on
the best use of mechanical and electronic devices.
It provides statistical data to the various departments and undertakes special cost studies, cost estimations,
reports on cost-volume-profit relationships, under the changing conditions of the organization.
13. Interim Reporting
This includes the preparation of monthly, quarterly, half-yearly income statements and the related reports,
cash flow and funds flow statements, scrap reports, etc.
14. Office Services
This includes maintenance of proper data processing and other data processing and other office
management services, reporting on the best use of mechanical and electronic devices.
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Distinctions between Management Accounting and Financial

Accounting
Financial accounting and management accounting are closely inter-related since management accounting
draws out a major part of the information form financial accounting and modifies the same for managerial
use.
Financial accounting ensures that the assets and liabilities of a business are properly accounted for and
provides shareholder investors, tax authority, creditors, etc.
On the other hand, management accounting provides information, especially for the use of managers who
are responsible for making proper decisions within an organization.
Financial accounting is concerned with the recording of day-to-day transactions of the business.
Though both financial and management accounting relies on the same financial data, there are some
differences between financial and management accounting.
Distinctions between Management Accounting and Financial Accounting are the following.
Point of
Management Accounting Financial Accounting
difference
Management accounting is especially Financial accounting is both for

for internal users. internal and external users.
Users Management accounting reports are Financial accounting reports arc
exclusively used by internal users viz. primarily used by external users, such
managers and employees. as shareholders, banks, and creditors.
The objective of management The objective of financial accounting is

Objective accounting is to assist internal to assist both internal and external
management. decision-makers.
GAAP is not mandatory to follow in GAAP is mandatory to follow in

Uses of GAAP
management accounting. financial accounting.
It emphasizes decisions on future

Events It emphasizes decisions on past events.
events.
No constraints are other than costs

Freedom of Constrained by generally accepted
about the benefits of improved
choices accounting principles (GAAP).
management decisions.
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Detailed reports: concern about details

Summary reports concern primarily
Type of Reports of parts of the entity, products,
with the entity as a whole.
departments, territories, etc.
Concern about how measurements

Behavioral Concern about how to measure and
and reports will influence a manager’s
implications communicate economic phenomena.
daily behavior.
The field is less sharply defined—

Delineation of The field is more sharply defined—
heavier use of economic, decision
Activities lighter use of related disciplines.
science, and behavioral sciences.
Timespan Flexible, varying from hours to years Less flexible; usually 1 month to 1 year.
Financial accounting records are

In management accounting, cost, and
maintaining in the form of revenue,
Methodology revenue are mostly reported by
income and expenditure, and property
responsibility centers or profit centers.
accounts.
Annual Annual reporting of management Annual reporting of financial

Reporting accounting is not mandatory. accounting is mandatory.
Characteristics It holds qualitative characteristics. It holds quantitative characteristics.
Fundamental
Emphasizes relevance. Emphasizes objectivity and verifiability.
quality
Enhancing
Emphasizes timeliness. Emphasizes precision.
Quality
Rules It has the managers’ own rules. It has no accountants’ own rules.
A financial accounting system

Management accounting system
produces information that is used by
External vs. produces information that is used
parties external to the organization,
Internal within an organization, by managers
such as shareholders, banks, and
and employees.
creditors.
May pertain to smaller business units

Segment Pertains to the entire organization or
or individual departments, in addition
reporting materially significant business units.
to the entire organization.
Management accounting focuses on Financial accounting focuses on

Focus
the future and present. history.
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Financial accounts are supposed to be

No specific format is designed for in accordance with a specific format so
Format management accounting systems. that financial accounts of different
(Formal and informal recordkeeping) organizations can be easily compared.
(Formal recordkeeping)
Management accounting helps

Financial accounting helps in making
Planning and management to record, plan, and
investment decisions and in credit
Control control activities to aid the decision -
rating.
making process.
Quantitative and qualitative.

Information Quantitative and monetary.
Monetary and non-monetary.
Reporting
Well-defined – annually, semi-annually,
frequency and As needed – daily, weekly, monthly.
quarterly. (Verifiable)
duration.
Preparing financial accounting reports There are no legal requirements to

Optional is mandatory, especially for limited prepare reports on management
companies. accounting.
Drafted according to management Drafted according to GAAP – Generally

Legal / Rules
suitability. Accepted Accounting Procedure.
Cost accounts are not Reserved under

Follows a full process of recording,
Management Accounting. The data
Accounting classifying, and summarizing for
from financial
Process analysis and interpretation of the
statement and cost ledgers are
financial information.
analyzed.
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Module -2
Marginal Costing
Definition: Marginal Costing is a costing technique wherein the marginal cost, i.e. variable cost is charged
to units of cost, while the fixed cost for the period is completely written off against the contribution.
The term marginal cost implies the additional cost involved in producing an extra unit of output,
which can be reckoned by total variable cost assigned to one unit. It can be calculated as:
Marginal Cost = Direct Material + Direct Labor + Direct Expenses + Variable Overheads
Characteristics of Marginal Costing

1. Classification into Fixed and Variable Cost: Costs are bifurcated, on the basis of variability into
fixed cost and variable costs. In the same way, semi variable cost is separated.
2. Valuation of Stock: While valuing the finished goods and work in progress, only variable cost are
taken into account. However, the variable selling and distribution overheads are not included in the
valuation of inventory.
3. Determination of Price: The prices are determined on the basis of marginal cost and marginal
contribution.
4. Profitability: The ascertainment of departmental and product’s profitability is based on the

contribution margin.
In addition to the above characteristics, marginal costing system brings together the techniques of cost
recording and reporting.
Marginal Costing Approach
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The difference between product costs and period costs forms a basis for marginal costing technique,
wherein only variable cost is considered as the product cost while the fixed cost is deemed as a period
cost, which incurs during the period, irrespective of the level of activity.
Facts Concerning Marginal Costing

1. Cost Ascertainment: The basis for ascertaining cost in marginal costing is the nature of cost, which
gives an idea of the cost behavior, that has a great impact on the profitability of the firm.
2. Special technique: It is not a unique method of costing, like contract costing, process
costing, batch costing. But, marginal costing is a different type of technique, used by the
managers for the purpose of decision making. It provides a basis for understanding cost
data so as to gauge the profitability of various products, processes and cost centers.
3. Decision Making: It has a great role to play, in the field of decision making, as the changes in the
level of activity pose a serious problem to the management of the undertaking.
Marginal Costing assists the managers in taking end number of business decisions, such as replacement of
machines, discontinuing a product or service, etc. It also helps the management in ascertaining the
appropriate level of activity, through break even analysis, that reflect the impact of increasing or decreasing
production level, on the company’s overall profit.
Contribution Margin Definition

What Is the Contribution Margin?
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The contribution margin can be stated on a gross or per-unit basis. It represents the
incremental money generated for each product/unit sold after deducting the variable
portion of the firm's costs.
The contribution margin is computed as the selling price per unit, minus the variable
cost per unit. Also known as rupees contribution per unit, the measure indicates how a
particular product contributes to the overall profit of the company. It provides one way to
show the profit potential of a particular product offered by a company and shows the
portion of sales that helps to cover the company's fixed costs. Any remaining revenue left
after covering fixed costs is the profit generated.
The Formula for Contribution Margin Is
The contribution margin is computed as the difference between the sale price of a product and the
variable costs associated with its production and sales process.
Contribution Margin= Sales Revenue – Variable Cost
The above formula is also used as a ratio, to arrive at an answer in percentage terms, as follows:
Contribution Margin Ratio =Sales Revenue - Variable Costs /Sales Revenue
What Does the Contribution Margin Tell You?

The contribution margin is the foundation for break-even analysis used in the overall cost and sales
price planning for products. The contribution margin helps to separate out the fixed cost and profit
components coming from product sales and can be used to determine the selling price range of a
product, the profit levels that can be expected from the sales, and structure sales commissions paid to
sales team members, distributors or commission agents.
Fixed Cost Versus Variable Cost

One-time costs for items such as machinery are a typical example of a fixed cost, that stays the same
regardless of the number of units sold, although it becomes a smaller percentage of each unit's cost as
the number of units sold increases. Other examples include services and utilities that may come at a
fixed cost and do not have an impact on the number of units produced or sold. For example, if the
government offers unlimited electricity at a fixed monthly cost of Rs.100, then manufacturing ten units
or 10,000 units will have the same fixed cost towards electricity.
Fixed monthly rents or salaries paid to administrative staff also fall in the fixed cost category.
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Prof. Naveen Sharma
Fixed costs are often considered as sunk costs that once spent cannot be recovered. These cost
components should not be considered while taking decisions about cost analysis or profitability
measures.
Format of Income statement under Marginal Costing
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PARTICULARS AMOUNT (₹) AMOUNT (₹)
A. Sales XXX Prof. Naveen Sharma
B. (-) Variable cost xx
*Direct Material xx
*Direct Labour xx
*Direct Expenses xx
*Other variable costs -----
Variable Cost of Produced Goods XXX
(+) Opening Stock Xx
(-) Closing Stock (xx)
-----
Variable Cost of Sold Goods XXX
(+) Variable Administrative Overheads Xx
(+) Variable Selling and distribution overhead xx
-----
Variable Cost of Sales XXX
-------
C. Contribution ( A-B) XXX
D. (-) Fixed Overheads (xx)
*Fixed production overhead (xx)
*Fixed administrative overheads (xx) XXX
*Fixed selling and distribution overheads ----- ------
E. Profit Under Marginal Costing (C-D) XXX
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Prof. Naveen Sharma
Marginal Costing Formula

Marginal Costing equation, profit volume ratio, Break -even point, Margin of safety, cost break- even
point, finding the selling price, finding the profit,.
Marginal Costing
1 Marginal Costing Equation Sales – VC = FC + Profit
2 Contribution Sales – VC
Contribution Profit + FC
Profit Volume Ratio( in Marginal

3 Contribution / Sales
costing)
Profit = Contribution) Change in Profit / Change in Sales
(Profit = EBIT) Change in Contribution / Change in Sales
100% – VC Ratio (PV % + VC % = 100% of

Sales)
4 Break Even Point Total Revenue = Total Cost
Break Even Point(In Rupees) FC / PV Ratio
Break Even Point(In Rupees) Break Even Point * Selling Price
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Prof. Naveen Sharma
Break Even Point(Quantity) FC / Contribution p.u
At BEP, Total Contribution = Total Fixed

Note:
Cost
5 Margin Of Safety Total Sales – Break even Sales
Margin Of Safety(In Rupees) Profit / PV Ratio
Margin Of Safety(Quantity) Profit / Contribution p.u
Indifference Point / Cost Break Even

6 Total Sales = Total Profits
Point
(In Rupees) Difference in FC / Difference in VCR
(In Rupees) Difference in FC / Difference in PVR
(In Quantity) Difference in FC / Difference in VC p.u
Difference in FC / Difference in Contribution

(In Quantity)
p.u
7 Shut Down Point
(In Rupees) Avoidable FC / PV Ratio
(In Quantity) Avoidable FC / Contribution p.u
8 Avoidable FC Total FC – Min Unavoidable FC
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Prof. Naveen Sharma
OTHERS
1 Contribution Profit + FC
2 Sales(In Rupees) Contribution / PV Ratio
3 Profit Contribution – FC
4 Contribution Sales * PVR
5 Finding the Selling Price Total VC / VCR
6 Finding the Profit MOS * PVR
Note: Always MOS + PVR = 100%
STATEMENT OF PROFIT
Particulars Amount
Sales ***
Less:-Variable cost **
Contribution ***
Less:- Fixed cost ***
Profit ***
1. Sales = Total cost + Profit

2. Sales = Variable cost + Fixed cost + Profit
3. Total Cost = Variable cost + Fixed cost
4. Contribution = Profit + Fixed Cost
5. Contribution = P /V Ratio
6. Variable Cost = Sales – Contribution
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Prof. Naveen Sharma
Variable cost = It changes directly in proportion with volume
1. Variable cost Ratio = {Variable cost / Sales} * 100
2. Sales – Variable cost =Contribution OR Fixed cost + Profit
3. Contribution = Sales * P/V Ratio
PROFIT VOLUME RATIO [P/V RATIO]:-

1. {Contribution / Sales} * 100
2. {Contribution per unit / Sales per unit} * 100
3. {Change in profit / Change in sales} * 100
4. {Change in contribution / Change in sales} * 100
BREAK EVEN POINT [BEP]:- OR BEP SALES

1. Fixed cost / Contribution per unit [in units]
2. Fixed cost / P/V Ratio [in value] (or) Fixed Cost * Sales value per unit / Contribution
MARGIN OF SAFETY [MOS]

1. Actual sales – Break even sales
2. Net profit / P/V Ratio
3. Profit / Contribution per unit [In units]
3. Sales unit at Desired profit = {Fixed cost + Desired profit} / C. per unit
4. Sales value for Desired Profit = {Fixed cost + Desired profit} / P/V Ratio
5. At BEP Contribution = Fixed cost
Change in total cost

Variable cost Ratio = X100
Change in total sales
6. Indifference Point = Point at which two Product sales result in same amount of profit
= Change in fixed cost

(in units)
Change in variable cost per unit
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Prof. Naveen Sharma
= Change in fixed cost (in units)

Change in contribution per unit
=Change in Fixed cost
(Rs.)
Change in P/Ratio
= Change in Fixed cost (Rs.)
Change in Variable cost ratio
7. Shut down point = Point at which each of division or product can be closed
= Maximum (or) Specific (or) Available fixed cost

P/V Ratio (or) Contribution per unit
If sales are less than shut down point then that product is to shut
down.
Note
1. When comparison of profitability of two products if P/V Ratio of one product is greater
than P/V Ratio of other Product then it is more profitable.
2. In case of Indifference point if, (Sales Indifference point)
a. Select option with higher fixed cost (or) select option with lower fixed cost.
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Prof. Naveen Sharma
Practical Questions:
Question No.1:
From the following data, Calculate (a) P/V Ratio and (b) Break Even Point :
Selling price per unit Rs.20, Variable Cost per unit Rs.12 and Fixed Cost Rs.40,000
Solution :
Selling price per unit Rs.20
Less: Variable Cost Per unit (Rs.12)
Contribution per unit Rs.8
P/V Ratio = Contribution per unit / Sales per unit * 100
=Rs.8/Rs.20 *100
= 40%
B.E.P ( in units) = Fixed Cost / Contribution per unit
= Rs.40,000 / Rs.8
= 5,000 units
B.E.P( in Rupees) = Fixed Cost / P/V Ratio
= Rs.40000/0.4
= Rs.1,00,000
Question No. 2:
Direct Material Cost per unit Rs.5
Direct Labour Cost per unit Rs.3
Direct Expenses per unit Rs.2
Variable Overhead Cost per unit Rs.2
Total Fixed Cost Rs.1,00,000
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Prof. Naveen Sharma
Solution:
Less: Variable Cost Per Unit -
Direct Material Cost per unit Rs.5
Direct Labour Cost per unit Rs.3
Direct Expenses Cost per unit Rs.2
Variable Cost per unit Rs.2 (Rs.12)
P/V Ratio = C / S *100

= Rs.8 / Rs.20 *100
= 40%
B.E.P.( in units ) = Fixed Cost / C per unit
= Rs.1,00,000 / Rs.8
= 12,500 units
B.E.P.( in Rupees) = Fixed Cost / P/V Ratio
= Rs.1,00,000 / 0.4
= Rs.2,50,000
Question No.3
Selling price per unit Rs.40, Material Cost Rs.20, Variable Overheads per unit Rs.4, Fixed Cost Rs.1,20,000
Question No.4:
Variable Cost per unit Rs.8
Contribution Cost per unit Rs.12
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Prof. Naveen Sharma
Fixed Cost Rs.60,00

0
Solution:
Selling price = Variable Cost + Contribution
= Rs.8 + Rs.12
= Rs.20
= Rs.12 / Rs.20 * 100
= 60%
B.E.P.( in Rs.) = Fixed Cost / P/V Ratio
= Rs.60,000/ 0.6
= Rs.1,00,000
B.E.P.( in units) = Fixed Cost / C per unit or ( B.E.P Sales in Rs. / Selling price per unit)
= Rs.60,000 / Rs.12 or( Rs.1,00,000/ Rs.20)
= 5,000 units
Question No.5:
Variable cost Rs.80,000
Fixed cost Rs.2,00,000
Profit Rs.1,20,000
Solution:
Contribution = Profit + Fixed Cost
= Rs.1,20,000 + Rs.2,00,000
= Rs.3,20,000
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Prof. Naveen Sharma
Sales = Contribution + Variable Cost

= Rs.3,20,000 + Rs.80,000
= Rs.4,00,000
OR
Sales (Sp) (100%) Rs.4,00,000
Less: Variable Cost (Vc) Rs.80,000

(20%)
Contribution (C) (80%) Rs.3,20,000
Less: Fixed Cost (Fc) Rs.2,00,000
Profit (P,OP, EBIT) Rs.1,20,000
P / V Ratio = C / S *100
= Rs.3,20,000 / Rs.4,00,000 *100
= 80%
B.E.P.( in Rs.) = Fixed Cost / P/V Ratio
= Rs.2,00,000 / 0.8
= Rs.2,50,000
Question No. 6
Following information are given for manufacturing of a product:
Fixed cost Rs.4,00,000
Materials Rs.10 per

unit
Labour Rs.5 per unit
Direct Expenses:
Fuel Rs.3 per unit
Carriage Inwards Rs.2 per unit
Selling price Rs.40
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Prof. Naveen Sharma
Calculate Break-even point in terms of units. Also find out new B.E.P. If selling price is reduced by 10% per
unit.
Solution:
Income Statement
Sales per unit Rs,40
Less: Variable Cost :
Materials per unit Rs.10
Labour per unit Rs.5
Fuel per unit Rs.3
Carriage Inwards per Rs.2

unit
B.E.P.( in units) = Fixed Cost / C per unit

= Rs.4,00,000 / Rs.20
= 20,000 units
Calculation of new selling price:
New selling price = old selling price – 10% reduced
= Rs.40 – (10% of Rs.40)
= Rs.40 – Rs.4
= Rs.36
New Contribution per unit = New selling price – Variable Cost
= Rs.36 – Rs.20
= Rs.16 per unit
New B.E.P.( in units) = Fixed Cost / New Contribution per unit
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Prof. Naveen Sharma
= Rs.4,00,000 / Rs.16
= 25,000 units
Question No. 7:
From the following data, calculate the new selling price per unit if the break- even point is to be bought
down to 4,000 units.
Fixed Cost Rs.40,000
Solution:
P /V Ratio or Contribution = Fixed Cost / B.E.P
= Rs.40,000 / 4000 units
=Rs.10
New selling price = New Contribution per unit + Variable Cost per unit
= Rs.10 + Rs.12
= Rs.22
Question No.8:
Calculate the sales required to earn profit of Rs.20,000 from the following data:
Fixed Cost Rs.40,000, P/ V Ratio 25%
Solution:
Desired Sales = ( Fixed Cost + Desired Profit ) / P/V Ratio
= (Rs.40,000 + Rs.20,000) / 25%
= Rs.60,000 / 0.25
= Rs.2,40,000
Income Statement
Sales (100%) Rs.2,40,000
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Prof. Naveen Sharma
Less: Variable Costs(75% ) ( Rs.1,80,000)
Contribution or P/V Rs.60,000

Ratio(25%)
Less: Fixed Cost ( Rs.40,000)
Profit Rs.20,000
Question No. 9:
Calculate the sales required to earn profit of Rs.30,000 from the following data:
Total Cost Rs.1,00,000, Variable Cost Rs.60,000, P/V Ratio 20% .
Solution:
Fixed Cost = Total Cost – Variable Cost
= Rs.1,00,000 – Rs.60,000
= Rs.40,000
Desired Sales =( Fixed Cost + Desired Profit) / P/V Ratio
= (Rs.40,000 + Rs.30,000) / 20%
= Rs.70,000 / 0.2
= Rs.3,50,000
Question No.10: ( H.W.)
Calculate the sales required to earn profit of Rs.1,40,000 from the following data:
Total Cost Rs.1,20,000, Variable Cost Rs.80,000, Sales Rs.2,00,000
Question No. 11:
X Ltd. Provides you the following data:
Selling Price per unit Rs.20
Units Sold 6,000 units
Fixed Costs Rs.40,000
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Prof. Naveen Sharma
It is proposed to reduce the selling price by 20%. Calculate (a) New P/V Ratio, (b) New Break Even Point,
(c) Additional sales required to obtain the same amount of profit as before.
Solution:
Old Income statement
Sales (6,000 * Rs.20) Rs.1,20,000
Less: Variable Cost(6,000 * Rs.12) (Rs.72,000)
Contribution 48,000
Less: Fixed Cost (Rs.40,000)
Profit Rs.8000
New Selling Price per unit = Old Selling Price per unit – 20% reduce
= Rs.20 – (20% of Rs.20)
= Rs.20 – Rs.4
= Rs.16
New Contribution = New Selling price – Variable Cost
= Rs.16 – Rs.12
= Rs.4 per unit
New P/V Ratio = C / S * 100
= Rs.4 / Rs.16 * 100
= 25%
New B.E.P (in units) = Fixed Cost / C per unit
= Rs.40,000 / Rs.4
= 10,000 units
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Prof. Naveen Sharma
Additional Sales required to obtain the same amount of profit as before:

Desired Sales (in units) = (Fixed Cost + Desired Profit) / New Contribution Per unit
= (Rs.40,000 + Rs.8,000) / Rs.4
= Rs.48,000 / Rs.4
= 12,000 Units
Additional Sales required = New Sales – Old Sales
= 12,000 units – 6,000 units
= 6,000 Units
Question No.12
X Ltd. Provides you the following data:
Sales Rs.4,00,000
Variable Cost Rs.1,60,000
Fixed Cost Rs,2,00,000
It is proposed to reduce the selling price by 20% Calculate (a) New P/V Ratio, (b) New Break Even Point,
(c) Additional sales required to obtain the same amount of profit as before.
Solution:
Income Statement
Sales Rs.4,00,000
Less: Variable Cost (Rs.1,60,000)
Contribution Rs.2,40,000
Less: Fixed Cost (Rs.2,00,000)
Profit Rs.40,000
# Calculation of New selling price:

New Sales = Old Sales – 20% reduce
= Rs.4,00,000 – ( 20% of Rs.4,00,000)
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Prof. Naveen Sharma
= Rs.4,00,000 - Rs.80,000
= Rs.3,20,000
# Calculation of New Contribution:
New Contribution = New sales – Variable Cost
= Rs.3,20,000 – Rs.1,60,000
= Rs.1,60,000
# Calculation of New P/V Ratio:
New P/V Ratio = New Contribution / New Sales * 100
= Rs.1,60,000 / Rs.3,20,000 * 100
= 50%
# Calculation of New BEP:
New B.E.P. = Fixed cost / New P/V Ratio
=Rs,2,00,000 / 50%
= Rs.2,00,000 / 0.5
=Rs.4,00,000
# Additional sales required to obtain the same amount of profit as before
Desired Sales =( Fixed Cost + Desired Profit ) / New P/V Ratio
=( Rs.2,00,000 + Rs.40,000 ) / 0.5
= Rs.2,40,000 / 0.5
= Rs.4,80,000
Additional sales required = New sales – Old Sales
= Rs.4,80,000 – Rs.4,00,000
= Rs.80,000
Question No.13
Calculate profit when sales are Rs.2,40,000 from the following data:
P/V Ratio 25%, Fixed cost Rs.40,000
Solution:
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Prof. Naveen Sharma
Desired Profit = (Desired Sales * P/V Ratio) – Fixed Cost

= ( Rs.2,40,000 * 0.25 ) – Rs.40,000
=Rs.60,000 – Rs.40,000
= Rs.20,000
Question No.14
Total Costs Rs.1,00,000, Variable Costs Rs.60,000, P/V Ratio 20%
Solution:
# Calculation of Fixed Cost:

= Rs.1,00,000 – Rs.60,000
= Rs.40,000
Desired Profit = (Sales * P/V Ratio) – Fixed Cost
= (Rs.3,50,000 * 0.2 ) – Rs.40,000
=Rs.70,000 – Rs.40,000
= Rs.30,000
Question No.15
Total Costs Rs.1,20,000 Variable Costs Rs.80,000, Sales Rs.2,00,000
Solution:
= Rs1,20,000 – Rs.80,000
= Rs.40,000
Income Statement
Sales Rs.2,00,000
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Prof. Naveen Sharma
Less: Variable cost (Rs.80,000)
Contribution Rs.1,20,000
Profit Rs.80,000

= Rs.1,20,000 / Rs.2,00,000 * 100
= 60%
Desired Profit = (Sales * P/V Ratio) – Fixed Cost
= (Rs.3,00,000 * 0.6) – Rs.40,000
= Rs.1,80,000 - Rs.40,000
= Rs.1,40,000
Question No.16
From the particulars given below, calculate:
(a) Break- even sales,
(b) Margin of Safety, and
(c) Sales to earn a profit of Rs.4,000
Selling Price Rs.20,000
Total Cost Rs.16,000
Variable Cost Rs.12,000
Solution:
= Rs.16,000 – Rs.12,000
= Rs.4,000
Income Statement
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Prof. Naveen Sharma
Sales Rs.20,000
Less: Variable (Rs.12,000)

Cost
Contribution Rs.8,000
Profit Rs.4,000
P/V Ratio = Contribution / Sales * 100

= Rs.8,000 / Rs.20,000 *100
= 40%
B.E.P Sales( in Rs.) = Fixed Cost / P/V Ratio
= Rs.4,000 / 0.4
= Rs.10,000
Margin of Safety (M.O.S ) =Actual Sales – B.E.P. Sales
= Rs.20,000 – Rs.10,000
= Rs.10,000
Desired Sales = (Fixed Cost + Desired Profit) / P/V Ratio
= (Rs.4,000 + Rs.4,000 ) / 0.4
= (Rs.8,000 ) / 0.4
= Rs.20,000
Question No. 17
(a)Find Out BEP Sales if Budgeted output is 80,000 units. Fixed cost is Rs.4,00,000 Selling price per unit is
Rs.20 and Variable Cost per unit is Rs.10.
(b) Calculate Selling price, if Marginal Cost is Rs.2,400 and P/V Ratio is 20%
(c) Find Out margin of Safety if Profit is Rs.20,000 and P/V Ratio is 40%
Solution:
(a)B.E.P Sales( in Rs.)= Fixed Cost * Sales / (Sales – Variable cost )
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Prof. Naveen Sharma
= Rs.4,00,000 * Rs16,00,000 / (Rs.16,00,000 – Rs.8,00,000)

= Rs.4,00,000 * Rs.16,00,000 / Rs.8,00,000
= Rs.8,00,000
(b)
Sales (100%) Rs.3,00

0
Less: Marginal Cost (S – C ) ( 100% - Rs.2,40

20%) =80% of sales 0
Contribution(P/V Ratio)=20% Rs.600
Since 80%= Rs.2,400

So 100% is Rs.2,400 * 100 / 80
= Rs.3,000
( C ) M.O.S. = P / P/V Ratio
= Rs.20,000 / 40%
= Rs.20,000 / 0.4
= Rs.50,000
Question No.18
R. S. Manufacturing Ltd. Budgets production of 3,00,000 units at a Variable Cost of Rs.10 each. The fixed
costs are Rs.20,00,000. The Selling price is fixed to yield 20% profit on cost.
You are required to calculate:
( i ) P/V Ratio, and ( ii ) B.E.P
Solution:
Income Statement
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Prof. Naveen Sharma
Sales(3,00,000 * Rs.20) Rs.60,00,000.
Less: Variable Cost ( 3,00,000 * Rs.10 ) (Rs.30,00,000)
Contribution Rs30,00,000.
Less: Fixed Cost ( Rs.20,00,000 )
Profit ( 20% on cost so, 20% on Rs.10,00,000

Rs.50,00,000 )
P / V Ratio = C / S *100
= Rs.30,00,000 / Rs.60,00,000 * 100
= 50%
B.E.P ( in units ) = Fixed Cost / C per unit
= Rs.20,00,000 / Rs.10
= 2,00,000 units
Question No. 19
From the following data, Calculate:
(a) Fixed Costs ; (b) Sales required to earn a profit of Rs.2,000
(C) Profit when sales are Rs.20,000
(d) New Break – Even Point if selling price is reduced by 20%
P/ V Ratio 40%, MOS 20% and Actual Sales Rs.12,500
Solution:
M.O.S = P / P. V Ratio so
P = M.O.S * P / V Ratio
=20% * 40%
= 0.2 * 0.4
P = 0.08 or 8%
P = 8% of sales
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Prof. Naveen Sharma
P= 8% of Rs.12,500
P = 1,000
C = 40% of sales
C = 40% of Rs.12,500
C = Rs.5,000
Fixed Cost = C – P
= Rs.5,000 – Rs.1,000
= Rs.4,000
# Sales required to earn a profit of Rs.2,000
Desires Sales = (Fixed Cost + Desired Profit) / P. V Ratio
= (Rs.4,000 + Rs.2,000) / 40%
= (Rs.6,000) / 0.4
= Rs.15,000
# Profit when sales are Rs.20,000
Desired Profit = (Desired sales * P / V Ratio) – Fixed Cost
= (Rs.20,000 * 40% ) – Rs.4,000
= (Rs.8,000) - Rs.4,000
= Rs.4,000
# New Break –Even Point if selling price is reduced by 20%
New Selling price = Old selling price – 20% reduce
= Rs.12,500 – (20% of Rs.12,500)
= Rs.12,500 – Rs.2,500
= Rs.10,000
New Contribution = New sales – Old Variable Cost
= Rs.10,000 – ( 60% of Rs.12,500)
= Rs.10,000 – ( Rs.7,500)
= Rs.2,500
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Prof. Naveen Sharma
New P /V Ratio = C / S *100

= Rs.2,500 / Rs.10,000 *100
= 25%
New B.E.P Sales( in Rs.) = Fixed cost / P.V Ratio
= Rs.4,000 / 25%
= Rs.4,000 / 0.25
= Rs.16,000
Question No.20 (H.W.)

From the following data, Calculate:
(a) Fixed Costs
(b) Sales required to earn a profit of Rs.2,000
(c) Profit when sales are Rs.40,000
(d) New break-even point if selling price is reduced by 10%
P/V Ratio 20%, MOS 80% and Actual Sales Rs.1,00,000
Question No.21
P Ltd. Provides you the following information:
Year 2011 Year 2012
Total sales Rs.1,50,000 Rs.2,00,000
Profit Rs.30,000 Rs.50,000
Required: Calculate the following:

Profit / Volume ratio; (b) Fixed cost; (c) B.E.P; (d) Profit when sales are Rs.2,80000 (e) Sales required to earn a
profit of Rs.90,000.
Solution:
Year 2011 Year 2012 Change
Total Sales Rs.1,50,000 Rs.2,00,000 Rs.50,000
Profit Rs.30,000 Rs.50,000 Rs.20,000
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Prof. Naveen Sharma
# Profit / Volume Ratio:

P/V Ratio = Change in profit / Change in sales * 100
= Rs.20,000 / Rs.50,000 * 100
= 40%
Contribution = Sales * P/V Ratio
= Rs.1,50,000 *40%
= Rs.1,50,000 * 0.4
= Rs.60,000
# Fixed Costs:
Fixed Cost = Contribution – Profit
= Rs.60,000 – Rs.30,000
= Rs.30,000
# Break – Even Point:
# B.E.P( in Rs.) = Fixed Cost / P.V Ratio
= Rs.30,000 / 40%
= Rs.30,000 / 0.4
= Rs.75,000
# Profit when sales are Rs.2,80,000
Desired Profit = ( Desired sales * P/V Ratio) – Fixed Cost
= ( Rs.2,80,000 * 40% ) – Rs.30,000
= Rs.1,12,000 – Rs.30,000
= Rs.82,000
Desired sales = ( Fixed Cost + Desired Profit ) / P.V Ratio
= ( Rs.30,000 + Rs.90,000 ) / 40%
= Rs.1,20,000 / 0.4
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Prof. Naveen Sharma
= Rs.3,00,000
Question No.22
Himank Ltd. Provides you the following information:
1st half of the year 2nd half of the year
Total Sales Rs.15,00,000 Rs.6,00,000
Profit or Loss Rs.3,00,000 (Rs.1,50,000)

Profit / Volume ratio; (b) Fixed costs for the year; (c) B.E.P. for the year; (d) Profit when sales are Rs.20,00,000;
(e) Sales required to earn a profit of Rs.5,00,000.
Solution:
1st half of the year 2nd half of the year Change
Total Sales Rs.15,00,000 Rs.6,00,000 Rs.9,00,000
Profit or Rs.3,00,000 (Rs.1,50,000) Rs.4,50,000

Loss
# P/V Ratio = Change in Profit / Change in Sales *100

= Rs.4,50,000 / Rs.9,00,000 * 100
= 50%
# Fixed Cost for the year
= (50% of Rs.15,00,000) – Rs.3,00,000
= Rs.7,50,000 – Rs.3,00,000
=Rs.4,50,000
= Rs.4,50,000 * 2
= Rs.9,00,000
# Break – Even Point for the year:
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Prof. Naveen Sharma
B.E.P. = Fixed cost / P.V Ratio

= Rs.9,00,000 / 50%
= Rs.9,00,000 / 0.5
= Rs.18,00,000
# Profit when sales are Rs.20,00,000
Desired Profit = ( Desired sales * P/V Ratio) - Fixed cost
= (Rs.20,00,000 * 50%) – Rs.9,00,000
= Rs.10,00,000 – Rs.9,00,000
= Rs.1,00,000
# Sales required to earn a profit of Rs.5,00,000
Desired Sales = (Fixed cost + Desired Profit) / P.V Ratio
= (Rs.9,00,000 + Rs.5,00,000) / 50%
= Rs.14,00,000 / 0.5
= Rs.28,00,000
Question No.23
Suchita Ltd. Provides you the following information:
Year 2020 Year 2021
Total Sales Rs.20,000 Rs.30,000
Total Cost Rs.17,000 Rs.21,600

Profit / Volume ratio; (b) Fixed costs; (c) B.E.P. ; (d) Profit when sales are Rs.50,000; (e) Sales required to earn
a profit of Rs.59,000.
Solution:
Year Year 2021 Change

2020
Total Sales Rs.20,00 Rs.30,000 Rs.10,000
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Total Cost Rs.17,00 Rs.21,000 Rs.4,000

0
Profit ( S- Rs.3,000 Rs.9,000 Rs.6,000

Tc)
# P/V Ratio = Change in Profit / Change in Sales *100

= Rs.6,000 / Rs.10,000 * 100
= 60%
# Fixed Cost for the year
= (60% of Rs.20,000) – Rs.3,000
= Rs.12,000 – Rs.3,000
=Rs.9,000
# Break – Even Point for the year:
B.E.P. = Fixed cost / P.V Ratio
= Rs.9,000 / 60%
= Rs.9,000 / 0.6
= Rs.15,000
# Profit when sales are Rs.50,000
Desired Profit = ( Desired sales * P/V Ratio) - Fixed cost
= (Rs.50,000 * 60%) – Rs.9,000
= Rs.30,000 – Rs.9,000
= Rs.21,000
Desired Sales = (Fixed cost + Desired Profit) / P.V Ratio
= (Rs.9,000 + Rs.59,000) / 60%
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= Rs.68,000 / 0.60
= Rs.1,13,333
Question No. 24
Selling price per unit Rs.10, Variable cost per unit Rs.6 . Fixed cost Rs.2,000, Actual sales Rs.20,000. Calculate
Margin of safety( in units), Margin of safety (in value) and Margin of safety (in %) .
Solution:
Income Statement
Sales Rs.20,000, Rs.10 per unit
Less: (Rs.12,000) (Rs.6 per unit)

Variable(Rs.20,000/Rs.10)=2,00
0 units cost(2,000*6)
Contribution Rs.8,000 Rs.4 per unit
Less: Fixed cost (Rs.2,000)
Profit Rs.6,000 Rs.3 per unit
# Margin of Safety (in units)

M.O.S (in units) = Profit / Contribution per unit
= Rs.6,000 / Rs.4
= 1,500 units
# Margin of Safety (in value)
M.O.S (in Rs.) = Profit * Selling price per unit / Contribution per unit
= Rs.6,000 * Rs.10 / Rs.4
= Rs.60,000 / Rs.4
= Rs.15,000
OR
M.O.S.(in Rs.) = M.O.S in units * Sp
= 1500 units * Rs.10
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= Rs.15,000
Note: You can also use P / P.V Ratio
# Margin of Safety (in %)
M.O.S. (in %) = Margin of safety (in unit) / Actual sales (in unit) *100
= 1500 / 2,000 *100
= 75%
Question No. 25
P / V Ratio 40%, Margin of safety 60%, Sales Rs.1,50,000 . Calculate Break Even Sales, Fixed cost and Net
profit.
Solution:
# Break Even Sales:
Break-even sales = Actual sales – Margin of safety
= Rs.1,50,000 – 60% of Rs.1,50,000
= Rs.1,50,000 – Rs.90,000
= Rs.60,000
# Profit:
Profit = Margin of safety * P/V Ratio
= 60% of Rs.1,50,000 *40%
= Rs.90,000 * .40
= Rs.36,000
# Fixed Cost:
Fixed cost = Break Even sales * P/V Ratio
= Rs.60,000 * 40%
= Rs.60000 * .40
= Rs.24,000
Question No.26
Break Even Sales Rs.16,000, Total cost Rs.17,600, Break Even Sales 1600 units. Margin of Safety 400 units .
Calculate Fixed Cost.
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Solution:
# Selling price per unit
Sp = B.E.P. in Rs. / B.E.P. in units
= Rs.16,000, / 1,600, units
= Rs.10 per unit
# Actual sales in Rs.
Actual Sales = B.E.P. in units + Margin of safety in units
= 1,600 units + 400 units
=2000 units * Rs.10
= Rs.20,000,
# Profit
Profit = Actual Sales – Total cost
= Rs.20,000 – Rs.17,600
= Rs.2,400
# P/V Ratio
MOS = P/ P.V Ratio
P /V Ratio = P / M.O.S *100
= Rs.2,400 / (400 units* Rs.10) *100
= Rs.2,400 / Rs.4,000 * 100
= 60%
# Fixed Cost
= (60% of Actual sales ) – profit
= 60% of Rs.20,000 – Rs.2,400
=Rs.12,000 – Rs.2400
= Rs.9,600
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Module – 3
DECISION – MAKING
APLICATIONS OF MARGINAL COSTING
1. Profit planning
2. Evaluation of performance
3. Make or Buy Decisions
4. Closure of a Department or Discontinuance of a Product
5. Maintaining a Desired Level of Profit
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6. Offering Quotations
7. Accepting an Offer or Exporting below Normal Price
8. Alternative Use of Production Facilities
9. Problem of Key Factor
10. Selection of a Suitable Product Mix
# Make or Buy Decision

*Basis of Make or Buy Decision:
A decision as to whether to make the component or buy the component from as outside supplier should
be based on Marginal Cost Analysis .
*Considerable Factors:
The following factors should be considered in Make or Buy decision.
Cost Factors Non-Cost Factors
1. Marginal cost of making the component 1. Capacity of supplier – Ensure whether the
supplier has capacity to the requirements.
2. Contribution lost due to non-manufacture 2. Reliability of Supplier – Ensure whether the

of a product which is currently produced supplier can be relied upon for the quality of
using the facilities which now to be used for goods to be supplied.
making the component.
3. Cost of buying the component from an 3. Timely Delivery-Ensure whether the supplier will
outside supplier. make timely delivery of the components.
4. Benefit resulting from the utilization of the 4. More than one supplier- Ensure that more than
capacity released due to discontinuance of the one supplier is available to reduce the risk of
manufacturing of the component( e.g. rental outside buying.
income from hiring out the capacity released,
contribution from production of new product
by using capacity released)
5. Reduction in fixed cost on buying the 5. Possible use of released production capacity
component. and facilities due to discontinuance of the
manufacturing of the components
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# Relative Economic of Make or buy

The relative economics of the “Make v/s Buy” decision is management control:
Generally for taking a Make v/s Buy decision comparison is made between the supplier’s price and the
marginal cost of making plus the opportunity cost. Make v/s buy decision is a strategic decision and
therefor, both short-term as well as long-term thinking about various costs and other aspects need to be
done.
A company generally buy a component instead of making it under following situation:
 If it costs less to buy rather than to manufacture it internally;
 If the return on the necessary investment to be made to manufacture is not attractive enough;
 If the company dose not have the requisite skilled manpower to make;
 If the concern feels that manufacturing internally will mean additional labour problem;
 If adequate managerial manpower is not available to take charge of the extra work of
manufacturing;
 If the component shows much seasonal demand resulting in a considerable risk of maintaining
inventories;
 If the transport and other infrastructure facilities are adequately available .
 If there is risk of technological obsolescence for the component such that it does not encourage
capital investment in the component .
 If the process of making is confidential or patented .
# Practical steps in Make or Buy decision
Step 1: Calculate the Relevant Cost of manufacturing the component.
(Note: Fixed overheads are not relevant cost but contribution lost due to non-manufacture of a
product which is currently produced using the facilities which now to be used for making the
component is relevant cost. Thus, lost contribution becomes relevant cost when the firm is
working at its full capacity.)
Step 2: Calculate the Relevant Cost of Buying the component as follows:
A- Cost of buying the component from an outside supplier.
B- Less: Benefits resulting from the utilization of the capacity released due to discontinuance of
manufacturing of component ( e. g. Rental income per hiring out the capacity released,
contribution from production of new production by using capacity released).
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Prof. Naveen Sharma
C- Less: Reduction in fixed costs (If any) due to discontinuance of manufacturing of the
component.
Step 3: Compare the Relevant Cost of manufacturing with the Relevant Cost of Buying.
Step 4: Making the component if Relevant cost of Manufacture is less than the Relevant Cost of
Buying.
OR
Buy the component if Relevant cost of manufacture is more than the Relevant cost of Buying
# Format of Statement Showing the Relevant Cost to Make and Buy
Statement Showing the Relevant Cost to Make and Buy
Particulars Make Buy and Buy and Released Buy and

Released capacity is rented Released
capacity remains out capacity is used
idle for another
product
Variable cost of Mfg. xxxx ----- ----- -----
Cost of Buying ---- xxxx xxxx xxxx
Less: Reduction in ---- (xxxx) (xxxx) (x x x )

fixed cost
Less: Rental Income ---- ----- (x x x) ----
Less: Contribution ---- ----- ----- (x x x x)

from another product
Relevant Cost xxxxx xxxxxx xxxxx xxxxx
Question No.1
A machine manufactures 10,000, units of a part at a total cost of Rs.21per unit of which Rs.18 is variable.
This part is readily available in the market at Rs.19 per unit.
If the part is purchased from the market then machine can either be utilized to manufacture other
component B in same quantity and contributing Rs.2 per component, or it can be hired out at Rs.21,000,.
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Prof. Naveen Sharma
Recommend which of the alternative is profitable.
Solution:
Statement Showing the Relevant Cost of Make and Buy
Particulars Make Buy and Released Buy and Released

capacity used for capacity rented out
other product
Variable cost of Mfg. (10,000 * Rs.1,80,000 --- ---

Rs.18)
Cost of buying (10,000 * Rs.19) ---- Rs.1,90,000 Rs.1,90,000
Less: Contribution from another ---- (Rs.20,000) ---

component(10,000 * Rs.2)
Less: Rental Income ----- ---- (Rs.21,000)
Relevant Cost Rs.1,80,00 Rs.1,70,000 Rs.1,69,000

0
Recommendation: The part should be bought from outside and released capacity should be hired
out since it will result in net saving of Rs.11,000 (i. e. Rs.1,80,000 – Rs.1,69,000)
Question No.2
Kunj Ltd. Manufactures 10,000 units of component ‘X’ per month. The total cost of a manufactured
component is Rs.100 as follows:
Material Rs.10 per unit
Labour@ Rs.10 per hour Rs.40 per unit
Overheads (40% variable) Rs.50 per unit
Total Rs100
An outside supplier has offered the same component at Rs.80 plus 10% GST plus Delivery cost of Rs.2. If
the component is bought, fixed overheads of extent of 60% could be avoided, if the capacity remains idle.
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Prof. Naveen Sharma
Required:
(a) Should the component be made or bought assuming that the released capacity remains idle.
(b) Evaluate the following two alternatives available to the manufactures:
(i) Rent out the released capacity at Re.1 per hour.
(ii) Manufacture a new product ‘Y’ which can be sold at Rs.73 per unit. The unit cost of product ‘Y’ is Rs. 60
as follows:
Material Rs.30
Labour @ Rs.10 per hour Rs.20
Variable overheads Rs.10
Total Rs.60
Solution:
# Calculation of Released capacity in hours = 10,000 * (Rs.40 / Rs.10) = 4
= 40,000 hours
# Calculation of Maximum units produce of product ‘Y’
= 40,000 hours / 2 hours
=20,000 units
Statement Showing the Relevant cost to Make and Buy
Particulars Make Buy and Buy and Buy and Released

Released Released capacity is used
capacity capacity is for product
remains idle rented out another
Variable cost of Mfg. Rs.7,00,00 ---- ---- ----

(Rs.10 + Rs.40 +Rs.20) 0
=Rs.70 * 10,000
Cost of buying(Rs.80 ---- Rs.9,00,000 Rs.9,00,000 Rs.9,00,000

+Rs.8 +Rs.2) = Rs.90 *
10,000
Less: Reduction in fixed ---- (Rs.1,80,000) ---- ----
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Prof. Naveen Sharma
overheads(10,000 * Rs.30
* 60%)
Less: Rental ---- ---- (Rs.40,000) ----

Income(10,000 * 4 * Re.1)
Contribution from ---- ---- ---- (Rs,2,60,000)

product ‘Y’(20,000 units *
(Rs.73 – Rs.60)=Rs.13
Relevant Cost Rs.7,00,00 Rs.7,20,000 Rs.8,60,000 Rs.6,40,000

0
Recommendation:
(a) The component should be manufactured since the cost of manufacturing is less than that of
buying from outside.
(b) The component should be bought from outside and released capacity used to produce product
‘Y’ since this decision will result in saving of Rs.60,000 (i.e. Rs.7,00,000 – Rs.6,40,000)
Question No.3
Auto Parts Ltd. has an annual production of 90,000 units for a motor component. The component’s cost
structure is as below:
Materials Rs.270 per

unit
Labour (25% Rs.180 per

Fixed) unit
Expenses:-
Variable Rs.90 per unit
Fixed Rs.135 per

unit
Total Rs.675 per

unit
(a)The purchase Manager has an offer from a supplier who is willing to supply the component at Rs.540
per unit. Should the component be purchased and production stopped?
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Prof. Naveen Sharma
(b)Assume the resources now used for this component’s manufacture are to be used to produce another
new product for which the selling price is Rs.485.
In the letter case, the material price will be Rs.200 per unit. 90,000 units of product can be produced, at the
same cost basis as above for Labour and Expenses. Discuss whether it would be advisable to divert the
resources to manufacture that new product, on the footing that the component presently being produced
would, instead of being produced, be purchased from the market.
Solution:
(a)Statement of the Variable Mfg. Cost and Purchase Cost of Component
Particulars Total Cost for 90,000 units Cost per unit (Rs.)
(Rs.)
Materials 2,43,00,000 270
Labour (75% of Rs.180) 1,21,50,000 135
Variable Expenses 81,00,000 90
Total Variable Cost (when 4,45,50,000 495

component is produced)
Less: Cost of Purchases (when (4,86,00,000) (540)

component is purchases)
Difference, Excess of purchase (40,50,000) (45)

price over Variable cost
Advice: If the component is purchased from the outside supplier, the company will have to pay Rs.45 per
unit more and on 90,000 units that company will have to spend Rs.40,50,000 more. Therefore, the
company should not stop the production of the component.
(b) Statement of contribution per unit if the Resources are used for new Product
Particulars Rs. Rs.
(A)Selling price of the product per 485

unit
(B)Less: Material Cost 200
Labour Cost 135
Expenses 90 425
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(C)Contribution per unit (A-B) 60
(D)Loss per unit if present (45)

component is purchased (Rs.540 –
Rs.495)
(E)Saving per unit (Rs.60 – Rs.45) 15
(F)Total Saving (90,000 units * Rs.15) 13,50,000
Advice : If the company diverts its resources for the production of another new product, it will benefit by
Rs.15 per unit. On 90,000 units, the company will save Rs.13,50,000. Therefore, it is advisable to divert the
resources to manufacture the new product and the component presently being produced should be
purchased from the market.
Whether To Accept Export Order Or Not

Sometime the volume of output and sales may be increased by reducing the normal prices of additional
sale. In this case the concern should be cautious enough to see that the sale below normal price in
additional markets should not affect the normal market. To be on the safe side the product may be sold
under the label of a different brand. If there is additional sale because of export orders, goods may be sold
at a price below the normal. In other words we can say that -
If surplus capacity is available accept the Export order if export price (along with export incentives) is more
than the incremental cost of producing order quantity otherwise not. Present fixed costs are not relevant
for export order decision. It should be ensured that dumping in export market at a price lower than local
price should not have any adverse effect on local sales.
Change in profit due to acceptance of export order may be calculated as follows:
Profit on Export order = (Net export price per unit – Marginal Cost per unit) * Export order
Quantity
Question No. 4
The cost of a manufacturing company for the product is:
Particulars Rs.
Materials 12
Labour 9
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Variable 6
Expenses
Fixed Expenses 18
Total 45
The unit of product is sold for Rs.51.

The company’s normal capacity is 1,00,000 units. The figures given above are for 80,000 units. The
company has received an offer for 20,000 units @Rs.36 per unit from a foreign customer.
Advice the manufacturer on whether the order should be accepted . Also give you advice if the order is
from a local merchant.
Solution:
Marginal cost for additional 20,000 units
Particulars Per For 20,000

unit units
Rs. Rs.
Materials 12 2,40,000
Labour 9 1,80,000
Variable Expenses 6 1,20,000
Total Marginal Cost 27 5,40,000
Additional revenue to be 7,20,000

realized(20,000 units * Rs.36)
Less: Marginal cost (5,40,000)
Net additional 1,80,000

revenue(Marginal
Contribution) (Rs.36 – Rs.27 =
Rs.9 * 20,000 units)
Advice: The offer should be accepted because it gives an additional contribution of Rs.1,80,000 . The total
profit will also increase by Rs.1,80,000 because fixed expenses have already been recovered from the local
market.
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Prof. Naveen Sharma
Further some, the order from the local customer should not be accepted at Rs.36 per unit or at any rate
below the normal price i.e. Rs.45 because it will result in the general reduction of selling price of the
product.
Note: Acceptance of the additional order should not lead to production being in excess of the present
capacity since, in that case, some fixed expenses may also go up substantially. If there is such an increase in
fixed expenses, the increase should also be considered by inclusion in the total additional cost to be
compared with the additional revenue.
Question No.5
A manufacturer of certain product has been selling exclusively in the Indian market upto now. He has just
received his first export enquiry and wants to quote as competitively as the circumstances will allow. His
latest Indian cost sheet is:
Particulars Rs.
Raw materials per unit 34
Direct wages cost per unit 13
Services ( 1/3 of fixed) per 06

unit
Fixed Work Overhead per 07

unit
Fixed Office Overhead per 02

unit
Total 62
Profit earned in India 06
Indian Selling price 68
Management is thinking of quoting a selling price somewhere between Rs.62 and Rs.68 per unit for this
export order. One of the directors suggests quoting an even lower price based on the principles of
Marginal costing. As the firm’s Accountant, you are requested to compute the lowest, the management
could quote on these principles assuming additional Expenses like special packing insurance etc. will
amount to Rs.4 per unit.
Solution:
Statement Showing the Lowest Price for the Export Enquiry
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Raw Materials Cost per unit Rs.34
Direct Labour cost per unit Rs.13
Variable Services cost per unit(2/3 of Rs.4

Rs.6)
Additional Expenses per unit for export Rs.4
Marginal Cost per unit for export Rs.55
Advice: On the above basis, any price above Rs.55 will be that lowest possible price which can be quoted
by the company.
Question No.6
Particular Rs.
Per
unit
Direct Material 3,200
Direct Labour 400
Variable Overheads 1,000
Fixed Overheads 200
Depreciation 200
Variable Selling 100

Overhead
Royalty 200
Profit 1,000
Total 6,300
Central Excise Duty 600
Selling price 6,900
(i)A foreign buyer has offered to buy 200 such motors at Rs.5,000 each. As a cost Accountant of the
company would you advise acceptance of the offer?
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Prof. Naveen Sharma
(ii)What should the company quote for a motor to be purchased by a company under the same
management, if it should be at cost.
Solution:
Statement showing the Relevant cost per unit for Export
Particulars Rs.
Direct Material 3,200
Direct Labour 400
Variable cost 1,000
Royalty(Considering it is paid on 200

production basis)
Total Variable Cost per unit 4,800
Recommendation:
(i) Offer from foreign buyer should be accepted since this decision will yield an incremental profit
of Rs.40,000 (i.e. 200Unit * Rs.200 profit per unit[Rs.5,000 – Rs,4,800] = Rs.40,000). This will further
increase by Export incentive minus the cost of extra packing required for Export. It should be
noted that no excise duty is leviable in exports.
(ii) Following price should be quoted for motor to be purchased by a company under the same
management.
Particular Rs. Rs.
Price (Excluding excise duty) 6,300
Less: Profit 1,000
Variable Selling 100 (1,100)

Overhead
Price to be quoted 5,200
Note: Excise duty should be added wherever payable.

Question No.7
Z Ltd. having an installed capacity of 10,000 units of a product is currently operating at 70% utilization. The
cost and price structures are as follows :
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Capacity Utilization Unit (Costs) in Rs. Unit price in Rs.
60% 160 200
70% 150 194
80% 148 190
90% 144
100% 142
The company has received an order for 2,000 units from Canada at price of Rs.130 per unit.
Required: Advise the company as to whether the export order should be accepted or not.
Solution:
Statement showing the Differential cost per unit
Capacity Production Unit cost (Rs.) Total costs (Rs.) Differential Differential cost per
Utilization(%) No .of units * cost(Rs.) unit(Rs.)[Differential
(in units)
Cost per unit cost / 1000 units]
60 6,000 160 9,60,000 - -
70 7,000 150 10,50,000 90,000 90
80 8,000 148 11,84,000 1,34,000 134
90 9,000 144 12,96,000 1,12,000 112
100 10,000 142 14,20,000 1,24,000 124
Statement showing the additional profit from Export
Particulars Rs. Rs.
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A. Sales of 2,000 units (2,000 2,60,000

* Rs.130)
B. : Cost of producing(2,000
units)
First 1,000 1,34,000
Next 1,000 1,12,000 2,46,000
C. Net profit 14,000
Recommendation: The company should accept the export order since it will increase the existing profit by Rs.14,000.
Shut Down Or Continue Decision

Basic of Decision:
A decision as to whether to shut down or continue should be based on the marginal cost analysis.
Considerable Factors:
The following major factors should be considered in shut down or continue decision:
Cost Factors Non-Cost Factors
1. Present Contribution 1. Loss of experienced employees on shut down.
2. Present Fixed Costs 2. Loss of Customers on shut down
3. Fixed costs of plant shut down. 3. Loss of Suppliers on shut down.
4. Additional Costs of plant shut down e. g. 4. Loss of Reputation on shut down.

(extra maintenance costs, Redundancy
payments)
5.Costs to be incurred on re – opening (e. g.

overhauling the plant, recruitment and
training of staff, cost of technological
obsolescence).
Practical steps in shut Down or Continue Decision:
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Step 1: Calculate Operating Losses if Plant is continued

= Present Sales – [ Present Variable costs + Present Fixed Costs]
Step 2: Calculate Operating Losses if Plant is Shut down
= Fixed costs if plant is shut down + Additional costs of plant shut down
Step 3: Continue the plant if Operating losses of continued plant are less than those of shut down plant
OR
Shut down the plant if operating losses of continued plant are more then those of shut down plant
(In otherworld’s if present if present contribution is sufficient to cover the avoidable fixed cost, continue the
operations, otherwise shut down)
Shut Down Point:

Shut Down point refers to that level of activity at which operating losses are just equal to fixed costs if the
plant is shut down. At this point management would be indifferent as to the shout down or continue
decision. Shout down point may be calculated as follows:
1. Shut Down Point (in Value) = Present Fixed costs – Fixed Costs if plant is shut down / P.V.Ratio
OR
= Avoidable Fixed Cost / P.V Ratio
2. Shut Down Point (in units) = Present Fixed costs – Fixed Costs if plant is shut down / C per unit
OR
= Avoidable Fixed Cost / C per unit
Shut Down or Continue Decision on the basis of Shout Down point

Actual Level of Activity Whether to Shut Down or Continue
If Actual Sales = Shut Down Point Either Shut Down or Continue
If Actual Sales >Shut Down point Continue
If Actual Sales < Shut Down Point Shut Down
Question No.8 (Due for G)
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Universe Ltd. Manufactures 20,000 units of ‘X’ in a year at its normal production capacity. The unit cost as
to variable costs and fixed costs at this level are Rs.13 and Rs.4 respectively. Selling price unit is Rs.20.
Due to trade depression, it is expected that only 2,000 units of ‘X’ can be sold during the next year. The
management plans to shut-down the plant. The fixed costs for the next year then is expected to be
reduced to Rs.33,000. If the plant is shut down, plant maintenance would cost Rs.8,000 and on reopening
of the factory, cost of overhauling the plant and cost of training and engagement of new personnel would
amount to Rs. 3,000 and Rs.1,000 respectively. Should the plant to be shut-down? What is the shut-
down point?
Solution:
Statement of showing operating Losses (Next Year)
Particulars If plant is If Plant is Shut-

Operated Down
(Rs.) (Rs.)
Sales [2,000 units * Rs.20] 40,000 --
Less: Variable Costs[2,000 (26,000) --

units * Rs.13]
Contribution [Rs.7 per unit] 14,000 --
Less: Fixed Costs(20,000*4) (80,000) (33,000)
Additional Cost if Shut _ (12,000)

down(Rs.8,000 + Rs.3,000 +
Rs.1,000)
Operating Loss (66,000) (45,000)
Recommendation: The plant should be Shut- Down since operating losses of shut down are less than
those of continued plant.
Shout –Down Point = Total Fixed costs - Shut Down costs / Contribution per unit
= Rs.80,000 – Rs.45,000 / [Rs.20 P.U – Rs.13 P.U]
= Rs.35,000 / Rs.7 P.U
= 5,000 units
Plant should be shut down since the Actual Sales are less than Shut Down (i.e.5,000 units)
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Question No.9
(a) X Ltd. Provides you the following information:
1. Production and Sales at present 25,000 units
2. Sales in Rupees 6,25,0000 p.a.
3. P/ V Ratio 20%
4. Fixed costs at present Rs.4,80,000 p.a.
5. Fixed Costs when the plant is shut down Rs.3,60,000 p.a.
Required: Advise the company whether the plant should be shut down and calculate the Shut Down
Point.
(b) If in the above part (a) the existing sales (in units) are reduced by 5% shall your decision be
changed?
Solution:
Part (a)
Particulars If Plant is Continued (Rs.) If Plant is Shut Down (Rs.)
A. Sales [100%] 6,25,000 Nill
B. Less: Variable (5,00,000) Nill

Costs[@80%]
C. Contribution[@20%] 1,25,000 Nill
D. Less: Fixed Costs (4,80,000) (3,60,000)
E. Profit / Loss (3,55,000) (3,60,000)
Recommendation: Since the Operating losses, If Shut Down are larger than those, if not Shut down, the
plant should not be SHUT DOWN.
Shut Down Point = Fixed Costs at present – Fixed costs if Shut Down / P. V Ratio
=Rs.4,80,000 – Rs.3,60,000 / 20%
= Rs.1,20,000 / 0.2
= Rs.6,00,000
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Shut down point (in units) = Shut down point in Rupees / Selling price per unit
= Rs.6,00,000 / Rs.25
= 24,000 units
Plant should not be shut down since the Actual Sales (i.e. 25,000 units) are more than the shut down point
(i.e. 24,000 units)
(Part B)
Particulars If Plant is continued If Plant is Shut Down (Rs.)

(Rs.)
Sales@95% of Actual Sales 5,93,750
Less: Variable Costs (95% of (4,75,000)

Actual Variable Costs)
Contribution 1,18,750
Less: Fixed Cost (4,80,000) (3,60,000)
Operating Profit / Loss (3,61,250) (3,60,0000)
Recommendation: Since the Operating losses, If shut down, are lesser than those if plant is continued, the
plant should be shut down.
25,000units * 95/100 = 23,750 units
Product Mix Decisions

Product mix decisions involve deciding upon the priority of products to be produced and sold so as to
maximize the profit. For the purposes of understanding, product mix decisions may be studied under the
following six headings:
1. Product mix Decision when there is one key factor.

2. Product Mix Decision when there is only one key factor and product specific fixed costs are
also given.
3. Product Mix Decision where there are more than one key factors.
4. Product Mix Decision when there are more then one level of activity.
5. Product Mix Decision when a product passes through various departments and departmental
hours are limited.
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6. Product Mix Decision when Sales Demand of two or more products at different Selling Prices
are given.
# Product Mix Decision when there is only one key factor:

Let us first understand what is key factor?
Meaning of Key Factor Key Factor is a factor which limits the activities of
an undertaking. The extent of its influence must
first be assessed while preparing functional
budgets and taking decisions about the
profitability of a product.
Examples of Key Factor Some of examples of key factor are:

(a) Shortage of Raw Material
(b) Shortage of Labour Hours
(c) Machine Capacity available
(d) Sales capacity available
(e) Cash available
Basis of Decision The product mix decision should be taken on the

basis of contribution per unit of key factor
i.e. Contribution per unit / Key factor per unit
Procedure The following procedure may be followed to

decide the most profitable product mix.
Step 1: Calculate the contribution per unit of key
factor
= Contribution / Key factor per unit
Step 2: Assign the Ranking (say I, II, III ) to
various products on the basis of contribution per
unit of key factor [ e.g. Rank I to largest
contribution, Rank II to second largest
contribution and so on ]
Step 3: First allocate the key factor resources ( say
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Material, Labour Hours, Machine Hours) to meet

the committed sales of products ( if any )
Step 4: Then allocate the balance of key factor
resources to products ranked on the basis of
contribution per unit of key factor [ e.g. first
allocate to Rank I Product upto maximum sales
demand, then allocate to Rank II product and so
on ]
Step 5: Find out the quantity of each product to
which key resources have been allocated and
total contribution for such product mix. This is
called the most profitable product mix.
Step 6: Calculate the profit for the suggested
product mix.
Basis for Deciding upon priority of products To decide upon the priority of products, the
following guidelines may be used:
Case Basis for deciding

upon the priority of
products
(a) If maximum sales (a) Contribution per

(in units) is a limiting unit
factor
(b) If maximum sales (b) Profit- volume ratio

(in value) is a limiting
factor
(c) If raw material is a (c) Contribution per

limiting factor unit of raw material
required to produce
one unit of a product
(d) If labour hour is a (d) Contribution per

limiting factor unit of labour hour
required to produce
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(e ) If machine hour (e) Contribution per

is a limiting factor unit of machine hour
required to produce
(f) If there is heavy (f) P/ V Ratio

demand for the
product
(g) If there is low (g) Low Break-Even

demand for the product Point
Question No.10
X Ltd. Which produces two products using the same raw – material and production facilities, provides you
the following information:
Product ‘ A’ Product ‘B’

(Rs.) (Rs.)
Selling price per unit 100 80
Material @ Rs.2 per kg 20 10
Labour @ Rs.3 per hour 15 30
Variable Overheads @ Rs.4 per 40 16

machine hour
Total Fixed Overheads:

Rs.6,00,000
Required: Comment on the profitability of each product when :-

(a) Sales Quantity is limited;
(b) Sales Value is limited;
(c) Raw – Material is in short supply;
(d) Labour hours are limited;
(e) Production Capacity (in term of Machine Hour) is limited;
(f) There are Heavy demand condition; and
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(g) There are low demand condition.

Solution:
Statement showing the Contribution per unit of key Factor
Particulars Product ‘ A’ Product ‘B’
Selling price per unit Rs.100 Rs.80
Less: Variable costs:-
Materials per unit (Rs.20) (Rs.10)
Labour per unit (Rs.15) (Rs.30)
Variable O.H per unit (Rs.40) (Rs.16)
Contribution per unit Rs.25 Rs.24
1.P/ V Ratio = C / S*100 25% 30%
2.Contribution per kg of Raw Material = C / Raw materials per unit Rs.25/10kg Rs.24/5kg
Rs.2.5 Rs.4.8
3.Contribution per labour hour = C per unit / Labour hour per unit Rs.25 / 5Lhrs. Rs.24 / 10Lhrs
Rs.5 Rs.2.4
4.Contribution per machine Hour = C per unit / Machine Hour per Rs.25 / 10Mhrs. Rs.24 / 4Mhrs.
unit
Rs.2.5 Rs.6
5.Break – even- Point = Fixed costs / C per unit Rs,6,00,000 Rs.6,00,000

Rs.25 Rs.24
24,000 units 25,000 units
Recommendation:
(a) When Sales Quantity is limited - Production ‘A’ is more profitable because its contribution per
unit is higher than that of Product ‘B’.
(b) When Sales value is limited – Product ‘B’ is more profitable because its P/ V Ratio is higher
than that of Product ‘ A’
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(c) When Raw Material is in Short Supply – Product ‘B’ is more profitable because its Contribution
per kg. of Raw material is higher than of Product ‘A’
(d) When Labour Hours are limited – Product ‘A’ is more profitable because its Contribution per
labour is higher than that of Product ‘B’
(e) When Production capacity in term of Machine Hour is limited – Product ‘B’ is more profitable
because its Contribution per Machine Hour is higher than that of Product ‘A’
(f) When there are Heavy Demand Condition – Product ‘B’ is more profitable because P/ V Ratio
is higher than that of Product ‘A’
(g) When there Low Demand Condition – Product ‘A’ is more profitable because its Break – Even
Point is lower than that of Product ‘B’
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Module 4
Cash Flow Analysis
Cash Flow Statement:
What is Cash Flow Statement?
The Meaning of Cash Flow Statement or statement of cash flows can be defined as ‘cash
flow statements exhibit the flow of incoming and outgoing cash. This statement assesses
the ability of the enterprise to generate cash and to utilize the cash. This statement is one
of the tools for assessing the liquidity and solvency of the enterprise’.
A cash flow statement is a financial statement that presents total data. Including cash
inflows a business gains from its continuing progress and external financing sources, as
well as all cash outflows that pay for trading activities and finances during a delivered
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time. In other words, a cash flow statement is a financial statement that estimates the cash
produced or used by a firm in a presented time.
As mentioned initially, the cash flow statement furnishes data about the shift in the
position of Cash Equivalents and Cash of a firm, over an accounting period. The pursuits
according to this change are incorporated into investing, financing and operating.
However,
 While outlining a cash flow statement, complete specifications of outflows and inflows
are furnished below these titles involving the net cash flow (or use)
 The average of the net ‘cash flows (or use) is operated out and is given as ‘Net Increase
or Decrease in Cash Equivalents and cash’ to which the amount of ‘cash and cash
equivalent at the commencement’ is summed and therefore the quantity of ‘cash and
cash equivalents at the end’ is reported.
 This total will be the same as the entire amount of cash at bank, cash equivalents (if
any) and cash in hand presented in the balance sheet.
 Then, if the cash flows from operating activities are formed by direct method while
outlining the cash flow statement, it will be known as ‘direct method Cash Flow
Statement’.
 Though, unless it is stipulated precisely as to which approach is to be imbibed, the cash

flow statement may first be outlined by an indirect method as is prepared by most
organizations in work.
Advantages of Cash Flow Statement:
 A cash flow statement, when employed with other financial reports, permits users to
assess variations in net assets of a firm and its economic system. It involves liquidity
and stability, the capability to influence the amounts and timings of cash flows to adjust
to varying conditions and possibilities.
 Cash flow data evaluate the capability of a firm to produce cash and cash equivalents. It
permits users to generate models to assess and analyze the existing value of the
expected cash flows of various companies.
 It also assists in stabilizing its cash inflow and outflow, following in acknowledgement
to the varying situation. It is also essential in verifying the correctness of prior estimates
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of anticipated cash flows and in exploring the association between profitability and net
cash flow and the result of varying cost prices.
The statement of cash flow gives insights, help an investor to understand the status of a
company’s operations, from where the money is coming, and how efficiently the money is
utilized. The statement is essential as it assists investors to understand whether an
organization financial status is reliable or not.
On the other hand, creditors, use this statement to analyze how much funds (liquid cash) a
company has to support its operating expenditures and pay the debts.
Elements of the Cash Flow Statement
 Cash flow from operating activities
 Cash flow from investing activities
 Cash flow from financing activities
The cash flow statement is different from the balance sheet and income statement,
because, it does not include the future transaction of cash listed on credit. Therefore,
money is not equal to net income, whereas, on the income statement and balance sheet, it
should be equal, including cash sales and sales made on credit.
Cash Flow from Operating Activities:

Operating activities are the operations of a company directly associated with furnishing its
commodities and services to the marketplace. These are the enterprise’s focus trading pursuits,
such as producing, allocating, retailing and marketing a good or service. Operating activities are the
principal source of revenue and expenditure in a firm.
The operating activities on the cash flow statement comprise of various uses and sources cash from
the company’s operational activities. In simple words, it shows how much money a company has
generated from its products or services.
Few items that operating activities include are:
 Vouchers from sales of goods and services
 Interest returns
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 Payment of Income-tax
 Payment credited to suppliers for goods and services used for production
 Payment to salaries and wages
 Rent payments
 Additional operating expenses
For an investment and trading company, vouchers from the sale of debt, loans, or equity are also
incorporated. In the indirect method of preparing a cash flow statement, deferred tax, amortization,
depreciation, dividends or revenue received from investment, gains or losses of a non- current
asset, are also clubbed. However, buying or selling of long-term asset is not included.
How Cash Flow is Calculated?

Cash flow is calculated by changing a few things in the net income of a company.Such as by
adding or deducting differences in expenses, revenue, credit transactions, and expenses, from one
period to the next. It is essential to make adjustments because non-cash things are evaluated with
net income (income statement) and total assets and liabilities (balance sheet).
Therefore, the determination of cash flows demands special consideration. Few are mentioned
below:
 A direct method of how important sections of gross cash payments and gross cash receipts are
revealed. Similarly, an indirect method whereby net profit or loss is duly adjusted for the
effects of :
 Proceedings of a non-cash kind
 Any accruals or deferrals of past/future working cash receipts
 Items of income or expenses associated with investing or financing cash flows. It is necessary to
specify here that below the indirect method, the outset point is net profit and loss before
taxation and extraordinary things as per Statement of Profit and Loss of the company. Then this
amount is for non-cash items, etc., adjusted for determining cash flows from functioning
pursuits.
Methods of Cash Flow Statement

Cash flow from operating activities can be determined using both Indirect or Direct methods.
These processes are explained in detail as follows :
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 Direct Methods: Here, the notable titles of cash outflows and inflows (namely employee
benefits expenses paid, cash received from trade receivables, etc.,) are contemplated. It is
significant to perceive here that items are reported on accrual data in the statement of profit and
loss. Therefore, some changes are made to transform them into a cash basis.
 Indirect Method: Indirect method of determining cash flow from operating pursuits starts with
the amount of net profit and loss. This statement includes the results of all operating activities of
a firm. However, an account of profit and loss is outlined on an accrual base and not on a cash
basis. It involves non-operating items (such as profit and loss on the sale of fixed assets, interest
paid, etc. Non-cash items such as goodwill to be written-off, depreciation, etc.). Hence, it
becomes vital to regulate the amount of net profit and loss as depicted by a statement of profit
and loss for landing at cash flows from operating activities.
Accounts Receivable and Cash Flow

All the changes made in accounts receivable (AR) of the balance sheet from the accounting year to
the next should be presented in cash flow.
In case, if accounts receivable falls, it indicates that more cash has been credited to the company
from customers while paying their credit accounts. So, the decreased amount is then combined with
net sales. But, if the accounts receivable is increased from one accounting period to the next, then
the increased amount is deducted from net sales because these amounts are depicted as revenue and
not cash.
Inventory Value and Cash Flow

On the other hand, a rise in inventory depicts that a company has invested more funds in buying
more extra raw materials. If the inventory payment is paid by cash, then the increase in the value of
inventory is subtracted from net sales. If the purchases are made on credit, then there would be an
increase in accounts payable in the balance sheet. Therefore, the increased amount from one year to
the other will be added to net sales.
Investing Activities and Cash Flow

All the utilization of funds from a firm’s investments is included in investing activities. In this
category, sale or possession of an asset, credits offered to merchants or collected from
customers, payments associated with an acquisition or amalgamation are include.
Cash Flow from Financing Activities:

It covers all the cash sources starting from banks or investors, to cash used to pay shareholders.
Similarly, a settlement for stock repurchased, payment of interests, and the compensation of debt
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are recorded in this category. In cash financing when funds are raised, it is known as “cash in” and
when dividends are given it is known as “cash-out”.
Objectives of Cash Flow Statement:

The Main Objectives Are:
 To provide information about cash inflows and outflows from operating, investing and financing
activities.
 To determine net changes in cash and cash equivalents.
What are Inflows and Outflows of Cash?
# Inflows of Cash
 All transactions that lead to an increase in cash and cash equivalents are classified as inflow of
cash.
# Outflows Of Cash
 All transactions that lead to a decrease in cash and cash equivalents are classified as outflows of
cash.
Cash and Cash Equivalents:
Cash
 Cash comprises of cash in hand and demand deposits with banks.
Cash Equivalents
 Cash equivalents are short term, highly liquid investment that is readily convertible into a
known amount of cash.
Limitations of Cash Flow Statement
(1) Ignores Non-cash transactions
(2) Ignores the accrual concept
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(3) Historical in Nature
(4) Not a Substitute for an Income Statement
(5) Not suitable for judging Liquidity of the enterprise
Cash and Cash Equivalents - As Per Schedule III, Part I of The Companies
Act, 2013
1. Balance with banks
2. Cheque in hand
3. Cash in hand
4. Short-term marketable securities
5. Balance with banks held as margin money
6. Bank deposits with more than 12 months of maturity
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Cash Flow Statement

AS.-3 [Para 18(b)]
Indirect Method
Particulars Rs. Rs.

(A) Cash Flow from Operating Activities
Net Profit/Loss before tax and extraordinary items : *****
Add: Adjustments for Non-Cash Expenses:
Depreciation -----
Loss on Sale of fixed Assets ------
Any Assets Written off during the year ------
Add: Non- Operating Expenses:
Interest Paid on Debentures ------
Dividend Paid on Shares -----
Operating Profit before Working Capital Changes *****
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Add: Decrease in Current Assets +
Add: Increase in Current Liabilities +
Less: Decrease in Current Liabilities ( )
Less: Increase in Current Assets ( )
Cash Generation from Operation ****
Less: Tax Paid during the year ( )
Net Cash Flow from Operating Activities

****
(B) Cash Flow from Investing Activities :-

Purchase of Fixed Assets ( )
Purchase of Investments ( )
Sale of Fixed Assets +
Interest Received +
Dividend Received +
Net Cash Flow from Investing Activities ****
Cash Flow from Financing Activities:-

(C)
Proceeds from issue of Shares Capital -----
Proceeds from issue of Debentures ----
Proceeds from long term borrowings -----
Redemption of Shares / Debentures ( )
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Dividend Paid on Shares ( )
Net Cash Flow from Financing Activities ***
[A + B + C ]= Net increase / decrease in Cash -----
Add: Cash and Cash Equivalents at the beginning +
CASH AND CASH EQUIVALENTS AT THE END ------
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Question No.1
The comparative Balance Sheet of a company are given below:
Liabilities 2006 2007 Assets 2006 2007
(Rs.) (Rs.) (Rs.) (Rs.)
Share Capital 35,000 37,000 Goodwill 5,000 2,500
Debentures 6,000 3,000 Land 10,000 15,000
Creditors 5,180 5,920 Book Debts 7,450 8,850
Provision for 350 400 Cash 4,500 3,900

D/D
Profit and 5,020 5,280

Loss (R.E)
51,550 51,600 51,550 51,600
Additional information available are:
(1) Dividend paid amounted to Rs.1,750
(2) Land was purchased for Rs.5,000 and amount provided for the amortization of goodwill
amounted to Rs.2,500
(3) Debentures were repaid to the extent of Rs.3,000
You are required to prepare Cash Flow Statement as per AS - 3
Solution:
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Cash Flow Statement
AS -3(Para 18 –b)
Indirect Method
Rs. Rs.
(A) Cash Flow from Operating Activities:
Profit & loss a/c 2007 5,280
Less: Profit & loss a/c 2006 -5,020
Profit during the year 260
Add: Dividend paid 1,750
Net profit before tax 2,010
Adjustment for:
Goodwill written off 2,500
Increase in creditors 740
Increase in provision for D/D 50
Increase in Book Debts -1,400
Decrease in Stock 3,250
Net Cash from Operating Activities (A) 7,150

(B) Cash Flow from Investing Activities:
Purchase of Land -5,000
Net Cash Flow from Investing Activities -5,000
(C) Cash Flow from Financing Activities:
Issue of Share Capital 2,000
Redemption of debentures -3,000
Dividend paid -1,750
Net Cash Flow from Financing Activities -2,750
Net Cash and Cash Equivalents[A+B+C] -600
Cash and Cash Equivalents in the beginning 4,500
Cash and Cash Equivalents at the end 3,900
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Question No.2
The summary of Balance Sheet of X Ltd. on 31st March is as under:
Liabilities 2007 2008 Assets 2007 2008

Rs. Rs. Rs. Rs.
Share Capital 4,00,000 5,20,000 Goodwill 40,000
Creditors 79,000 82,270 Machinery 2,25,900 2,32,400
Bill Payable 67,560 23,050 Building 2,97,000 2,88,500
Bank O/D 1,19,020 Stock 2,22,080 1,94,740
Provision for
Tax 80,000 1,00,000 Advances 4,630 1,470
Reserves 1,00,000 1,00,000 Debtors 1,70,350 1,45,250
Cash in
P&LA/C 79,380 82,440 hand 5,000 5,400
9,24,960 9,07,760 9,24,960 9,07,760
Additional Information:
(a)During the year ending 31st March, 2008, an additional dividend of Rs.52,000 was paid.
(b)The assets of another company were purchased for Rs.1,20,000 payable in fully paid shares of
the company. These assets consisted of Stock Rs.43,280, machinery Rs.36,720 and Goodwill
Rs.40,000. In additional, sundry purchases of Machine were made totaling Rs.11,300.
(c)Income – Tax paid during the year 2007 – 08 was Rs.50,000.
(d)The net profit for the year before tax Rs.1,25,060.
Prepare cash flow statement as per AS – 3.
Solution:
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Cash Flow Statement
AS – 3[para- 18(b)]
Rs. Rs.
1 Cash Flow from Operating Activities:
Net profit before tax and extraordinary items 1,25,060
Add: Depreciation * 50,020
Operating profit before working capital changes 1,75,080
Decrease in Debtors 25,100
Decrease in Advances 3,160
Decrease in Stock * 70,620
Increase in creditors 3,270
Decrease in Bills Payable (44,510)
Income tax paid during the year (50,000)
Net Cash from Operating Activities 1,82,720

2 Cash Flow from Investing Activities:
Purchase of Machine (11,300)
Net Cash from Investing Activities (11,300)

3 Cash Flow from Financing Activities:
Payment of Dividend (52,000)
Net cash from Financing Activities (52,000)

Net increase Cash and cash equivalent 1,19,420
Add: Cash in hand at the beginning 5000
Less: Bank overdraft at the beginning (1,19,020)
Cash and cash equivalent at the end of the year 5,400
Working note:
1. Calculation of Decrease/increase in
Stock:
Value in 2007 Rs.2,22,080
Add: Purchases by Shares 43,280
Less: Value in 2008 (1,94,740)
Decrease in Stock 70,620
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2.Calculation of Depreciation:
(a)On Buliding:
Value in 2007 Rs.2,97,000
Less: Value in 2008 (2,88,500)
Depreciation on Building Rs.8500

(b) On Machinery:
Value in 2007 Rs.2,25,900
Add: Purchase by Shares Rs.36,720
Add: Purchase by cash Rs.11,300
Rs.2,73,920
Less: Value in 2008 (2,32,400)
Depreciation on Machinery Rs.41,520
Total Depreciation during the year Rs.50,020
To, Cash a/c 50,000 By, Bal. b/d 80,000
To, Bal./c/d 1,00,000 By, Provision 70,000

made during
the year
1,50,000 1,50,000
70,000 + 52,000, + 3.060 = 1,25,060
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Question No.3
The following are the Balance Sheet of ACC Ltd.
Liabilities 31.03.2007 31.03.2008 Assets 31.03.2007 31.03.2008

Rs. Rs. Rs. Rs.
Share capital 3,20,000 4,00,000 Plant & Machinery 2,00,000 2,80,000
Reserves 60,000 80,000 Building 1,60,000 2,40,000
Profit & loss 24,000 40,000 Investment --- 40,000
Debentures --- 80,000 Receivable 2,80,000 2,00,000
Provision for Tax 28,000 40,000 Stock 80,000 1,60,000
Proposed
Dividend 40,000 80,000 Cash at bank 80,000 80,000
Creditors 3,28,000 2,80,000
8,00,000 10,00,000 8,00,000 10,00,000
Additional information:
(a) Depreciation @ 25% was charged on the opening value of Plant & Machinery.
(b) Building under construction was not subject to any depreciation.
(c) Rs.20,000 was paid as income- tax during the year.
(d) An old machine costing Rs.20,000 (W.D.V. Rs.8,000) was sold for Rs.14,000
Prepare Cash Flow Statement.
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Solution:
Rs. Rs.
Cash Flow from Operating Activities :
(A)
Net Profit before tax and extraordinary items * 148,000
Less: Profit on sale of Machinery * -6,000
Add: Depreciation * 50,000
Operating Profit before Working Capital Change 192,000
Add: Decrease in receivables 80,000
Less: Increase in Stock -80,000
Less: Decrease in Creditors -48,000
Less: Income Tax Paid -20,000
Net Cash from Operating Activities 124,000
(B) Cash Flow from Investing Activities :
Purchase of Plant & Machinery * -138,000
Purchase of Investments -40,000
Purchase of Buildings -80,000
Sale of Plant & Machinery 14,000
Net cash flow from Investing Activities -244,000

C) Cash Flow from Financing Activities :
)
Issue of Share Capital 80,000
Issue of Debentures 80,000
Payment of Dividends (P.Y.) -40,000
Net Cash Flow from Financing Activities 120,000

[A +B +C ] Net Cash and Cash Nil
Equivalents
Add: Cash and cash Equivalents at the beginning 80,000
Cash and Cash Equivalents at the end 80,000
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Working Note:
(1) Calculation of Net Profit before tax : Rs.

P & L A/c 31.3.2008 40,000
P & L A/c 31.3.2007 -24,000
Net Profit during the year 16,000
Add: Non -Operating Exp.:-
Increase in General reserve 20,000
Proposed Dividend 2007-08 80,000
Provision for tax 2007-08* 32,000
Net Profit before tax 148,000
2. Calculation of Provision for tax
Tax Account
Particulars Rs. Particulars Rs.
To, Cash a/c[ Tax
paid during the 20,000 By, Balance b/d 28,000
year
To, Balance c/d 40,000 By, P & L a/c 32,000
(Provision
made during
the year*
60,000 60,000
3. Calculation of Purchase of Plant and Machinery
Plant & Machinery

(a/c W.D.V.)
Particulars Rs. Particulars Rs.
To, Balance b/d 2,00,000 By, Depreciation a/c 50,000
To, Profit on 6,000
sale of Machine By, Cash a/c 14,000
To, Cash a/c * 1,38,000 ( Sale of Machine)
( Purchase) By, Balance c/d 2,80,000
3,44,000 3,44,000
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Module – 5
Budgeting and Budgetary Control
Definition and Concept of Budget:
A budget is an instrument of management used as an aid in the planning, programming

and control of business activity. A budget may be defined as a financial and/or
quantitative statement, prepared and approved prior to a defined period of time, of the
policy to be pursued during that period for the purpose of attaining a given objective. It
may include income, expenditure and employment of capital.
Thus budget is a written plan of action. A budget is used for cost control purposes and it is
one of the most important overall control devices employed by management. A budget
represents the financial requirements of different sections of the business during a given
period to achieve an estimated profit based upon a given volume of sales.
A budget is based upon past statistical data and it predicts the estimated labour, sales,
production and other management requirements for future, i.e., for a definite budgetary
period (of time). A budget can be thought of as an overall plan for the operation of the
business in terms of sales, production and expenditures. Thus budget acts as a
coordinating device among the various functions of the business.
Definition and Concept of Budgetary Control:
Budgetary control makes use of budgets for planning and controlling all aspects of
producing and/ or selling products or services. Budgetary control attempts to show the
plans in financial terms. Budgetary control is the planning in advance of the various
functions of a business so that the business can be controlled. Budgetary control relates
expenditure to a section or department who incurs the expenditure, so that the actual
expenses can be compared with the budgeted ones, thus providing a convenient method of
control.
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Prof. Naveen Sharma
Budgetary control includes forecasts of income and expenditures (for the budgetary
period) on equipment, machinery, manpower, materials, etc., necessary for the efficient
production and distribution of estimated volume of sale. The budgetary control when
applied to a business as a whole or to different sections within the business-compares
actual performance and the predicted performance and thus enables all levels of
management and supervision to know how their sections (of business) are moving
towards the achievements of budgeted targets.
Is corrective action needed; should it be applied? Thus, budgetary control attempts to

bring actual performance at par with the predicted performance by keeping a strict
supervisory eye on the actual performance and by exercising a control, if necessary.
Control follows the planning and co-ordination. Deviations from predicted plan or
performance are noticed by comparing actual and budgeted performances and costs.
The differences between the two (i.e., predetermined and actual) figures-the variances-are
analyses and an action is taken quickly, at the right time and in the correct place to correct
the actual performance – as per the predicted or predetermined plan or performance.
The Objectives (Functions) of Budgets, Budgeting and Budgetary Control:
1. Budget should specify units to be produced, broken down into sizes and styles, as well as
cost of production.
2. Budget should analyze all the factors affecting the sections/departments and the
business as a whole.
3. Budget should facilitate planning within the company. It should help planning future
income and expenses.
4. Budget should harmonize departmental programs.
5. Budget should serve as a medium of propagating policies throughout the business

enterprise.
6. Budget should hold back or control unwise expenditure.
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7. Budget should help stabilizing production and harmonies production and sale
programs.
8. Budgeting should decide basis for expenditure of funds.
9. Besides planning, budgetary control should provide a basis for, measuring performance
and exercising control-control means noting when expenditures fall outside the budget
estimates, tracing down the cause of such variation and taking necessary corrective action.
10. Budgetary control should watch the progress of achievements of the business
enterprise and evaluate policies of the management.
11. Budgetary control should pin-point those areas which are not working efficiently and
according to the predetermined targets.
12. Budgetary control, after planning, should coordinate the activities of a business so that
each is a part of an integral total.
13. Budgetary control should facilitate financial control; and control each function so that
the best possible results may be obtained.
Advantages of Budget, Budgeting and Budgetary Control:
1. Policy plans and actions taken are all reflected in the budgetary control system. There is
a formal recognition of the targets which the business hopes to achieve.
2. Not only departmental programs are developed, over expenditures in departments are
also curtailed and controlled.
3. Budgeting makes for better understanding, coordination and harmony of action in a

business enterprise, because all departments take part in budget preparation.
4. The targets, goals and policies of a business enterprise are clearly defined.
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5. Deviations from predetermined plans are brought to notice through variance analysis
and corrective action is stimulated by reports, statements and personal contacts.
6. It provides management with a guide of daily activities; thus helps determining

performance and efficiency of each department, thereby leading to improvement.
7. It informs management the progress made towards achieving the predetermined

objectives.
8. It facilitates financial control.
9. Total capital required and price of an item (product) can be estimated in advance.
10. Budgetary control builds morale when operated in a truly managerial spirit, i.e., it
should not acquire merely a clerical outlook (or approach).
Limitations of Budget:
(i) Since budget is based on estimates, i.e., estimated sales, estimated costs, estimated
business conditions, etc. it may need periodic revisions because estimates may not come
out to be cent per cent true.
(ii) A budget may not work if the idea of budgeting is not sold properly to different
sections of the business. Only the persons working in different sections can make an
established budget, a success. Thus it should be a cooperative budgeting.
A budget cannot work until the desire to make it work is established in the minds of
persons working in the different sections of a business concern.
Types of budget
1. Main budgets
Budgeting is performed for planning and control purposes. Budgeting allows identifying
and setting business objectives and goals. There is a variety of budgets. The most
common budget types include the following:
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 Master budget
 Production Budget
 Cash Budget
 Flexible budget(Expenses )
 Capital expenditure Budget.
 Sales Budget.
 Zero Base Budget
These budget types are briefly explained below.
Master Budget is the set of financial and operating budgets for a specific accounting
period, usually the next fiscal or calendar year. Master budget is prepared quarterly or
annually. The format of the master budget varies with business nature and size. Operating
budgets are used in daily operations and are the basis for financial budgets. Operating
budgets include the following: sales, production, direct materials, direct labor,
overhead, selling and administrative expenses, cost of goods manufactured, and cost of
goods sold. Financial budgets include a budgeted income statement and balance
sheet, cash budget, and capital expenditures budget. Budgeted income statement and
budgeted balance sheet are also called pro forma financial statements.
Production Budget is provides an estimate of the total volume of production and its
product wise distribution. Generally, the production budget is based on the sales
budget. The responsibility for overall production budget lies with works manager and for
departmental production budgets, departmental works manager are responsible.
Production budget is essential for every manufacturing concern. It helps in increasing

production capacity. There is optimum use of material, labour and plant and production
may also be kept in control.
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Format of Production Budget
Production Budget (in Units)
For the Budget period ending - - -
Product 'X' Product 'Y'

Particulars/ Period I Qtr. II Qtr. III Qtr. I Qtr. II Qtr. III Qtr.
A. Budgeted Sales --- --- --- --- --- ---
B. Add: Budgeted --- --- --- --- --- ---
Closing Stock of
Finished Goods
C. Less: Budgeted --- --- --- --- --- ---
Opening Stock of
Finished Goods
D. Budgeted --- --- --- --- --- ---
Production
Question No.
NSH Ltd. provides you the following information:
Product 'A' Product 'B'

Sales (in units) as per Sales Budget :
1st Quarter 2021 1,000 2,000
2nd Quarter 2021 2,360 1,000
3rd Quarter 2021 2,160 1,250
4th Quarter 2021 2,480 750

Stock Position as on 1.1.2021 :
Percentage of 1st Quarter 2021 sales 20% 100%

Stock Position ending 1st, 2nd and 3rd Quarter
Percentage of Next Quarter's sales 50% 50%

Stock Position on 31.12.2021 2,200 1,000
Required: Prepare Production Budget for the year 2021.
Solution:
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Production Budget for the year 2021
Product Produc
'A' t 'B'
1st Q. 2nd Q. 3rd Q. 4th Q. 1st Q. 2nd Q. 3rd Q. 4th Q.
Qty. Qty. Qty. Qty. Qty. Qty. Qty. Qty.
A. Budgeted
Sales 1,000 2,360 2,160 2,480 2,000 1,000 1,250 750
B. Add: Closing
Stock 1,180 1,080 1,240 2,200 500 625 375 1,000
A+B = Production 2,180 3,440 3,400 5,000 2,500 1,625 1,625 1,750
Less: Opening
Stock -200 -1,180 -1,080 -1,240 -2,000 - 500 - 625 - 375
Unit to be
Produced 1,980 2,260 2,320 3,440 500 1,125 1,000 1,375
Cash Budget is the budget for expected cash inflows and outflows during the specific
period of time. Cash budget consists of four sections: receipts, disbursements, cash
surplus or deficit, and financing section. The receipts section lists the beginning cash
balance, cash collections from customers, and other receipts. The disbursements section
shows all cash payments (characterized by purpose). The cash surplus (deficit) section
provides the difference between cash receipts and cash disbursements. Finally, the
financing section examines in detail expected borrowings and repayments during the
period
Format of Cash Budget
Cash Budget
Particulars 1st Month 2nd Month 3rd Month

Rs. Rs. Rs.
(A )Cash Available:
Cash in hand (op.Bal.) Balance b/d Balance b/d Balance b/d
Cash Sales *** *** ***
Amount Received from *** *** ***
Debtors
Issue of shares/Deb. *** *** ***
Any other income **** **** ***
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Total (A) **** **** ****

(B) Cash Payments:
Cash Purchases *** *** ***
Amount paid to Creditors *** *** ***
Wages *** *** ***
Any other Exp. *** *** ***
Investment (If any ) *** *** ***
Dividend paid *** *** ***
Total (B ) *** *** ***
A -B = BALANCE/ OVERDRAFT Balance Balance Balance
Question No.1
Prepare Cash budget of Krishna Ltd. For April to June 2021 from the following
information:
1. Estimated Sales, Purchases and Expenses are as follows:
Particulars Jan.(Rs.) Feb.(Rs.) March (Rs.) April (Rs.) May (Rs.) June (Rs.)
Sales 2,00,000 4,00,000 6,00,000 8,00,000 10,00,000 12,00,000
Purchases 1,52,000 3,06,000 4,60,000 6,08,000 7,56,000 9,04,000
Wages 24,000 30,000 36,000 48,000 60,000 72,000
Admin Exp. 30,000 40,000 50,000 60,000 70,000 80,000
Selling & Dist.Exp 30,000 50,000 70,000 90,000 1,10,000 1,00,000
2. Cash Sales are 20% of total Sales.
3. 50% of credit sales collected in one month and the balance in two months.
4. Cash purchase are 25% of total purchases.
5. 50% of credit are paid within one month and the balance within two months.
6. No stock remain at the end of the month.
7. Commission on sales -10%.
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8. The time lag in the time of the wages in one third of the month and of Admin. experiences
one month.
9. Admin. expenses for each month include depreciation amounting Rs. 10,000.
10. 12% Rs.2,00,000 debentures of Rs. 100 each where issue on 1 st Jan.(Half early interest due
on 30th June and 31st December.
11. 36,000 Equity shares Rs. 10 each where issued on 1st May at 5% premium.
12. Cash balance at the end of the March Rs. 4,00,000
Solution:
Cash
Budget
Particulars April May June

Rs. Rs. Rs.
( A ) Cash Available :
Cash in hand 4,00,000 2,66,750 4,99,250
Cash Sales@20% 1,60,000 2,00,000 2,40,000
Collection from Debtors* 4,00,000 5,60,000 7,20,000
Issue of Equity shares* 3,78,000
Total ( A ) 9,60,000 14,04,750 14,59,250

( B ) Cash Payment :
Cash Purchases@25%* 1,52,000 1,89,000 2,26,000
Payment to creditors* 2,87,250 4,00,500 5,11,500
Wages Paid* 44,000 56,000 68,000
Admin. Exp. 40,000 50,000 60,000
Selling & Distribution 90,000 1,10,000 1,00,000
Commission on Sales@10% 80,000 1,00,000 1,20,000
Interest on Debentures ---- ---- 12,000
Total ( B ) 6,93,000 9,05,500 10,97,500
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( C ) Closing Balance [ A - B ] 2,66,750 4,99,250 3,61,750
Working Note:
1. Calculation of cash collection from Debtors
JAN. FEB. MARCH APRIL MAY JUNE

Total Sales 2,00,000 4,00,000 6,00,000 8,00,000 10,00,000 12,00,000
Less : Cash Sales@20% -40,000 -80,000 (1,20,000) (1,60,000) (2,00,000) (2,40,000)
(A) Credit Sales 1,60,000 3,20,000 4,80,000 6,40,000 8,00,000 9,60,000

(B) collection:
( a) 50% of Previous month 80,000 1,60,000 2,40,000 3,20,000 4,00,000
( b ) 50% of previous to P.M --- 80,000 1,60,000 2,40,000 3,20,000
Amount Received from
Debtors 80,000 2,40,000 4,00,000 5,60,000 7,20,000
2. Calculation of Payment to Creditors
Particulars Jan. Feb. March April May June

Total Purchases 1,52,000 3,06,000 4,60,000 6,08,000 7,56,000 9,04,000
Less: Cash Purch.@25% -38,000 -76,500 -1,15,000 -1,52,000 -1,89,000 -2,26,000
Credit Purchases 1,14,000 2,29,500 3,45,000 4,56,000 5,67,000 6,78,000

Payment to creditors:
(a) 50% of previous month ---- 57,000 1,14,750 1,72,500 2,28,000 2,83,500
(b) 50% of previous to P.M 57,000 1,14,750 1,72,500 2,28,000
Payment to creditors: ---- ---- ----- 2,87,250 4,00,500 5,11,500
3. Calculation of Wages:
April May June

2/3rd of current month's 32,000 40,000 48,000
Add: 1/3rd of previous
month's 12,000 16,000 20,000
Payment of Wages 44,000 56,000 68,000
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Question No.2
Prepare Cash Budget for the months of October, November and December, 2021 from the
following information:
1. Forecasts for receipts and payment:
Months Total Sales Total Purchases Wages Manuf.Exp. Dist.Exp.

Rs. Rs. Rs. Rs. Rs.
September 5,00,000 4,00,000 50,000 30,000 20,000
October 6,00,000 5,00,000 60,000 40,000 30,000
November 7,00,000 6,00,000 80,000 50,000 35,000
December 4,00,000 3,50,000 40,000 52,000 25,000
2. Cash Sales and cash purchases are 10% of Total Sales and Total purchases respectively
3. One month’s credit is allowed to customers. Suppliers also allow one month’s
credit.
4. Time lag for wages, manufacturing and distribution expenses is one month.
5. During the month of October interest amounting to Rs.12,000 will be received and
interest on loan to the extent of Rs.9,000 will be paid.
6. Dividend likely to be received in November will be Rs.7,000.
7. Sales of scrap during December will realize Rs.2,000.
8. Furniture costing Rs.6,000 will be purchased in November.
9. Loans worth Rs.15,000 will be paid in October.
10. Equity Shares worth Rs.80,000 will be issued in December.
11.Opening balance of cash and Bank on October 1, 2021 is Rs.1,60,000.
Solution:
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Cash Budget
For the months of Oct. - Dec.2021
Particulars Oct. Nov. Dec.
Rs. Rs. Rs.
( A ) Cash Available :
Cash in hand (Op.Bal.) 1,60,000 1,48,000 1,19,000
Cash Sales 10% 60,000 70,000 40,000
Collection from Debtors* 4,50,000 5,40,000 6,30,000
Issue of Equity shares --- --- 80,000
Sale of Scrap --- --- 2,000
Dividend Received --- 7,000 ---
Interest Received 12,000 --- ---
Total Receipts (A) 6,82,000 7,65,000 8,71,000
(B) Cash Payments:
Cash Purchases 10% 50,000 60,000 35,000
Paid to creditors* 3,60,000 4,50,000 5,40,000
Wages paid 50,000 60,000 80,000
Manuf. Expenses paid 30,000 40,000 50,000
Distribution Expenses paid 20,000 30,000 35,000
Interest on loan 9,000 --- ---
Purchase of furniture --- 6,000 ---
Repayment of Loan 15,000 --- ---
Total payment (B) 5,34,000 6,46,000 7,40,000
(A-B) =Balance / Deficit 1,48,000 1,19,000 1,31,000
Calculation of Amount collected from Debtors

Sep. Oct. Nov. Dec.
Total Sales 5,00,000 6,00,000 7,00,000 4,00,000
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Less : Cash Sales @10% (50,000) (60,000) (70,000) (40,000)

(A) Credit Sales 4,50,000 5,40,000 6,30,000 3,60,000
Amount Collection as under:
100% of Previous Month 4,50,000 5,40,000 6,30,000
Calculation of Amount Paid to Creditors

Sep. Oct. Nov. Dec.
Total Purchases 4,00,000 5,00,000 6,00,000 3,50,000
Less : Cash Purchases @10% (40,000) (50,000) (60,000) (35,000)
(A) Credit Purchases 3,60,000 4,50,000 5,40,000 3,15,000
Amount Paid to creditors as under:
100% of Previous Month 3,60,000 4,50,000 5,40,000
Question No.3
Prepare cash Budget of Arnav Ltd. for April to June 2021 from the following information:
1. Sales Jan. 1,000 units. Sales are expected to be increased by 1,000 units per month.
2. Uniform Selling Price of Rs.100 per unit was fixed after adding 25% to cost.
3. Cash Sales are 25% of Net Credit Sales.
4. 2% of Accounts Receivable constitute debt Losses. 50% of the good accounts receivable are
collected in the month following the sales, 50% of the remaining in the second month and the
balance in the third month.
5. Cash purchases are 1/3 of Net credit Purchases.
6. 50% of credit Purchases are paid within one month and the balance in two months.
7. The estimated expenses are as follows:

Rs. Rs. Rs. Rs. Rs. Rs.
Wages 12,000 15,000 18,000 24,000 30,000 36,000
admin.Exp. 10,000 15,000 20,000 25,000 30,000 35,000
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Selling & Dist.Exp. 15,000 25,000 35,000 45,000 55,000 50,000
8. Commission on Sales – 10%
9. The time lag in the payment of wages is 1/3 of the month and that of Admin. Expenses one
month.
10. 12% Rs.1,00,000 Debentures of Rs.100 each were issued on 1 st Jan.(Half yearly interest due on
30th June and 31st Dec.)
11. Estimated Advance tax for the assessment year 2021-22 is Rs.1,00,000. First installment of
Advance tax is 15% in June month.
12. 18,000 Equity Shares of Rs.10 each were issued on 1st May at 5% premium.
13. Cash balance at the end of March Rs.2,00,000.
Solution:
Cash Budget
For the month of April - June
Particulars April (Rs.) May (Rs.) June (Rs.)

(A ) Cash Available :
Cash in hand 2,00,000 1,17,775 2,16,825
Cash Sales* 80,000 100,000 120,000
Amount Received from Debtors* 1,76,400 2,54,800 3,33,200
Issue of Equity Shares --- 1,89,000 ---
TOTAL ( A ) 4,56,400 6,61,575 6,70,025
( B ) Cash Payments :
Cash Purchase* 74,000 92,500 1,11,000
Payment to Creditors* 1,37,625 1,94,250 2,49,750
Wages* 22,000 28,000 34,000
Admin. Exp. 20,000 25,000 30,000
Selling & Distribution Exp. 45,000 55,000 50,000
Commission on Sales@10% 40,000 50,000 60,000
Interest on Debentures --- --- 6,000
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Advance Tax --- --- 15,000

TOTAL ( B ) 338,625 444,750 555,750
( C ) Balance / Overdraft ( A - B ) 1,17,775 2,16,825 1,14,275
Working Note:
1. Calculation of Amount received from Debtors:

A. Sales ( Unit ) 1,000 2,000 3,000 4,000 5,000 6,000
B. S.P. per Unit *100 *100 *100 *100 *100 *100
C. Total Sales( A x B ) 1,00,000 2,00,000 3,00,000 4,00,000 5,00,000 6,00,000
D. Less: Cash Sales@20%* -20,000 -40,000 -60,000 -80,000 -100,000 -120,000
E. Credit Sales 80,000 1,60,000 2,40,000 3,20,000 4,00,000 4,80,000
F. Less:2% B/D -1,600 -3,200 -4,800 -6,400 -8,000 -9,600
G. Good a/c Receivable 78,400 1,56,800 2,35,200 3,13,600 3,92,000 4,70,400
50% of Previous month's 1,17,600 1,56,800 1,96,000
25% of Prev.to Prev. 39,200 58,800 78,400
25% of Third Prev.month 19,600 39,200 58,800
Amount Collected: 1,76,400 2,54,800 3,33,200
( B ) Calculation of cash Purchases and Payment to Creditors :

A. Total Sales in Rs. 1,00,000 2,00,000 3,00,000 4,00,000 5,00,000 6,00,000
B. Less: G.P.@20% -20,000 -40,000 -60,000 -80,000 -100,000 -120,000
C. Cost of Goods Sold 80,000 1,60,000 2,40,000 3,20,000 4,00,000 4,80,000
D. Less: Wages -12,000 -15,000 -18,000 -24,000 -30,000 -36,000
E. Total Purchases 68,000 1,45,000 2,22,000 2,96,000 3,70,000 4,44,000
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F. Less: Cash Purchases @ 25%* -17,000 -36,250 -55,500 -74,000 -92,500 -111,000
G. Credit Purchases 51,000 1,08,750 1,66,500 2,22,000 2,77,500 3,33,000
50% of Previous month [ a ] 83,250 1,11,000 1,38,750
50% of Previous to P.M [ b ] 54,375 83,250 1,11,000
Payment to Creditors [ a + b ]* 1,37,625 1,94,250 2,49,750
( C ) Calculation of Payment to Wages :
Particulars March April May June

Rs. Rs. Rs. Rs.
A. Total Wages 18,000 24,000 30,000 36,000
B. 1/3 of Previous month's --- 6,000 8,000 10,000
C. 2/3 of Current month's --- 16,000 20,000 24,000
D.[ B + C ]= Total Payment of
wages --- 22,000 28,000 34,000
Question No.4
Prepare a Cash budget for the three months ending 31th June,2021 from the information
given below:
1. Credit terms are:
Sales and debtors – 10% sales are on cash, 50% of the credit sales are collected next
month and the balance in the following month.
2. Creditors –
Materials 2 months
Wages ¼ month
Overheads ½ month
3. Cash and bank balance on 1st April,2021 is expected to be Rs.6,000.
4. Other relevant information are –
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(i) Plant and machinery will be installed in February,2021 at a cost of Rs.96,000.
The monthly installment of Rs.2,000 is payable from April onwards.
(ii)Dividend @ 5% on preference share capital of Rs.2,00,000 will be paid on 1st June.
(iii)Advance to be received for sale of vehicle Rs.9,000 in June.
(iv) Dividend from investments amounting to Rs.1,000 are expected to be received in

June.
(v)Income tax (advance) to be paid in June, is Rs.2,000.
Month Sales Materials Wages Overheads

Rs. Rs. Rs. Rs.
February 14,000 9,600 3,000 1,700
March 15,000 9,000 3,000 1,900
April 16,000 9,200 3,200 2,000
May 17,000 10,000 3,600 2,200
June 18,000 10,400 4,000 2,300
Solution:
Cash Budget
April May June

Rs. Rs. Rs.
(A) Receipts:
Op. Balance 6,000 3,950 3,000
Cash Sales* 16,00 1,700 1,800
Amount collected from Debtors* 13,050 13,950 14,850
Dividend received --- --- 1,000
Advance against vehicle --- --- 9,000
Total (A) 20,650 19,600 29,650

(B) Payments:
Paid to creditors 9,600 9,000 9,200
Wages * 3,150 3,500 3,900
Overheads* 1,950 2,100 2,250
Installment of Plant 2,000 2,000 2,000
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Dividend on Preference Shares --- --- 10,000

Advance Income tax paid --- --- 2,000
Total (B) 16,700 16,600 29,350
Surplus / Deficit 3,950 3,000 300
Working Notes:
1. Calculation of Amount collected from Debtors:
Particulars Feb. March April May June

Total Sales 14,000 15,000 16,000 17,000 18,000
Less: Cash Sales @10% (1,400) (1,500) (1,600) (1,700) (1,800)
Credit Sales 12,600 13,500 14,400 15,300 16,200

Amount collected from Debtors:
(a) 50% of previous month 6,300 6,750 7,200 7,650
(b) 50% of previous to P.M 6,300 6,750 7,200
Total Amount received from
Debtors: 13,050 13,950 14,850
2. Calculation of payment of Wages:

Actual Wages in the month 3,000 3,200 3,600 4,000
Wages paid as follows:
Next
1/4 of P.M - Month 750 800 900
3/4 of C.M - 2,250 2,400 2,700 3,000
Total Wages Paid 3,150 3,500 3,900
3. Calculation of payment of Overheads:

Actual Overheads in the month 1,900 2,000 2,200 2,300
Overheads paid as follows:
50% of P.M ----- 950 1,000 1,100
50% of C.M 950 1,000 1,100 1,150
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Total Wages Paid 1,950 2,100 2,250
Flexible (Expense) Budget is the budget at the actual capacity level. Because
flexible budget is dynamic, it is commonly used by companies. Flexible budget is adjusted
to the actual activity of the company. It can be easily prepared using a computerized
spreadsheet (e.g., Excel). At first, the relevant activity range is determined for the coming
period. Next, costs that are expected be incurred over the relevant range are analyzed.
These costs are then separated based on their cost behavior: fixed, variable, or mixed.
Finally, the flexible budget for variable costs at different points throughout the relevant
range is prepared. In other words, flexible budget matches expenses to specific revenue
levels or activity levels. For example, utility costs can be tied to the number of machines in
operation.
Flexible Budget
Question No.1
With the following data for 60% capacity, Prepare Flexible Budget for production at 80%
and 100% Capacity:
Production at 60% Capacity 600 Units
Labour Rs.20 per unit
Direct Expenses Rs.5 per unit
Factory Overhead(40% fixed) Rs.20,000
Administration Expenses(60% fixed) Rs.15,000
Solution:
Flexible Budget
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Particulars At 60% At 80% At 100%

Capacity Capacity Capacity
Production (600 units) (800 units) (1,000 units)
Rs. Rs. Rs.
(A) Variable Cost:
Materials (Rs.50 per unit) 30,000 40,000 50,000
Labour (Rs.20 per unit) 12,000 16,000 20,000
Variable Factory Cost *@60% 12,000 16,000 20,000
Variable Admin. Cost * @40% 6,000 8,000 10,000
Direct Cost (Rs.5p.u) 3,000 4,000 5,000
Total (A) 63,000 84,000 1,05,000

(B) Fixed Cost:
Factory fixed cost * 8,000 8,000 8,000
Administration fixed cost * 9,000 9,000 9,000
Total (B) 17,000 17,000 17,000

A + B = Total Cost 80,000 1,01,000 1,22,000
Working Note:
# Calculation of Variable and Fixed cost of Factory Overhead:
Total FOH = Rs.20,000
(a)Fixed FOH = Rs.20,000@40%
= Rs.8,000
(b)Variable FOH = Rs.20,000 @ 60% = Rs,12,000
At 60%capacity = Rs.12,000
At 80% capacity = Rs.12,000 * 80 / 60
= Rs.16,000
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At 100% Capacity = Rs.12,000 * 100 / 60
= Rs.20,000
# Calculation of Fixed and variable Administration Cost:
Total Administration Cost = Rs.15,000
(a)Fixed Administration Cost = Rs.15,000 @60%
= Rs.9,000
(b)Variable Admin.Cost = Rs.15,000 @40%
= Rs.6,000
At 60% Capacity = Rs.6,000
At 80% Capacity = Rs.6,000 *80 / 60
= Rs.8,000
At 100% capacity = Rs.6,000 * 100 / 60
= Rs.10,000
Question No.2
A company working at 50% capacity and manufacture 10,000 units of a product. At 50%
capacity the product cost is Rs.180 per unit and selling price is Rs.200 per unit. The
break- up of cost is as below
Wages Rs.30 per unit
Factory Overhead (40% fixed) Rs.30 per unit
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Prof. Naveen Sharma
Administrative Overhead (50% fixed) Rs.20 per unit
At 60% - Raw material cost goes-up by 2% and sales price falls by 2%.
At 80% - Raw material cost increase by 5% and sale price decrease by 5%.
Prepare a Flexible Budget at 60% and 80% capacity.
Solution:
Flexible budget
Particulars 50% Capacity 60% Capacity 80% Capacity
(10,000
Production: units) (12,000 units) (16,000 units)
Rs. Rs. Rs.

(A) Variable Cost: 100+2=102*12000 100+5=105*16000
100*10,000= = =
Materials 10,00,000 12,24,000 16,80,000
Wages 3,00,000 3,60,000 4,80,000
Variable Factory Overhead @ 60% * 1,80,000 2,16,000 2,88,000
Variable Administration Overhead

@50% 1,00,000 1,20,000 1,60,000
Total (A) 15,80,000 19,20,000 26,08,000
(B) Fixed Cost:

Fixed Factory Overhead @40% 1,20,000 1,20,000 1,20,000
Fixed Administration Overhead @50% 1,00,000 1,00,000 1,00,000
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Prof. Naveen Sharma
Total
(B) 2,20,000 2,20,000 2,20,000
A +B = Total
Cost 18,00,000 21,40,000 28,28,000
Add: Profit (Sales –Total

Cost) 2,00,000 2,12,000 2,12,000
20,00,000
Sales (S.P*No.of (Rs.200*10,00 23,52,000 30,40,000
units) 0) (Rs.196 * 12,000) (Rs.190 * 16,000)
Working Note:
# Calculation of Variable and Fixed cost of Factory Overhead:
Total FOH = Rs.30 per unit* 10,000 units
Total FOH = 3,00,000
(a)Fixed FOH = Rs.3,00,000@40%
= Rs.1,20,000
(b)Variable FOH = Rs.3,00,000 @ 60% = Rs,1,80,000
At 50%capacity = Rs.1,80,000
At 60% capacity = Rs.1,80,000*60/50
= Rs.2,16,000
At 80% Capacity = Rs.1,80,000*80/50
= Rs.2,88,000
# Calculation of Fixed and variable Administration Cost:
Total Administration Cost = Rs.20 per unit *10,000 units (Base)
Total Administration Cost = Rs.2,00,000
(a)Fixed Administration Cost = Rs.2,00,000 @50%
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Prof. Naveen Sharma
= Rs.1,00,000
(b)Variable Admin.Cost = Rs.2,00,000 @50%
= Rs.1,00,000
At 50% Capacity = Rs.1,00,000
At 60% Capacity = Rs.1,00,000*60/50
= Rs.1,20,000
At 80% capacity = Rs.1,00,000*80/50
= Rs.1,60,000
#Calculation of Sales :
Sales = Selling price per unit * No. of units
At 50% Capacity = Rs.200 per unit *10,000
= Rs.20,00,000
At 60% Capacity = New selling price * No. of units
= Rs.200 –(2% of Rs.200)* 12,000 units
= Rs.200 – Rs.4 * 12,000 units
= Rs.196 * 12,000
= Rs.23,52,000
At 80% Capacity = New selling price * No. of units
= Rs.200 –( 5% of Rs.200)* 16,000 units
= Rs.200 – Rs.10 * 16,000 units
= Rs.190 * 16,000
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Prof. Naveen Sharma
= Rs.30,40,000
Question No.
Prepare a Flexible Budget for overheads on the basis of the following data. Ascertain the
overhead at 50%, 60% and 70% Capacity.
At 60% Capacity Rs.
Variable Overheads:
Materials 6,000
Labour 18,000
Semi-Variable Overheads:
Electricity (40% fixed) 30,000
Repairs (80% fixed) 3,000
Fixed Overheads:
Depreciation 16,500
Insurance 4,500
Salaries 15,000
Labour Hours 1,86,000
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Prof. Naveen Sharma
Solution:
Flexible Budget and Overhead Rates
Items 50% 60% 70%

Capacity Capacity Capacity
(A)Variable
Cost:
Materials 5,000 6,000 7,000
Labour 15,000 18,000 21,000
Total (A) 20,000 24,000 28,000
(B)Semi-
Variable Cost
Electricity * 27,000 30,000 33,000
Repairs& 2,900 3,000 3,100

Maintenance *
Total (B) 29,900 33,000 36,100
©Fixed Cost :
Depreciation 16,500 16,500 16,500
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Prof. Naveen Sharma
Insurance 4,500 4,500 4,500
Salaries 15,000 15,000 15,000
Total (C) 36,000 36,000 36,000
A+B+C= Total 85,900 93,000 1,00,000
Labour Hours 1,55,000 1,86,000 2,17,000
Overheads Rate Rs.0.55 Rs.0.50 Rs.0.46
Working Note:
# Calculation of Fixed and Variable Electricity Expenses:
Total Electricity Expenses at 60% Capacity:
(A)Fixed Electricity Expenses = Rs.30,000 @ 40%
= Rs.12,000
(B) Variable Electricity Expenses :
Total Electricity Expenses = Rs.30,000 @ 60%
At 60% Capacity = Rs.18,000
At 50% Capacity = Rs.18,000 * 50 /60
= Rs.15,000
At 70% Capacity = Rs.18,000 *70 / 60
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Prof. Naveen Sharma
= Rs.21,000
Total Semi-variable Electricity Expenses on 50% Capacity :
Total Expenses = Fixed + Variable
= Rs.12,000 + Rs.15,000
= Rs.27,000
At 70% =
= Rs.12,000 + Rs.21,000
= Rs.33,000
# Calculation of Fixed and Variable Repair and Maintenance Expenses:
(A)Fixed Repair Expenses :
Total Repair cost = Rs.3,000 @ 80%
= Rs.2,400
(B) Variable Expenses :
Total Repair Expenses = Rs.3,000 @ 20%
= Rs.600
At 60% Capacity = Rs.600
At 50% Capacity = Rs.600 * 50 / 60
= Rs.500
At 70% Capacity = Rs.600 * 70 / 60
= Rs.700
Question No. Due for E
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Prof. Naveen Sharma
A department of Reliable India Company attains sales of Rs.6,00,000 at 80% of its normal
capacity. Its expenses are given below :
Rs.
(A)Administrative Overhead:
1.Office Salaries 90,000
2.General Expenses 2% of Sales
3.Depreciation 7,500
4.Rent and Rates 8,750
(B)Selling Cost :
1.Commission 8% of Sales
2.Travelling Expenses 2% of Sales
3.Sales Office Exp. 1% of Sales
4.General Expenses 1% of Sales
(C )Distribution Cost:
1.Salary Rs.15,000
2.Rent Rs.1% of Sales
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Prof. Naveen Sharma
3.Other Expenses 4% of Sales
Draw up Flexible Administration, Selling and Distribution Costs Budget, Operating at

90%, 100% and 110% of normal Capacity.
Solution:
Flexible Budget
80% capacity 90% 100% 110%

Particulars (Base) Capacity Capacity Capacity
Rs. Rs. Rs. Rs.
Sales 6,00,000 6,75,000 7,50,000 8,25,000
(A) Administration Costs:
Office Salaries 90,000 90,000 90,000 90,000
General Expenses @2% of Sales 12,000 13,500 15,000 16,500
Depreciation 7,500 7,500 7,500 7,500
Rent & Rates 8,750 8,750 8,750 8,750
Total Admin. Cost = 1,18,250 1,19,750 1,21,250 1,22,750

(B) Selling Costs:
Commission @ 8% of Sales 48,000 54,000 60,000 66,000
Travelling Expenses @ 2% of
Sales 12,000 13,500 15,000 16,500
Sales Office @ 1% of Sales 6,000 6,750 7,500 8,250
General Expenses 1% of Sales 6,000 6,750 7,500 8,250
Total Selling Costs = 72,000 81,000 90,000 99,000

(C )Distribution Costs:
Salary 15,000 15,000 15,000 15,000
Rent @1% of Sales 6,000 6,750 7,500 8,250
Other Expenses @ 4% of Sales 24,000 27,000 30,000 33,000
Total Distribution Costs = 45,000 48,750 52,500 56,250

A+B+C = Total Cost 2,35,250 2,49,500 2,63,750 2,78,000
Profit (Sales –Total Cost) 3,64,750 4,25,500 4,86,250 5,47,000
Sales 6,00,000 6,75,000 7,50,000 8,25,000
Question No.
The following data are available in respect of SNS Manufacturing Ltd. for the year 2021:
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Prof. Naveen Sharma
Items : Rs.
(A)Fixed Expenses:
Salaries and Wages 9,50,000
Rent, Rates and taxes 6,60,0000
Depreciation 7,40,000
Other Fixed Expenses 6,50,000
(B)Semi-Variable Expenses(at
50% Capacity) :
Maintenance and Repair 3,50,000
Indirect labour 7,90,000
Sales department Salary 3,80,000
Sundry Expenses 2,80,000
(C)Variable Expenses (at 50%

Capacity) :
Materials 21,70,000
Labour 20,40,000
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Prof. Naveen Sharma
Direct Expenses 7,90,000
Total 98,00,000
Assume that the Fixed Expenses remain constant for all levels of production.
Semi –Variable Expenses remain constant between 45% to 65%, increasing by 10%
between 65% to 80% capacity and by 20% between 80% to 100% capacity.
Sales at various levels are :
Capacity Sales in Rs.
50% 100 lack
60% 120 lack
75% 150 lack
90% 180 lack
100% 200 lack
Prepare a Flexible Budget for the year 2021 and forecast the profit at 50%, 60%, 75% and
100% capacity.
Solution:
Flexible budget
50% 60% 75% 100%

Particulars Capacity Capacity Capacity Capacity
Rs. Rs. Rs. Rs.
(A) Variable Expenses :
Materials 21,70,000 26,04,000 32,55,000 43,40,000
Labour 20,40,000 24,48,000 30,60,000 40,80,000
Direct Expenses 7,90,000 9,48,000 11,85,000 15,80,000
Total (A) 50,00,000 60,00,000 75,00,000 100,00,000
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Prof. Naveen Sharma
(B) Semi-Variable Expenses :

Maintenance and Repairs 3,50,000 3,50,000 3,85,000 4,20,000
Indirect Labour 7,90,000 7,90,000 8,69,000 9,48,000
Sales department salaries 3,80,000 3,80,000 4,18,000 4,56,000
Sundry Expenses 2,80,000 2,80,000 3,08,000 3,36,000
Total (B) 18,00,000 18,00,000 19,80,000 21,60,000
(C ) Fixed Expenses :
Salaries and Wages 9,50,000 9,50,000 9,50,000 9,50,000
Rent, Rates and Taxes 6,60,000 6,60,000 6,60,000 6,60,000
Depreciation 7,40,000 7,40,000 7,40,000 7,40,000
Other Fixed Expenses 6,50,000 6,50,000 6,50,000 6,50,000
Total (C) 30,00,000 30,00,000 30,00,000 30,00,000

A+B+C = Total cost 98,00,000 1,08,00,000 1,24,80,000 1,51,60,000
Profit 2,00,000 12,00,000 25,20,000 48,40,000
Sales 100,00,000 1,20,00,000 1,50,00,000 2,00,00,000
Capital Expenditure Budget is the budget for expected investments in capital

assets and long-term projects. It is usually prepared for 3 to 10 years. Investments in
capital assets include purchasing fixed assets such as plant, land, buildings, machinery,
equipment, and mineral resources. Long-term projects might be undertaken to develop
new products, expand existing product lines, or reduce costs. Sometimes a capital project
committee is created to overlook capital budgeting processes. Such a committee is
typically separate from the budgeting committee.
Sales Budget is forecasts total sales in terms of quantity, items, period, value etc.
Sales budget is generally the fundamental budget on the basis of which all other functional
budgets are prepared. The budget is based on projected sales to be achieved in a budget
period. The sales manager is directly responsible for the preparation and execution of this
budget.
Format of Sales Budget
Sales Budget(in Total Value)
For the Budget period ending
Product / Product 'A' Product 'B'

Period
Units Rate Amount Units Rate Amount
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Prof. Naveen Sharma
Qty. Rs. Rs. Qty. Rs. Rs.

1st Quarter --- --- --- --- --- ---
2nd
Quarter --- --- --- --- --- ---
3rd
Quarter --- --- --- --- --- ---
4th
Quarter --- --- --- --- --- ---
--- --- --- ---
Question:
HN Ltd. provides you the figures for the year 2021:
Product Product
A B
Sales (in Quantity) :
1st Quarter 1,250 1,600
2nd Quarter 2,950 800
3rd Quarter 2,700 1,000
4th Quarter 3,100 600
Selling Price per unit Rs.24 Rs.50
Targets for 2022:
Sales Quantity, (20%) 25%

Increases / Decrease
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Prof. Naveen Sharma
Selling price, 25% (20%)
Increase / Decrease
Sales area X, Y, and Z respectively produce 10%, 20% and 70% of product A and 70%, 20%
and 10% of Product B sales.
Required: Prepare sales budget for the year 2022.
Solution:
Sales Budget (in Total) for the year 2021
Production
A Product B
Units S.P Per Unit Amount Units S.P Per unit Amount
Period Rs. Rs. Rs. Rs.
I Quarter 1,000 30 30,000 2,000 40 80,000
II Quarter 2,360 30 70,800 1,000 40 40,000
III Quarter 2,160 30 64,800 1,250 40 50,000
IV Quarter 2,480 30 74,400 750 40 30,000
TOTAL 8000 2,40,000 5,000 2,00,000
SALES BUDGET
( AREA - WISE )
PRODUCT PRODUCT
A B
X (10%) Y (20%) Z (70%) Total X (70%) Y (20%) Z (10%) Total
Period Rs. Rs. Rs. Rs. Rs. Rs. Rs. Rs.
I Quarter 3,000 6,000 21,000 30,000 56,000 16,000 8,000 80,000
II Quarter 7,080 14,160 49,560 70,800 28,000 8,000 4,000 40,000
III Quarter 6,480 12,960 45,360 64,800 35,000 10,000 5,000 50,000
IV
Quarter 7,440 14,880 52,080 74,400 21,000 6,000 3,000 30,000
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Prof. Naveen Sharma
TOTAL 24,000 48,000 1,68,000 2,40,000 1,40,000 40,000 20,000 2,00,000
Working Notes:
Cal. Of Units sold for Product A

P.Y (1st Quarter) 1250
(-)20% -250 1000

II Quarter 2950
(-)20% 590 2360

III Quarter 2700
(-)20% 540 2160

IV Quarter 3100
(-)20% 620 2480

132 | P a

Management Accounting

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Management Accounting

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Management Accounting: Definition, Functions, Objectives, Roles

Management accounting is a special branch of accounting. It is a modern and scientific innovation of

Meaning and Definition of Management Accounting

Some beautiful definitions of management accounting are mentioned below:

According to R. N. Anthony, “Management Accounting is concerned with accounting information that is

Characteristics/Nature of Management Accounting

 Management accounting is no bound by the rules of financial accounting. Financial accounting

Functions of Management Accounting

Management accounting is an important medium of communication. Different levels of management (top,

4. Analyses and interprets data

5. Serves as a means of communicating

7. Uses also qualitative information

As a result, an interrelationship grows among the different parts of the enterprise.

11. To assist in motivation.

Purpose and Objectives of Management Accounting

Main purpose and objectives of management accounting may be summarized as under:

2. Planning and Policy Formulation

All management work is accomplished by decision making.

Management accounting helps management in controlling the performance of the organization.

Tools or Techniques of Management Accounting

4. Historical Cost Accounting

7. Analysis of Financial Statement

Based on these past events, the future course of action is projected.

This is an important tool for management accounting.

10. Management Information System

11. Statistical Techniques

12. Ratio Accounting

Limitations of Management Accounting

1. Management Accounting is only a tool.

3. Limitations of Basic Records

The use of management accounting requires knowledge of several related subjects.

The installation of management accounting involves a basic change in an organizational setup.

10. Top-heavy Structure

11. Provides Only Data

12. Broad-Based Scope

13. Not an alternation to administration

14. Opposition to Change

Management accounting demands a break away from traditional accounting practices.

Importance or Roles of Management Accounting in the

The importance/role of management accounting can be stated as follows:

2. Increasing Efficiency to Business Operations

4. Increase Labor Efficiency

5. Achieve Management Efficiency

6. Help Management Function

Management accounting helps in this respect preparing various reports.

Scope of Management Accounting

10. Statistical Methods

12. Method and Procedures

13. Interim Reporting

14. Office Services

Distinctions between Management Accounting and Financial

Management accounting is especially Financial accounting is both for

The objective of management The objective of financial accounting is

GAAP is not mandatory to follow in GAAP is mandatory to follow in

It emphasizes decisions on future

No constraints are other than costs

Detailed reports: concern about details

Concern about how measurements

The field is less sharply defined—

Financial accounting records are

Annual Annual reporting of management Annual reporting of financial

Characteristics It holds qualitative characteristics. It holds quantitative characteristics.

A financial accounting system