• Cost

• The amount of expenditure (actual or notional) incurred or attributable to a given thing. CIMA

• The recourses that have been or must be sacrificed to attain a particular objective.

• To ascertain the cost of a specified thing or activity ICAI

• Cost accounting

• “The process of accounting for cost which begins with the recording of income and expenditure or the base

on which they are calculated and ends with the preparation of periodical statements and reports for
ascertaining and controlling costs” ICAI

• “cost accounting is the process of accounting for cost from the point at which its expenditure is incurred or

committed to the establishment of its ultimate relationship with cost centers and cost units.” CIMA
• Cost centre

• A location, person, or item of equipment (or group of these) for which cost may be ascertained and used for the

purpose of cost control.

• Cost center is the smallest organizational sub-unit for which separate cost collection is attempted.

• Personal and impersonal cost centre

• Production and service cost centre

• Operation and process cost centre

• It can be also classified as a standard cost centre and discretionary cost centre and Productive,

Unproductive and Mixed Cost Centers.

• Cost unit

• a unit of product or service in relation to which costs are ascertained

• It is a branch of knowledge

• It is a science

• It is an art

• It is a profession

• It guides for the ascertainment of cost of production

• It discloses profitable and unprofitable activities

• It provides information for estimates

• It helps for inventory control

• It helps for cost control by using budgetary control and standard costing
• To ascertain cost per unit of the product, job, operation, process, service

• To analyse and classify cost by process or operation or by different elements of cost

• To provide required data for fixation of price and formulation of policies

• To ascertain the profitability of each product and advise management for cost control and thus maximizing profit

• To exercise effective cost control

• To assist management in decision making

• To help in the preparation of the budget and implementing budgetary control

• To help in the preparation of standard cost

• to provide information for estimates

• To provide a basis for cost reduction

• To disclose sources of wastages (material, time or expenses or in the use of machine or equipment) and to indicate any inefficiencies and their causes.
• Cost recording

• Cost ascertainment

• Cost analysis

• Cost comparison

• Cost control

• Cost report

• Statutory compliance
• Cost Control

Ensuring that the costs are as per the predetermined set standard and if any variation from these set
standards is found by comparing standard and actual cost, corrective action is carried out if it is
necessary.

• Cost Reduction

• The achievement of a real and permanent reduction in the unit cost of goods manufactured or services

rendered without altering the quality of the product.

• Cost control is basically a preventing function whereas cost reduction is a corrective function.
• Expensive

• Duplication of work

• Requirement of reconciliation

• Inapplicability

• Different methods for different industry/products

• The application of appropriate techniques and concepts in processing historical and projected economic

data of an entity to assist management in establishing plans for reasonable economic objectives and in the

making of rational decisions with a view towards these objectives. AAA

• Management accounting is an integral part of management concerned with identifying, presenting and

interpreting information used for formulating strategy, planning and controlling activities, decision

making, optimizing the use of resources, disclosure to shareholders and others external to the entity,

disclosure to employees and safeguarding assets. CIMA

• Collection of data

• Analysis and interpretation of data

• Planning and forecasting

• Ensuring control

• Communication

• Performance evaluation

• Helping in decision making

• Preparation of report
• To formulate Planning and policy

• To analysis and interpretation of the financial statement

• To assist in Decision-making

• To help in control

• To assist in communicating

• To Facilitate Coordination of Operations

• To advise management
 Financial statement analysis  Control Techniques
 Comparative statement analysis,  Standard costing,
 Common size analysis,  Budgetary control
 Trend analysis,
 Statistical and graphical chart
 Ratio analysis,
 linear programming,
 Cash flow analysis etc.
 investment chart,

 Decision making  sales and revenue chart etc.

 Marginal costing,

 Differential costing,

 CVP analysis,

 Capital budgeting etc.

• Based on accounting information

• Based on the future estimate

• It is not a substitute for management

• Heavy structure

• Scope for personal bias

• Resistance within the organisation

• Incompleteness of data
 Management Accounting Cost Accounting
1 Its objective is to assist management in the The objective of the cost accounting is to ascertain
process of planning, controlling, decision making the cost and assist management for cost control and
by providing necessary information on time. cost-related decision making
2 It uses quantitative as well as qualitative data It uses quantitative cost data in monetary terms
3 It is wider in scope it includes budgeting, It deals with cost ascertainment and cost control of
planning, effective and efficient performance of the business
the business.
4 Its success depends upon the existence of sound Its success does not depend upon the existence of
cost accounting system the Management Accounting system
5 It is based on information provided by financial It is based on Cost related data
accounting and cost accounting
6 It concerned with short-range and long-range It is more concerned with short-term planning.
planning and uses sophisticated techniques for
planning and forecasting prices.
7 It is concerned more with the impact and effect It is concerned more with the ascertainment,
aspect of cost. allocation and accounting aspects of costs.
8 The management accountant places the data in a The approach of the cost accountant is much
wider perspective narrower than that of a management accountant
9 It provides historical as well as predictive It provides historical cost information for future cost-
information for future decision making related decision making
 Financial accounting Management accounting
1 It deals with business transactions and events It deals with the event for business as a whole as well as
for a business as a whole. various division and subdivisions
2 It is based on the monetary transaction of the It is primarily based on data as obtained from financial
business accounting.
3 Its main function is to recording, classifying Its main function is to assist management in the process of
and summarizing transaction and events in the planning, controlling, performance evaluation and
books of accounts and preparation of financial decision making by proving necessary information to the
statements. management.
4 Reports are meant for the management as well Reports are exclusively meant for management of the
as external users such as shareholders, concern.
creditors etc.
5 Reports are always subject to statutory audit. Reports are not subject to statutory audit.
6 Its success does not depend upon the Its success depends upon the sound financial accounting
existence of a sound management accounting system.
system.
7 Financial accounting data are historical in It analyses the data as they take place and also
nature. anticipates such events for the future.
8 It is governed by accounting principles and The form and content of the management accounting
concepts. information is formulated and governed by the needs and
purpose for the same.
• Cost centre

• A location, person, or item of equipment (or group of these) for which cost may be ascertained and used for the

purpose of cost control.

• Cost centre is the smallest organizational sub-unit for which separate cost collection is attempted.

• Personal and impersonal cost centre

• Production and service cost centre

• Operation and process cost centre

• It can be also classified as a standard cost centre and discretionary cost centre and Productive,

Unproductive and Mixed Cost Centers.

 By nature  By decision making
 Direct Cost  Pre-determined cost
 Indirect Cost  Standard cost
 Opportunity cost
 By element
 Materials cost
 Marginal cost
 Labour cost
 Differential cost
 Expenses
 Shutdown cost

 By behaviour  By controllability
 Controllable cost
 Fixed cost
 Uncontrollable cost
 Variable cost
 Semi-variable cost  By normality
 Normal cost
 By functions
 Abnormal cost
 Production overhead
 Administration  By time
 Selling  Sunk cost
 Distribution  Estimated cost
 Research and Development
 Cost Sheet for the Period ---------------------
Par ticulars Amount Amount Units
Opening Stock of Raw Material
***
Purchase of Raw materials
***
Purchase Expenses
***
Less Closing stock of Raw Materials
***
Raw Materials Consumed
***
Direct Wages
***
Direct Expenses
***
PRIME COST ***

Factory Expenses:
Factory Rent ***
Factory Power ***
Indirect
Material ***
Indirect
Wages Supervisor Salary ***
Factory Insurance ***
Factory Asset Depreciation ***
Work Cost incurred ***
***
Opening Stock of WIP
Less Closing stock of WIP ***
***
***
FACTORY COST/WORKS COST
***

Administrative Expenses:-
Office Rent
***
Asset Depreciation
***
General Charges
***
Audit Fees
***
***
COST OF PRODUCTION ***

Opening stock of Finished Goods

***
Less Closing stock of Finished Goods
***
***
COST OF GOODS SOLD ***

Selling and Distribution Expenses

Sales man Commission
***
Sales man salary
***
Traveling Expenses
***
Advertisement
***
Transporation expenses
***
Sales Tax
***
Bad Debts
***
***
COST OF SALES ***

Profit ***
SALES ***
The following items are of financial nature and thus excluded while preparing a cost sheet
• Cash discount
• Interest paid
• Preliminary expenses written off
• Goodwill written off
• Provision for taxation
• Provision for bad debts
• Transfer to reserves
• Donations
• Income tax paid
• Dividend paid
• Profit/loss on the sale of assets
Cost of raw materials on June 1 30,000

Purchase of raw materials during the month 4,50,000

Wages paid 2,30,000
Factory overheads 92,000
Cost of work in progress on June 12,000

Cost of raw materials on June 30 15,000

Cost of stock of finished goods on June 60,000

Cost of stock of finished goods on June 30 55,000

Selling and distribution overheads 20,000

Sales 9,00,000
Administration overheads 30,000
 Cost sheet for the month of June
Particulars Amount (₹) Amount (₹)
Opening stock of raw materials 30000
Purchase of raw materials 450000

Less Closing stock of raw materials -15000

Raw material consumed 465000

Direct wages 230000

Prime Cost 695000

TT Ltd. has two production departments and P1 and P2 and two service departments S1 and S2.
Expenses of these departments are as follows:
P1 ₹ 51837, P2 ₹ 12163 ,S1 ₹ 40000 and S2 ₹ 16000
Expenses of service departmetns are to be apportioned as follows
Particulars P1 P2 S1 S2
S1 50% 40% 10%
S2 30% 50% 20%
Apportion the cost of service departments.

Solution:
Repeated distribution method

Overheads distribution statement

Production Dept. Service Dept.
Item P1 (₹) P2 (₹) S1 (₹) S2 (₹)
Overheads as per primary distribution 51837 12163 40000 16000
Cycle I
Apprtionment of cost of S1 to P1,P2, S2 (5:
4:1) 20000 16000 (40000) 4000
Apportionment of cost of S2 to P1,P2,S1
(3:5:2) 6000 10000 4000 (20000)
Cycle II
Apprtionment of cost of S1 to P1,P2, S2 (5:
4:1) 2000 1600 (4000) 400
Apportionment of cost of S2 to P1,P2,S1
(3:5:2) 120 200 80 (400)
Cycle III
Apprtionment of cost of S1 to P1,P2, S2 (5:
4:1) 40 32 (80) 8
Apportionment of cost of S2 to P1,P2(3:5) 3 5 (8)
Total overheads 80000 40000 0 0

Simultaneous Equation Method

X= 40000+20%Y
Y=16000+10%X
Let X is total overheads for S1 and Y is total Overheads for S2
X= 40000 +20% Y
Y= 16000 +10% X

X = 40000 + 0.2 Y
Or X = 40000 + 0.2 (16000 + 0.1 X)
Or X =40000 + 3200 + 0.02 X
Or X = 43200 + 0.02 X
Or X -0.02 X =43200
Or 0.98 X = 43200
X = 43200/0.98
X = 44082 (Approx.)
By using the value X in Y = 16000 + 10% X
Y = 16000 + 4408
Y = 20408 (Approx.)
Total overheads for S1 44082
Total overheads for S2 20408

Overheads distribution summary

Production Departments
P1 (₹) P2 (₹)
Overheads as per primary distribution 51837 12163
Apportionment of 90% of overheads of S1
to P1,P2 (5:4) 22041 17633
Apportionment of 80% of overheads of S2
to P1, P2 (3:5) 6122 10204
Total 80000 40000

Trial and Error Method

Total Cost of each service departments.

Items S1 (₹) S2 (₹)
As per primary distribution 40000 16000
Apportionment of cost of S1 to S2 (10%) 4000
Apportionment of cost of S2 to S1 (20%) 4000
Apportionment of cost of S1 to S2 (10%) 400
Apportionment of cost of S2 to S1 (20%) 80
Apportionment of cost of S1 to S2 (10%) 8
Apportionment of cost of S2 to S1 (20%) 2
Total 44082 20408

Overheads distribution summary

Production departments
Item P1 (₹) P2 (₹)
As per primary distribution 51837 12163
Apportionment of 90% of overheads of S1
to P1,P2 (5:4) 22041 17633
Apportionment of 80% of overheads of S2
to P1,P2 (3:5) 6122 10204
Total overheads of production dept. 80000 40000
OVERHEADS : ALLOCATION, APPORTIONMENT AND ABSORPTION
 OVERHEADS : ALLOCATION AND ABSORPTION
 The indirect portion of total cost constitutes the overhead cost, which is an aggregate of indirect material cost,

indirect labour and indirect expenses.

 Expenditure over and above prime cost is known as overhead.

 Indirect costs incurred for the benefit of several cost centres and cost units, cannot be conveniently identified

with a cost centre or cost unit, it can be apportioned to or absorbed by the cost centres or the cost units.

 Steps in the distribution of overheads

• Collection of overheads under separate headings

• Allocation and apportionment to production departments and service departments

• Re-apportionment of service department cost to production departments

• Absorption of overhead
 Functional classification

 Manufacturing overhead

 Administration overhead

 Selling and distribution overhead

 Classification based on behaviour

 Fixed overhead

 Variable overhead

 Semi-fixed overhead

 Element wise classification

 Indirect materials

 Indirect labour

 Indirect expenses
• Allocation and apportionment of such items to cost centres is also known as departmentalization or

primary distribution of overhead.

• A factory is divided into subdivision or departments for running it smoothly and efficiently.

• Each department represents a division of activity e.g. repairs department, power department, stores

department, tools department, cash department etc.

• Natural flow of raw materials, the flow of production, the sequence of operation, the efficiency of the

concern, control and responsibility etc. are taken into consideration while departmentalization.
• Allocation of overhead is the process of identification of overheads with cost centres. Cost allocation of the overhead is the

allotment of whole items of cost to cost centres or cost units or refers to the charging of expense which can be identified wholly
with a particular department.

• Cost apportionment is the allotment of proportions of items of cost to the cost centres or cost units. It refers to the allotment of

expenses which can’t be identified wholly with a particular department, such expenses require apportionment over two or more cost
centres or cost units.

• Differences between cost allocation and apportionment

 Cost allocation refers to the allotment of the whole item of cost to a cost centre or cost unit whereas cost apportionment deals with the allotment of

the proportion of items of cost to cost centres or cost unit.

 Allotment is a direct process whereas apportionment requires a suitable basis for subdivision of cost.

 For example expenses on general repairs and maintenance pertaining to a department can be allocated to that department but apportioned to the

various machine running in that department.

 Service or utility principles - according to the service rendered or benefit received from the service.

 Ability to pay principles – higher share is apportioned to cost centres or cost units which contribute

more towards the profit of the concern.

 Survey principles – a survey is made of the various factors involved and the share of overhead to be

borne by each cost centre is determined.

 Efficiency or incentive principles - on the basis of budget or standard set for each cost centre.
 Proportion of the value of building and plants (depreciation, insurance, maintenance etc.)

 Floor area of departmental buildings (lighting and heating, rent etc.)

 Production hour of direct labour and machine (factory expenses, administration expenses, expenses of

research and experimentation etc.

 No. of employees (labour welfare expenses, wages of timekeepers, medical expenses etc.)

 Technical estimates (expenses of electricity, water gas etc.)

 Service department renders a service that contributes in an indirect manner to the manufacture of the
product, it does not itself change the shape, form or nature of materials that is converted into finished
goods. Examples are the labour welfare department, purchase department, canteen etc.

 No cost unit pass-through service departments therefore, Service department cost are to be re-
apportioned to the production department in order to facilitate charging of all factory overheads to cost
units.
 Apportionment of overheads of service departments done to production department only.

 Apportionment to production as well as the service department, a service department render services
not only to the production department but also to the other service department. This inter-service
department apportionment may be either on a reciprocal or non-reciprocal basis.

 Non-reciprocal distribution (step ladder method) when various service departments are non-
interdependent, a service department renders services to other department but do not receive
service from that department.
 Cost of service department which render the service apportioned first,

 Cost of other department comprises of its own cost plus share allotted to it from other service departments

 When there are more than two service departments the service department should be arranged in descending
order (department serves the largest no. of department apportioned first and so on)
 Reciprocal distribution method when service departments are mutually dependent.

 Simultaneous Equations Method, algebraic equations are used for apportionment

 x=a+by, y=a+bx where x and y are the overhead expenses of department X and Y respectively.

 Repeated Distribution Method, The first service department is apportioned to other service department and production
department, the amount of this department is closed.

 Second service department including share of first is similarly apportioned to other service department and production
department, this department shows nil balance.

 The first department thus gets a share of second and re-apportioned in the same way.

 This process goes until the balance of service departments becomes very small and then transferred to the production
department only.

 Apportionment is done on the basis of services rendered

 ABSORPTION OF OVERHEADS
 Overhead absorption is the process of allotment of overhead to the cost units.

 After the allocation and apportionment, the overhead falling to the share of the department is to be

absorbed by cost units.

 The total cost of production department includes, its own expenses, the share of common expenses and

share of the cost of the service department.

 It is necessary to charge each unit of production with its share of overhead expenses to ascertain the total

cost of each unit.

 Absorption means the distribution of the overhead expenses allotted to a particular Department over the

units produced in that department.

OVERHEAD RATES
 METHODS OF ABSORPTION
• On the basis of direct materials,

• On the basis of prime cost,

• On the basis of direct labour cost,

• On the basis of labour hour rate,

• On the basis of machine hour rate and

• On the basis of rate per unit of output

 DIRECT MATERIAL COST METHOD
• Under this method, the cost of direct material consumed is the base for calculating the amount

of overhead absorbed. The overhead rate base on this method is computed by the following
formula

• Overhead rate = 𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑜𝑓𝑎 𝐷𝑒𝑝𝑎𝑟𝑡𝑚𝑒𝑛𝑡

∗ 100
𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝐷𝑖𝑟𝑒𝑐𝑡 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑎𝑙𝑙 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑠

• This method is applied where one kind of article is produced, the quantity and cost of material

charged to each unit being the same, prices of the materials are stable and proportion of
overhead to the total cost is significant. Calculation of overhead rate is simple.
 PRIME COST METHOD
• This method is based on the fact that both materials and labour contribute to factory overheads.

Hence, Prime cost should be taken as the base for absorbing the factory overhead.

𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑜𝑓 𝑎 𝐷𝑒𝑝𝑎𝑟𝑡𝑚𝑒𝑛𝑡

• Overhead rate = ∗ 100
𝑃𝑟𝑖𝑚𝑒 𝐶𝑜𝑠𝑡

• This method is used when a standard article is produced requiring a constant quantity of

materials and number of hours.

 DIRECT LABOUR COST METHOD
• This method is suitable when direct labour constitutes a major proportion of the total cost of

production where labour employed and types of work performed a uniform and the ratio of
skilled and unskilled Labour are constant.
𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑜𝑓 𝑎 𝐷𝑒𝑝𝑎𝑟𝑡𝑚𝑒𝑛𝑡
• Overhead rate = ∗ 100
𝐷𝑖𝑟𝑒𝑐𝑡 𝐿𝑎𝑏𝑜𝑢𝑟 𝐶𝑜𝑠𝑡

• Under this method, consideration is given to the time factor and used when labour rate is more

stable than material prices.

 LABOUR HOUR RATE METHOD
• This method fully recognizes the significance of the element of time in the incurring and

absorption of manufacturing overheads. This method is admirably suitable when any large use
of machinery not involved in operations
𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑜𝑓 𝑎 𝐷𝑒𝑝𝑎𝑟𝑡𝑚𝑒𝑛𝑡
• Direct Labour Hour Rate =
𝐷𝑖𝑟𝑒𝑐𝑡 𝑙𝑎𝑏𝑜𝑢𝑟 𝐻𝑜𝑢𝑟
 MACHINE HOUR RATE METHOD
• This method is used when work is carried out mostly by machines.
𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
• Machine hour rate =
𝑀𝑎𝑐ℎ𝑖𝑛𝑒 ℎ𝑜𝑢𝑟𝑠 𝑑𝑢𝑟𝑖𝑛𝑔 𝑎 𝑔𝑖𝑣𝑒𝑛 𝑝𝑒𝑟𝑖𝑜𝑑

• Steps for calculation of machine hour rate

• 1. Calculate the total overheads apportioned to the production department

• 2. Apportion further these overheads to machines or group of machines in the department

• 3. Allocate the machine-specific cost

• 4. Aggregate the overheads

• 5. Estimate total productive hours for the machines

• 6. Use the above formula

 RATE PER UNIT OF OUTPUT METHOD
• This is the simplest of all the methods, also known as a unit cost method.
𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑
• Overhead rate = 𝑁𝑜. 𝑜𝑓 𝑢𝑛𝑖𝑡𝑠 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑

• This method is used when a business firm produces only one item of product or a few sizes,

quantities or grades of the same product.

Company ABC Ltd has three production departments P1, P2 and P3 and a service department S.
The following information are available for one month of 25 working days of 8 hours per day,
calculate labour hour rate for each of the production departments.

Total S P1 P2 P3
Power and Lighting (₹) 2200 480 400 600 720
Supervisor's Salary (₹) 4000 20% 30% 30% 20%
Rent (₹) 1000
welfare (₹) 1200
Others (₹) 2400 400 400 800 800
Number of workers 20 60 80 40
Floor area in sq. ft. 1000 1200 1600 1200
Service rendered to production departments 50% 30% 20%

Solution:

(₹)

S P1 P2 P3
Power and Lighting 480 400 600 720
Supervisor's Salary 800 1200 1200 800
Rent (floor area) 200 240 320 240
welfare (no. of workers) 120 360 480 240
Others 400 400 800 800
Total 2000 2600 3400 2800
Apportionment of service dept. overheads (2000) 1000 600 400
Total overheads ------ 3600 4000 3200

Labour hours 12000 16000 8000

Labour hour rate (total overheads/labour hours) 0.3 0.25 0.4

Working notes

1. Rent ₹ 1000 for 5000 sq. ft. (total of P1 + P2 + P3 + S) thus ₹ 0.20 (1000/5000) per
sq. ft.
2. Welfare ₹ 1200 for 200 worker thus ₹ 6 (1200/200) per worker
3. Labour hours = No. of Day × No. of hours per day × No. of workers
a. P1 = 25 × 8 × 60 = 12000 hours
b. P2 = 25 × 8 × 80 = 16000 hours
c. P3 = 25 × 8 × 40 = 8000 hours
 Calculation of Machine hour rate

Particulars ₹
Standing charges: Per annum
Rent (15000*4*25%) 15000 Depreciation
Lighting (1000*12*25%) 3000 Purchase of machine
Foreman's salary (30000*1/6) 5000 Installation
Insurance premium 3000 Total
Total 26000 Less Scrap value
Total
Standing charges per hour (26000/2000) 13.00
Depreciation per hour
Variable charges: Per hour
Depreciation 20.00
Repairs (5000/2000) 2.50
Power (2 units *0.5) 1.00
Consumable stores (4000/2000) 2.00

Machine hour rate 38.50

 ₹
400000
100000
500000
100000
400000

20
1
2
3
4
 Marginal Cost
 The amount at any given volume of output by which aggregate cost changed if the volume of output is increased or
decreased by one unit. CIMA
 Additional cost of producing an additional unit of product or cost of one unit of product which would be avoided if
that unit was not produced.
 Marginal Cost is variable in nature.

 Marginal costing
 The ascertainment of marginal costs and the effect on profit of changes in volume or type of output by
differentiating between fixed costs and variable costs. In this technique of costing only variable costs are
charged to operations, processes or products leaving all indirect costs to be written off against profits in
the period in which they arise. CIMA
 Marginal Costing is also known as variable costing
 Basic Equation
 Total Sales -Variable costs = Contribution
 Contribution - Fixed costs = Profit
 Contribution is the difference between total sales and total variable cost (Contribution per unit is the difference
between selling price and variable cost per unit)
 Characteristics
• Segregation of costs
• Marginal Cost as product cost
• Fixed cost as a period cost
• Valuation of finished goods and
WIP
• Fixation of price
• Contribution
• Determination of Profit
 Advantages
• Simple technique
• Managerial decisions
• Cost control
• Valuation of inventory
• No under or over absorption
• Constant cost per unit
• Aid to profit planning
 Practical Application
• Fixation of the selling price
• Make or buy decision
• Key or limiting factor analysis
• Selection of suitable product mix
• Profit planning
• Selecting alternative method
 Limitations
• Difficulty in the segregation of cost into fixed
and variable
• Ignores time factor
• Difficulty in application
• Ignoring fixed cost while the valuation of
closing stock and WIP
• Suitability in capital intensive industry
• Improper pricing
• Assuming fixed cost and Variable cost per unit,
sales price are constant
 Income statement (Marginal Costing)
Particulars ₹ ₹
Sales **

Variable Manufacturing Cost :

Raw materials consumed **
Direct wages **
Manufacturing overhead **
Cost of goods produced **
Opening stock of finished goods **
(value at the previous period)
Closing stock of finished foods (**)
(value at current variable cost)
Variable Administration, selling & distribution overhead **
Total Variable cost (**)
Contribution (Sales-Variable Cost) **
Fixed Manufacturing, Admin., Selling & Distribution overhead (**)
Net Profit **
 Income statement (Absorption Costing)
Particulars ₹ ₹
Sales **

Production Cost :
Raw materials consumed **
Direct wages **
Variable Manufacturing overhead **
Fixed Manufacturing overhead **
Cost of Production **
Opening stock of the finished goods **
(Value at the previous production period)
Closing stock of the finished foods (**)
(Value at the production cost of the current period)
Cost of Goods sold **
Add (less) under (over) absorption of fixed manufacturing overhead **
Administration overhead **
selling & distribution overhead **
Total cost (**)
Net Profit (Sale-Total Cost) **
1. When production is equal to sales

• When there is no opening and closing stock, profit or loss under both marginal costing and absorption costing

are equal

• When opening and closing stock are the same, provided fixed cost element in opening and closing stock are

same, profit or loss under both marginal costing and absorption costing are equal

2. When production during a period is more than sales, profit as per absorption costing will be more than

the profit as per marginal costing.

3. When production during a period is less than sales, profit as per marginal costing will be more than the

profit as per absorption costing.

Solution:

(a)

Income Statement (Marginal Costing)

For the year ending……………………….
Amount Amount
Particulars (₹) (₹)
Sales (1000 units *15) 15000
Variable Manufacturing Cost:
1100 units * 7
Cost of goods produced 7700
Less Closing Stock (100 units * 7) (700)
Cost of goods sold 7000

Variable selling and administration overhead (1000 units *0.5) 500

Total Variable cost (7500)
Contribution (Sales- Variable Cost) 7500
Less Fixed overheads:
Manufacturing overhead 2200
Selling and Administration overhead 400 (2600)
Profit 4900
 CVP (Cost Volume Profit) analysis is an extension of marginal costing technique. It studies the
interrelationship among the cost of the production, the Volume of the Production and the Profit.

 There exits the relationship between Cost, Volume and Profit if the volume increases; Cost per unit
decreases and profit per unit increases.

 There is a direct relationship between volume and the profit, whereas the inverse relationship between the
volume of output and cost.

 The study of the effects on future profit of changes in fixed cost, the variable cost, sales price, quantity and
mix. CIMA

 CVP analysis is useful for the management in budgeting and profit planning as it studies the effect of
change in selling price, change in volume of sales, change in variable cost and fixed cost on profit.
 The following purposes served by CVP Analysis

 Planning and forecasting of profit at a different level of activity

 Useful in setting up a flexible budget

 Evaluation of performance

 Formulating price policies

 Ascertainment of the amount of overhead to be charged to product costs at various level of operation

 For the purpose of the understanding relationship among Cost, Volume and Profit. The following concepts are desirable

to study.
 Contribution

 P/V ratio

 Break even point

 Contribution is the difference between sales and marginal cost; it contributes towards the fixed costs and profit.

 Contribution = Sales –Variable Cost

 Contribution = Fixed cost + Profit

 Contribution – Fixed cost = Profit

 P/V Ratio (Profit Volume ratio)

 Relationship between contribution and sales.

 One of the important ratios to study the profitability of the operations of a business

 P/V ratio= or

 P/V ratio =
 Level of operation where total costs are equal to total revenue

 Break even analysis is the widely used technique to study CVP analysis.

 In a narrow sense, it is concerned with the determination of Break-Even point (BEP), i.e. the level of activity
where total costs equal to total sales (where there is no profit and no loss)

 In a broader sense, it is concerned with the determination of probable profit at any level of production or sales

 Break-Even point in units =

 Break-Even point in ₹ = or Break-even units Selling price per unit

/

 Desired sales =
/
Source: Ravi M Kishore (2016), Cost & Management Accounting, 6th Edition, Taxman, P 541
 Margin of safety

It refers to the excess of budgeted (or actual) sales over the Break-even sales. There should be a reasonable margin of
safety to run the business in a profitable position. It provides the strength and stability of a concern.

Margin of Safety (MOS) =Actual sales – Break-Even Sales or

/

 Assumption

 All costs can be segregated in fixed cost and variable cost

 Fixed costs remain constant at various level of activity

 Variable cost per unit remains constant

 Production units and sales units are the same

 Selling price remains constant at all levels of output.

1. Selling price for a product is ₹ 240 per unit, variable cost is ₹ 160 per unit. Fixed expenses are ₹
16000 for the year. Calculate
(i) Break-even point in units and Break-even sales in ₹
(ii) Amount of profit when sales are 300 units
(iii) Sales to be made to earn ₹ 10000 for the year
2. Sales and profit for the year 2017 were ₹ 150000 and ₹ 10000 and for the year 2018, ₹ 200000
and ₹ 20000, respectively; calculate BEP.
3. The following information relates to a company.

₹ per unit

Material cost 8.00

Variable manufacturing expenses 5.00

Selling price 20.00

Dealer’s commission (10%) 2.00

Fixed cost ₹ 200000 for the year

Sales 80000 units

Due to tough competition the company need to put some extra efforts to sell. The following two
proposals have been made

(i) Reducing selling price by 10%

(ii) Increasing dealer’s margin by 5% (total 10+5).

Compare and recommend, which proposal should be followed keeping in view of maintaining the
present profit.
Solution (1)

(i) ₹
Selling price per unit 240
Less Variable cost per unit 160
Contribution per unit 80
Fixed cost 16000

P/V ratio = C/S 33.33%

BEP in units (FC/Contribution per unit) 200

BEP in ₹ (FC/P/V ratio) 48000

(ii)
Contribution per unit 80
Total contribution at 300 units of sale 24000
Less fixed cost 16000
Profit 8000

(iii)

Desired profit 10000

Desire sale (FC+Profit/P/V ratio) 78000

Solution (2)

Change in profit (20000-10000) 10000

Change in sales (200000-150000) 50000

P/V ratio = Change in profit /Change in sales 20%

P/V ratio C/S

C P/V ratio * S
C 40000 30000
Fixed cost (C-P) 20000 20000
BEP (FC/P/V ratio) 100000

Solution (3)

Material cost per unit 8

Variable manufacturing expenses 5
Dealer’s commission (10%) 2
Total Variable Cost 15

Fixed Cost 200000

Selling price 20
Sales volume (units) 80000

Contribution per unit 5

Total Contribution 400000

Profit (C-FC) 200000

(i)

Revised selling price 18.00

Varaible Cost :
Material cost per unit 8
Variable manufacturing expenses 5
Dealer’s commission (10%) 1.8
Total 14.8

Contribution per unit 3.20

Contribution/Contribution per unit) 125000

(ii)

Selling price 20

Revised dealer's commision 3.00

Varaible Cost :
Material cost per unit 8
Variable manufacturing expenses 5
Dealer’s commission 3.00
Total 16

Contribution per unit 4

Contribution/Contribution per unit) 100000

• A costing method where elements of cost are accumulated separately for each job or production order.

• The category of basic costing method which is applicable where the work consists of separate contracts, jobs or
batches, each of which is authorized by specific order or contract. CIMA

• A job is a specific order, it is an identifiable unit and it consists of a single order or contract.

• Job costing also known as job order costing, is a costing method where costs incurred for each element of
costs are identifiable with the job which is being completed based on the customer’s specific requirement.

• It is a form of specific order costing, where the product is produced or work is undertaken as an identifiable
unit based on the customer's specific requirements.

• It is applied in engineering works, printing, automobile servicing, furniture making, fabrication etc.

• Under this method costs are accumulated and collected for each job or order separately, each job is separately
identified and has its own characteristics.
• Features of job costing • Advantages
• It is a form of specific order costing. • It provides a detailed analysis of cost for each element

• Production or work is generally undertaken as per of cost

customer's order • It records cost more accurately
• Each job is treated as a cost unit
• It helps management to compare and analyse
• There may not be the uniformity in the flow of profitable and less profitable jobs
production from department to department.
• It provides a basis for the estimation of similar jobs to
• Cost of production is ascertained after the completion
be done in future.
of each job.
• It helps to measure profit or loss on each job.
• Job is done within the factory/workshop or customer’s
• It helps in the determination of predetermined
premise.
overhead rates in job costing.
• Product are not produced for stock purpose but
immediate delivery when it is completed. • It is useful in cost-plus contracts.
• Receiving an enquiry

• Estimation of the price of the job

• Receiving of order

• Production order

• Recording of costs (each job has a job cost card, bears a job number and used to collect all cost data)

• Materials (from material requisition notes/forms)

• Labours (from job timesheets, wages analysis sheet)

• Overheads (predetermined overhead rates)

• (in case of cost of an incomplete job; i.e. work in progress, it is essential to determine the closing value of WIP)

• Completion of job

• Profit or loss on a job

• Great deal of clerical work

• Scope of committing mistakes

• Cost comparison may become difficult due to the differences in jobs

• Cost ascertained in job costing is historical.

• Batch costing is a form of specific order costing, where a predetermined quantity of similar and identical

products are produced.

• Batch costing is an extension of job costing; it is used when the identical articles or components are

required for assembly and may be manufactured in definite batches.

• Batch costing is generally applied when customers order for a large number of identical units for same

product or components.

• It applied in readymade garments manufacturing, pharmaceutical industries, manufacturing of spare parts

and components, toys, tyres and tubes, engineering components etc.

• Features of batch Costing

• Each batch is treated as a cost unit.

• It is applied in industries where identical products are produced.

• Products may be produced for stock.

• Costs are accumulated and ascertained for each batch.

• Each batch is allotted a batch number and overheads are recovered batch-wise.

• Each batch consists of the predetermined number of articles and Per unit cost is ascertained by

Cost per unit =

• When products are produced in batches, the company need to determine the Economic Batch Size. It refers to

optimum quantity of a batch which should be produced at a point of time so that the Setup and Carrying Costs are
optimized.

• Setup cost (Machine set up costs) refers to the expenditure incurred for setting up and processing operations,

larger the size lower the setup cost. Carrying cost (Inventory holding costs) refers to expenditures for maintaining
a given level of inventory, larger the batch size higher the cost.

• Economic Batch quantity =

Where U = annual demand for the component/product, S= Setup cost per batch and C = Carrying cost per unit.
• The costing procedure for batch costing is similar to the job order costing, the following are some of the
differences between them
JOB COSTING
Each job is treated as cost unit
A job consists of a single order or contract
It is applied where work is undertaken as per customers
specific requirements
Products are not produced for the stock purpose
Each job is separate and independent of other jobs
BATCH COSTING
Each batch is treated as cost unit
A batch is a group of a similar product and may consist of
multiple orders
It is also a form of specific order costing and applies where
similar articles are produced
Products are produced for sale or use within the undertaking
and may for stock purpose.
Products are identical and manufactured in a continuous flow
Annual Demand for a component is 24000 units, setup cost per batch ₹ 324, carrying cost
₹ 1.2 per component. Calculate economic batch size (EBQ) and analyze the costs by
increasing and decreasing the number of units.

Solution
Annual Demand (U) Setup cost (₹) Carrying cost (₹) EBQ
24000 324 1.2 3600

Number of Setup cost per Carrying Cost per Total Cost

1000 7776 600 8376
2000 3888 1200 5088
3600 2160 2160 4320
4000 1944 2400 4344
6000 1296 3600 4896

Setup cost per annum = (Anuual demand/number of units)* Setup cost per batch
Carrying Cost per annum = Average inventory * Carrying cost per unit
Example of Average inventory (when number of units 1000) = 1000/2
Total cost at EBQ is minimum.
Following information relates to the manufacturing of a component C201.
₹
Cost of materials 0.4 per component
Operator wages 2 per hour
Machine hour rate 3 per hour
Setting up time of the machine 150 minutes
Manufacturing time per component 15 minutes
Prepare a cost sheet showing total cost and per unit cost, when a batch consists of
1000 components.

Solution

Cost sheet for a batch C201

Particulars Total Per unit
₹ ₹
Machine Set up cost (Fixed)
Wages (2.5 hours *2) 5
Machine overhead (2.5 hours *3) 7.5
Total (a) 12.5 0.01

Production cost (Varaible)

Materials (1000*0.4) 400 0.40
Wages (15*1000*2/60) 500 0.50
Machine overhead (15*1000*3/60) 750 0.75
Total (b) 1650 1.65
Total Cost (a+b) 1662.5 1.66
• Contract costing also called terminal costing is a costing method, which is applied in the business engaged in
constructional and repairs works. It is a form of specific order costing where the work is undertaken as per
customers specific order which is generally of long duration as compared to job costing.

• Contract costing is applied in the construction of a building, plants, bridges, roads, dams, ships, engineering
projects, production of motion pictures etc.

• Distinguishing features of contract costing

• Major part of work is done on sites

• Duration of the contract is a relatively longer period

• Higher proportion of direct costs

• Lower indirect costs such as head office expenses, stores and works

• A separate account is maintained for each contract

• Contract is the cost unit in contract costing

• Recording of costs

• Materials purchased for contract or supplied from the store are debited in the concerned contract

account. Materials returned to stores or amount received from the sale of surplus materials will be
credited to contract account. If materials received from another contract, it will appear on the debit side
whereas transferred from another contract will appear on the credit side. Materials stolen or destroyed
will be transferred to profit and loss account.

• Labours employed at site are treated as a direct cost and charged to the concerned account, salaries to

staffs for a specific contract are also charged to concerned contract account. A separate wages sheet
may be prepared for each contract.

• Site expenses are charged to concerned contract account when they incurred.
• The full value of plants and machinery will appear on the debit side and credited with the depreciated

value at the end or a contract account should be debited with the value of depreciation of plant and
machinery.

• Overhead expenses are few in contracts and should be distributed over several contracts on a suitable

basis such as percentage of the cost of materials or wages or prime cost or labour hour in case of a big
contract.

• In case of Sub-contracts such as the installation of a lift, electrical works, etc. will be charged to

concerned contract account.

• If the Extra work is substantial it should be treated as a separate contract, else the cost of extra work

should appear on the debit side of the contract account as ‘cost of extra work’.
• Specific terminology in contract costing

• It is normal practice in case of a large contract that contractor will be paid during the contract based on work

completed and duly certified. The Certificate of work done refers to the certificate by surveyors or architects
appointed by contractee certifying the value of work completed. Work uncertified refers to the work which
has been carried out by the contractor but not certified by the surveyors.

• In case of a large contract, the contractor cannot afford to block fund until the completion, a part of the

contract price is paid on time to time, based on the certificate of work done is known as Progress payment.

• The term of the contract may provide that, the entire amounts as per the certificate of work done, will not be

paid to the contractor, a small portion will be held back by the contractee is called Retention money. This
money retained as a safety measure in case the contractor is not able to fulfil one or more of the conditions
laid down in the contract.
• Types of the contract

• Fixed price contract, where both parties agree to a fixed price contract

• Escalation clause provides the safeguard against any likely changes in the price of materials or labour; if the

prices go beyond the specified limit, the contract’s price will be suitably adjusted. A contract with such a clause is
known as Fixed price contract with an escalation clause.

• Cost plus contract refers to the contract; where no fixed price could be settled, and the value of the contract is

determined by adding an agreed percentage of profit to the total cost.

• Work in progress

The value of the work-in-progress includes of the cost of work completed, both certified and uncertified, it appears
in the contract account and shown as a current asset in the balance sheet under the headings of work-in-progress.
 Job costing
In job costing, a job is small in size.
Each job is a cost unit.
Job work carried in the company’s workshop or customer
premises.
A job usually takes less time for completion.
The Selling price of the job is paid in full after completion Price is paid in instalments, depending upon the progress
of the job.
In job costing expenses may be direct and indirect.
Profit or loss from a job entirely transferred to profit and
loss account.
The number of jobs in hand at any time may be large.
Contract costing
In contract costing, the contract is the larger in value.
Each contract is a cost unit.
Work carried at the site.
A contract takes more time for completion.
of work.
Most of the expenses are direct in nature.
Proportionate profit transferred to profit and loss account.
Only a few contracts may be undertaken at a time.
• The entire cost of the contract can be ascertained when it is completed but a contract may take more

than a year to complete. Profits on the incomplete contract should be considered as follows,
• The contract, which has just started i.e. the completion stage of contract is less than 25% of the total contract

price, no profit shall be transferred to profit and loss account.

• If the completion of the contract is 25% or more but less than 50% of the total contract. The profit shall be

transferred to profit and loss account as below

Cash received
Profit = x Notional Profit x
Work certified
where notional profit = value of work certified - cost of work certified

Cash received = value of work certified – retention money

• If the completion of the contract is 50% or more but less than 90% of the total contract. The profit shall be

transferred to profit and loss account as below

Cash received
Profit = x Notional Profit x
Work certified
• The contract nearing completion, i.e. the completion of the contract is 90%, and more, profit to be taken to

profit and loss account is calculated by determining estimated profit

work certified
Profit = Estimated profit x or
contract price

work certified Cash received

Profit = Estimated profit x x
contract price Work certified

• Whole of loss if any should be transferred to profit and loss account

• Process costing is a costing method, which is used to ascertain the cost of the product at each process or

stage of production. It is applied in the industry, where the material has to pass through more than two
processes to being converted into finished goods.

• In process costing, costs are ascertained for each process, and the unit cost is ascertained by averaging the

total cost by the number of units produced in that process.

• It is applied in the industry like oil refining, chemical and drugs, food processing, cement, textiles etc.
• Features of process costing

• Production is continuous.

• Clearly defined process cost centres.

• Separate account for each process is opened.

• Final product of one process becomes the input for the next process.

• Normal and abnormal loss usually arise in different processes.

• Output is uniform and all units are identical.

• Cost per unit is determined by dividing the total cost of each process with normal output.

• Different products with or without by-products are simultaneously produced.

• Materials

Details of the cost of material are drawn from material requisition form/notes. Material issued from stores or
transfer from any other process will appear on the debit side of the concerned process account. The output at the
end of a process generally becomes the input for the next process then the next process's account debited at the
cost of transfer from the first process.

• Labour

Wages paid to labours for carrying out processing activities will appear on the debit side of the process account.
Labour cost may also be apportioned over the different processes on a suitable basis.

• Direct expenses

Expenses such as depreciation, repairs, maintenance, insurance etc. are debited to concerned process account

• Overheads

Overheads expenses apportioned over the different process on suitable bases.

Job costing Process costing
Production is carried out as per customers specific orders. Production is in continuous flow and products are homogenous.

Costs are determined for each job separately. Costs are ascertained for each process at the end of the accounting
period.
Each job is separate and independent of other jobs. Products are identical and manufactured in continuous flow and thus
lose their individual identity.
Work in progress may or may not exist at the beginning or end of Normally, the opening and closing work in progress exist.
the accounting period.
Control is comparatively difficult as each job is different than Proper control is comparatively easier as production is standardized.
others.
Cost of each job is ascertained by adding materials, labour and Per unit cost, is averaged by the number of units produced in the
overheads. process.
There is no transfer from one job to another job except there is Costs are normally transferred from one process to another process,
surplus work or excess production. the end product of one process becomes the input for the next
process.

Joint products or by-products generally do not arise in job costing. Joint products or by-products do arise in process costing.
• Due to the inherent nature of processes some quantities of materials are lost, while they are being
converted in the final product. It may happen due to wastages of material, evaporation of material, quality
of raw material, the technology used in production etc. These are normally unavoidable. These losses
have the following form;
• Normal loss refers to the loss which is unavoidable due to the inherent nature of production or
technology used. This loss can be estimated in advance based on experience and technical data. If
scrap possesses some value, it is credited to the process account. The loss is shared by usable units.
• Abnormal loss refers to the loss which is unexpected or due to abnormal conditions such as machine
break down, accident etc., it is a loss which is beyond the normal loss as estimated in advance. If the
abnormal loss has any scrap value, it is credited to the process account and the loss is transferred to
costing profit and loss account.
 Value of abnormal loss = 

• Abnormal gains arise when the actual loss is less than the normal loss. Since normal loss is an

estimate and hence actual output may differ as per the estimation. Abnormal gain is also called
unexpected gain in production in normal condition. It may arise due to overestimation of normal loss,
work efficiency etc. The amount of abnormal gain is transferred to costing profit and loss account.

Value of abnormal gain =  units of abnormal gain

• In the industries where process costing is applied, the problem of work in progress (WIP) is common.

There would be of incomplete units at the end of the year in each process. Since these units cannot be
treated as identical with the completed units, and it is valued based on the degree of completion,
usually on a percentage basis.

• Equivalent production represents the production of a process in terms of completed units. For example,

300 units are still in progress where 60% of work has been completed. The cost of WIP will be
equivalent to 180 (60% of 300) completed units.

Equivalent units of WIP = Actual No. of units in progress  % of work completed

• The following steps are followed for the determination of equivalent production.

• Calculation of equivalent units for each cost element by considering process loss, opening and

closing WIP and degree of completion.

• Finding out the net process cost for each element of costs.

• Determination of cost per unit of equivalent production for each element of the cost.

• Evaluation of output finished and transferred and WIP.

 Process I
Particulars Units Amount (₹) Particulars
To Units introduced (500 units @ ₹ 4) 500 2000 By Normal Loss @ ₹ 2
To Materials 2600 By Transfer to Process II
To Direct wages 2250
To Production oveheads 2250
500 9100

Process II
Particulars Units Amount (₹) Particulars
To Transfer from Process I 450 9000 By Normal loss @ ₹ 4
To Materials 2000 By Transfer to Process III @ ₹ 50
To Direct wages 3680 By Abnormal Loss @ ₹ 50
To Production oveheads 3680
450 18360

Process III
Particulars Units Amount (₹) Particulars
To Transfer from Process II 340 17000 By Normal loss @ ₹ 5
By Transfer to Finished goods stock
To Materials 1025 account @ ₹ 80
To Direct wages 1400
To Production overhead 1400
To Abnormal effective @ ₹ 80 15 1200
355 22025

Abnormal Loss A/C

Particulars Units Amount (₹) Particulars
To Process II @ ₹ 50 20 1000 Sale Proceeds @ ₹ 4
By Costing P & L A/c
20 1000

Abnormal Effective A/C

Particulars Units Amount (₹) Particulars
To Normal loss @ ₹ 5 15 75 By Process III @ ₹ 80
To Costing P & L A/c 1125
15 1200
Units Amount (₹)
50 100
450 9000

500 9100

Units Amount (₹) Working Notes ₹

90 360 (1)
340 17000 Normal Cost (18360 -360) 18000
20 1000 Normal output (80%) 360
Value of Abnormal loss 1000
450 18360 Normal output per unit 50

Units Amount (₹)

85 425 (2)

270 21600 Normal Cost (20825-425) 20400

Normal Output (75%) 255
Value of Abnormal effective 1200
Normal output per unit 80
355 22025

Units Amount (₹)

20 80
920
20 1000

Units Amount (₹)

15 1200

15 1200
• Budget

• A plan expressed in money. It is prepared and approved prior to the budget period and may show income,

expenditure and the capital to be employed.

• A financial or quantitative statement, prepared 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 the employment of capital. CIMA

• Budgeting

• The complete process of designing, implementing and operating budgets. The main emphasis in this is

short-term budgeting process involving the provision of resources to support plans which are being
implemented. ICSI
• Budgetary Control is the establishment of budgets relating to the responsibilities of executives to the

requirements of a policy and the continuous comparison of the actual with the budgeted results, either to
secure by individual action the objectives of that policy or to provide a basis for its revision. CIMA

• Budgetary control involves the following processes

• Establishment of budget or target performance

• Comparison with actual performance with the budget as above

• Ascertainment of difference between budget and actual performance

• Evaluation of the reasons for the difference between budget and actual performance

• Taking the suitable remedial actions if necessary to ensure that the budgeted performance may be attained.
 The objectives of budgetary control can be grouped under there broad heads.

• Planning
Budgets provide details plans, and it includes the plans relating to sales, raw material and labour requirement,
advertising, research and development activities, capital requirements etc. The planning should have taken place
before the preparation of the budgets. Budgets plans are quantified, and responsibility assigned to the executives
who are responsible for the implementation of such plans. These are prepared for the definite period and enable the
management to think ahead for anticipation and preparation for the future business condition.
• Directing and Coordinating
After the budget plans are prepared, it aids in the coordinating the efforts of the managers so that the objectives of
the organization as a whole are synchronized with the different budget plans in order to achieve the stated targets.
• Controlling
Control is necessary to ensure that the actual performance of operation compared with the planned targets and the
plans and objectives laid down in the budgets are being attained.
• Anticipation and preparation for changing business conditions

• Coordination of activities of various department of the business

• Increases business efficiency by exercising budgetary control

• It reveals the deviation of performance from the budget

• Effective utilisation of resources as production is carefully planned

• Motivates executives towards the attainment of objectives

• Provides yardstick for comparison of performance

• Encourages cost consciousness

• It aims at maximization of profits through careful planning and control of income and expenditures.
• Definition of organisational objectives

Budgets reflect organisational objectives and policies, and it is used for implementing those objectives.

• Principal budget factor (or key factor)

It is also called a key factor or limiting factor; examples are sales, plant capacity, raw material etc.

• Preparation of the organisational chart

The organisational chart is prepared, which shows the plan of the organisation and clearly defined authority and functional
responsibilities of each member.

• Creation of budget centres

It is a section of the organisation for which separate budgets prepared, and control exercised.

• Budget period

Period covered by a budget.

• Budget committee

Group of representative of various functions, which main functions are to review and recommend the revision of functional
budgets, approve and adopt the various budgets, analyse the performance reports and participate in decision making in strategic issues.

• Budget manual

A document which sets out the responsibilities of the persons engaged in the routine of and the forms and records required for
budgetary control. CIMA

A budget manual set out the principles of budgetary control, organizational chart, responsibility and authority of each manager,
method of accounting and control of expenditure, explanation of the key budgets, purpose and specimen for reporting and time table.

• Budget controller

Generally in a big concern, full-time budget controller is appointed, who is responsible for the preparation of the budget,
coordinating the activities of various departments and proper administration of budgeting control system.

• Budget report

Performance evaluation and reporting of variances is an integral part of control systems; therefore, a budget report should be
prepared so that it reveals the responsibility of the executives and departments. It should also highlight the reasons for the variances so
that the corrective action may be taken if it is necessary.

A budget report should be simple, promptly presented and provide essential information required.
 FUNCTIONAL BUDGETS

• Sales Budget

It is a forecast of total sales, expressed in money or quantity or both. A sales forecast is the commencement of the budgeting
process. It is a statement of planned sales in terms of quantity and value to be achieved during the budget period. Factors to be considered
for sales forecast include past sales, sales report, business conditions, market analysis etc.

• Production budget

It is a forecast of production during the budget period. It is prepared in two parts, the production budget for the units to be produced
during the budget period and production cost budget related to the costs of producing those physical units. Factors considered for the
preparation of production budget include production plan, the capacity of the business concern, inventory policy, sales budget and the
management policy.

• Plant Utilization Budget

It includes the estimation of the capacity of the plant to meet the budgeted production; the plant capacity is expressed in terms of
working hours, weights or other convenient units of the plant facilities.
 FUNCTIONAL BUDGETS

• Production cost budget

It includes direct material cost, direct labour cost and manufacturing overhead. Thus, the production cost budget can be prepared
after the preparation of the direct material cost budget, labour cost budget and production overhead budget.

• Materials budget

It is an estimate of the requirements of raw material and components required for the manufacturing of products. This budget is
prepared by applying standard material usage rates.

• Labour cost budget

An estimate of different grade of labour required is ascertained, and Standard rates for each grade is set for the preparation of labour
cost budget.
 FUNCTIONAL BUDGETS

• Production expense budget

This budget includes the total estimated cost of each item of factory overhead, which includes indirect material, indirect labour and
indirect expenses.

• Administrative Expense Budget

It is the estimate of expenses of administrative activities carried out in an organization, which includes the formulation of policies,
administration and control of operating activities, director’s fee, managing directors’ salary, office lighting etc. It is normally fixed in
nature.
• Selling and distribution expense budget

It is the forecast of selling and distribution expenses and closely concerned with the sales budget. This budget includes salesman
salaries, commissions, transportation expenses, freight charges, warehousing, etc. to be incurred in the budget period.
 FUNCTIONAL BUDGETS

• Research and Development budget

The estimate of the cost to be incurred in the budget period for design, development and technical research for products.

• Capital expenditure budget

It represents the expenditure on fixed assets during the budget period which includes the expenditure to be incurred for acquisition
or modernization of buildings, machinery, land and intangible items like patents etc.

• Cash Budget

A Cash budget is the estimate of cash receipts from all sources and cash payments for all purposes. It shows the plan of payments
and receipts of the cash during the budget period. It also shows the monthly flow of cash and the level of cash. The cash budget highlights
the surplus or shortage position of the cash over the period. It can be prepared by using (a) Receipts and Payments Method or (b)
Adjusted Profit and Loss Method or (c) Balance Sheet Method.
 Cash Budget of ___________for the months________
Opening balance of cash (a) **
Receipts:
Cash sales **
Collection from debtors **
Dividend/interest received **
Sale of fixed assets **
Sale of investment **
Raising of loan **
Tax refund **
Other Capital/Revenue receipts **
Total (b) **
Payments:
Cash Purchase **
Payments to creditors **
Payment of wages **
Payment of expenses **
Interest **
Dividend **
Purchase of fixed assets **
Purchase of investments **
Repayment of loans **
Total (c) **
Surplus/Shortage (b - c) = (d) **
Closing balance of cash (a + d) **
 MASTER BUDGET

• A master budget is the summary of the various functional budgets.

• It is also called a summary budget; it combines all the budgets for a period in one unit and shows the

overall budget plan.

• The summary budget incorporating its components functional budgets and which is finally approved,

adopted and employed. CIMA

• Master budget is prepared by the budget committee based on the coordinated functional budgets and

become the target for the company during the budget period.

• It summarizes functional budgets to produce a budgeted profit and loss account and balance sheet.
 FIXED AND FLEXIBLE BUDGETS

• On the basis of capacity, budgets are classified into the fixed and the flexible budget, these are prepared

based on activity level or utilization of capacity.

• Fixed budget is the budget, which is designed to remain unchanged irrespective of the volume of output

attained. It is based on the assumption that there will be no change in the budgeted activity level. It is
prepared for a fixed or standard volume of output and also called a rigid or static budget.

• As per CIMA terminology, Flexible budget is defined as a budget, which by recognising the difference in

behaviour between fixed and variable costs in relation to the fluctuations in output, turnover, or other
variable factors such as the number of employees, is designed to change appropriately with such
fluctuations.
BASIC BUDGET, CURRENT BUDGET, LONG TERM BUDGET AND SHORT TERM BUDGET

• A basic budget is a budget, which is prepared for use over a long period of time, it does not take into consideration of

current conditions and can be attainable under standard condition.

• A Current budget is a budget which is related to the current condition and is prepared for use of a short period of

time.

• The Long term budgets are prepared for the period longer than a year. It helps in business forecasting and forward

planning.

• Short term budget is prepared for a period less than a year and is very useful to lower levels of management for

control purpose.
 ZERO BASE BUDGETING
• A method of budgeting where preparation of budget starting from zero or a clean state.

• Conventional budget is generally prepared based on previous year information, which is taken as a base to start, and

prepared by giving attention to the changes from the previous year. It is also known as an incremental approach to
budgeting.

• Zero-based budgeting is not based on an incremental approach and the previous year figures.

• CIMA defined the Zero base budgeting “as a method of budgeting whereby all activities are evaluated each time a

budget is set.”

• It has several advantages such as it focuses on management decision making and analysis by reviewing the activities

every time when the budget is prepared.

 PERFORMANCE BUDGETING

• Performance budgeting relates to greater management efficiency; it is a budgetary system where input costs are

related to the performance at the end of the budget period.

• Performance budget represents the purposes and objectives for which funds required, the cost of the programmes

proposed for achieving those objectives and the quantities data measuring the accomplishments and work performed
under each programme. ICAI

• Performance budgets prepared in a way so that the items of expenditure related to the specific responsibility centre

closely linked with the performance.

• It presents an estimate for expenditure and incomes in terms of functions, programmes, activities and projects.
• Budgets are based on estimates

• It is not a substitute for management; it is a managerial tool only.

• Cooperation is required for the implementation of budgets.

• It is an expensive technique

• Danger of rigidity

• Overestimation of the costs may occur

• Revision of budgets due to changing conditions.

 Cash budget of three months - July 2016 to September 2016 (₹)
Pariculars July August September

Opening balance (a) 25000 57500 96500

Receipts:
Cash sales 140000 152000 121000
Collection from debtors:
Current month 36000 63000 54000
Previous month 47500 38000 66500
Total (b) 223500 253000 241500
Payments:
Cash purchases 17000 24000 18000
Payment to creditors 144000 153000 216000
Other expenses 20000 22000 21000
Salaries and wages 10000 10000 10000
Interest 5000
Total (c) 191000 214000 265000
Surplus/Shortage (d=b-c) 32500 39000 (23,500)
Closing balance (a+d) 57500 96500 73000
• Standard cost
A predetermined cost based on the technical estimates for materials, labour and overhead for a selected period of time
and under specified working conditions. It is set to provide a bases for control through variance analysis and in some cases for
fixation of the selling price.
Standard cost is defined by CIMA terminology as “planned unit cost of a product, component or the service produced
in a period. It may be determined on a number of bases, and its main use is in performance measurement, control, stock
valuation and establishment of the selling price.”

• Standard costing
Standard costing is the preparation and use of standard costs, their comparison with actual costs and the analysis of
variances to their causes and points of incidence. CIMA
The standard costing techniques comprise of ascertainment of standard cost, comparison of standard cost and actual
cost and controlling cost by evaluating reasons of variances and reporting to the management to take remedial action if it is
necessary.
 Advantages of Standard Costing  Limitations of Standard Costing
• It establishes yard-sticks for the comparison of actual cost with
• It is an expensive technique, standards are set
standard cost
• It can be used for the purpose of the valuation of the stock.
scientifically and requires high technical skills.

• It helps in fixation of price. • Establishment of the standard is difficult in practice.

• It also helps in predicting future costs.
• Requirement for frequent revisions may occur to
• It serves as a basis for measuring performance.
changing conditions.
• It provides a basis for incentive and thus helps in increasing
efficiency. • It is not suitable for non-standardized products.
• It helps in exercising effective cost control.
• Sometimes standard may create adverse psychological
• It aids in planning, budgeting and decision making.
effects, for example, if the standard set at a high level,
• It optimizes the use of resources such as working capital, current
assets. non-achievement may adversely affect efficiency.
• Remedial action can be initiated by following ‘Management by
exception’ principle.
• It aids in interim profit measurement.
The Preliminaries of the setting of standards comprises of following steps.

• Establishment of cost centers

It is the first step required before setting a standard.

• Classification of accounts

Different items of expenses are classified under suitable accounting headings.

• Types of standards

• The basic standard is established for use over a long period of time and from which current standards can be derived. This

standard is applied in the industry where only a small range of products are produced, and long term planning is required.
Since the conditions are changing in the business, this standard may become obsolete and are not realistic.

• The current standard is established for the use of over a short period of time, and it considers the current conditions of the

business.
 • Ideal standard can be attended under the most favourable conditions. This standard is based on maximum efficiency

under most favourable conditions and very difficult to attain.

• Expected or Attainable Standard, “a standard which can be attained if a standard unit of work is carried out

efficiently, a machine properly operated or a material properly used. Allowances are made for normal losses, waste
and machine downtime.” CIMA

• Setting of standards

• The success of the standard costing depends upon the establishment of correct standards. The standard cost is

determined for each element of costs (direct materials, direct labours and overheads).

• Standards for direct material costs

• Quantity standards for material used for the production and can be set by considering quality, size, material-grade, historical

data, technical estimates, test run and experiments, standard bills of materials, etc.

• Price standards can be established by analysing the factors such as price prevailing in the past, current price, market trends and

experience of similar concerns.

• Standard cost of material = Standard Quantity (SQ)  Standard Price (SP)

• Standards for direct labour cost

• Time standards, refer to the time which a worker should take to complete a job, can be set by taking into consideration of time

and motion studies; trail runs, the technical estimates, the experience of similar concern, standardization of products etc.

• Rate standards can be established by analysing the grades of labour required, current market rates and trends, minimum wage

rate policy etc.

• Standard cost of labour = Standard Hours (SH)  Standard Rate (SR)

• Standards for overhead

• Overheads are segregated into the fixed and variable overhead. By analysing the standard level of activity, the standard overhead

rate can be determined.

• Standard variable overhead rate =

• Standard fixed overhead rate =

 Standard Costing Budgetary Control
It is a technique of cost accounting, where standard costs It is planning exercise, where budgets are used for the
are used for variance analysis and control of the cost. analysis of actual performance and budgeted performance.
Standard cost is set scientifically in respect of each element Budgets are based on historical data or past performance
of cost based on engineering and technical data. with the adjustment to the future anticipated changes.
Standard is a unit concept. Budget is a total concept.
It may be expressed in quantity as well as in monetary terms It is mainly expressed in monetary terms.
Standards are minimum targets to be attained. Budgets are the ceilings or limits of expenses above which
the actual expenditure should not usually rise.
It deals with the manufacturing of a product, the process of It deals with the operations of a department of a business as
providing a service. a whole.
Standard costs are a projection of cost account. Budgets are the projection of financial account.
It requires the standardization of products. It does not necessarily involve standardization of products.
It concerned with the cost control and intensive in scope. It concerned with the operation of a business as whole and
extensive in scope.
• Variance refers to the deviation of the actual cost or profit or sales from the standard cost or profit or sales.

• When actual cost is less than the standard amount of cost, the deviation is known as favourable variance, and the
opposite is termed as an adverse variance.

• Variance analysis refers to analysis of performance in terms of variances in a standard costing system.

• Analysis of variances is done for each element of cost, and sales and profit. These are as follows
• Material variances

• Labour Variances

• Overhead variances

• Sales Variances and

• Profit variances.

In terms of sales and profit variances, if actual sale or profit is more than the standard or budgeted sale of profit, it is
favourable variance.
• Material variances are the difference between the total standard cost of material and the total actual cost of materials; it may be caused by many
reasons such as improper handling of materials, changes in price, changes in freight, changes in quality etc.

MCV = (SQ  SP) –(AQ  AP)

MPV= AQ (SP- AP) MUV = SP (SQ-AQ)

MMV = SP (RSQ – AQ) MYV= SCO (AY –SY)

• Where MCV = Material Cost Variance, MPV = Material Price Variance, MUV = Material Usage Variance, MMV= Material Mix Variance, MYV = Material Yield Variance

• SQ = Standard Quantity, AQ= Actual Quantity, SP= Standard Price, AP= Actual Price, RSQ =Revised Standard Quantity, SCO= Standard Cost of output per unit, SY= Standard
Yield, AY= Actual Yield.

• RSQ = Standard Proportion  Total Actual Quantity, Standard Proportion =

• Labour variance is also called the wages variance is the difference between the total standard cost of labour for actual output and the actual cost of labour

employed. It may be caused by employing different grades of labour, changes in wage rate, working conditions, use of non-standard materials etc.

LCV = (SH  SR) –(AH  AR) (standard hour for actual output is calculated)

LRV= AH (SR- AR) LEV = SR (SH-AH)

LMV = SR (RSH – AH) ITV= SR  IH LYV= SCO (AY –SY)

• Where LCV = Labour Cost Variance, LRV = Labour Rate Variance, LEV = Labour Efficiency Variance, LMV= Labour Mix Variance, ITV = Idle Time Variance and LYV = Labour
Yield Variance

• SH = Standard Hour, AH= Actual Hour, SR= Standard Rate, AR= Actual Rate, RSH =Revised Standard Hour, SCO= Standard Cost of output per unit, IH= Idle Hour, SY= Standard
Yield, AY= Actual Yield.

• RSH = Standard Proportion  Total Actual Hour, Standard Proportion =

 COST AND MANAGEMENT ACCOUNTING (BBAH-3.5)
Objective: The objective of this course is to acquaint the students with different methods and technique
of cost. This will enable the students to apply costing principles to evaluate the cost of a particular
job/process/contract and it will further enable them to compare the actual with the largest to know the
deviation/discrepancy if any and to take appropriate measures to minimize cost.
UNIT-I:
Overview of Cost Accounting, Concepts and practices. Difference between Cost Accounting and
Financial Accounting, Cost Accounting and Management Accounting, Management Accounting: Scope,
Objects and Functions and Limitations of Management Accounting, Tools and Techniques of
Management Accounting
UNIT-II:
Classification of Cost, Cost Center and Cost Unit, Preparation of cost sheet, Allocation and
Absorption of Overhead, Preparation of Labour hour mate & Machine hour mate.
UNIT – III:
Marginal Costing and Cost - Volume Profit Analysis.
UNIT – IV:
Job, Contract and Process costing.
UNIT – V:
Budgetary Control, Standard Costing and Variance Analysis.
References
1 Cost Accounting,S.. P. Jain & K.L. Narang,Kalyani Publishers.
2. Nigam B.M.L. & Jain, I.C., Cost Accounting. An Introduction, PHI.