INTRODUCTION TO COST & MANAGEMENT ACCOUNTING

Meaning and Definition Objective of Cost Accounting System Scope of Cost Accounting
Ascertainment of Cost: objective of Costing: Costing is the technique
Cost-The amount of expenditure cost accounting is accumulation and of ascertaining costs using some
attributable to a specified article, ascertainment of cost for each cost arithmetical process
Cost Accounting: it is a formal
product or activity. object.
mechanism of cost ascertainment
Costing- It is the technique and Determination of Selling Price: cost Cost Analysis: process of finding
process of ascertaining costs. accounting system provides a basis out the factors responsible for
for price fixation and rate variance and accordingly fixation
Cost Accounting- the process of of responsibility for cost
negotiation. differences.
accounting which begins with the
Cost Control:. It ensures that Cost Control: Identifying ways of
recording of income and expenditure expenditures are in consonance with reducing and controlling cost.
and ends with periodical statements predetermined set standard
cost is analyzed to whether
further cost reduction is
and reports. Assisting management in decision possible.
Cost Accountancy the application of making: It assists management in Cost Reports: Reports are
planning, implementing, measuring, prepared for the use by the
costing and cost accounting principles,
controlling and evaluation of various management which helps in
methods and techniques . planning and control,
activities
Management Accounting the performance appraisal and
Cost Reduction: It is permanent managerial decision making.
application of the principles of reduction in the unit cost without Statutory Compliances:
accounting and financial management impairing the quality of the product. Maintaining cost accounting
Cost Management- It is an application Can be done using value chain analysis records as per the rules

of management accounting concepts to & continuous research

MT- Aftr cost accounting is
MT - Selling price are set aftr ascertaining cost thn
plan, monitor and control costs. decision are taken for cost control & Reducn
analysed, compared & controlled th
statutory report is presented
 User of Cost Accounting System Essentials of Good Accounting System

Internal User External User Informative and simple: It should be practical, simple and capable of
meeting the requirements of a business concern.

Accurate and authentic: The data to be used by it should be accurate

Regulatory and authenticated Uniformity and consistency: It is required for
Manager Authorities benchmarking and comparability of the results of the system

Integrated and inclusive: It should be integrated with other systems

like financial, taxation & statistics etc. to have a complete overview
Auditors and clarity in results.
Operational
Flexible and adaptive: It should be flexible enough to make
Level Staff
amendment and modifications
Shareholder
Trust on the system: Management should have trust on the system
Employees and its output.
Creditor &
Lenders
MT- Simple & Flexible sys helps in maintaining Consistent
Integrated Trust

Classification of Cost

By Nature or By Variability By By Cost for

By Functions By Normality
Element or Behavior Controllability Decision Making

1.3
 CHAPTER-2 MATERIAL COSTING
Direct Materials cost of which can Material Procurement Procedure Duties of storekeeper
be directly attributable to the end • He should keep control over all
product for which it is being used, in an activities in Stores department.
economically feasible way. • He should ensure that all the
Indirect Material: The materials materials are stored in a safe
which are not directly attributable to a condition.
particular final product. • He should maintain proper
record of quantity received,
issued, balance in hand.
Requirement of Material Control • He should issue materials only
against the material requisition
• Purchase Procedure: For slip approved by the authority.
determine purchases are made,
after making suitable enquiries, at JIT Inventory Management
the most favourable terms to the
firm. JIT is a system of inventory
management with an approach to
• Documentation: Use of standard
have zero inventories in stores.
forms for placing the order, noting • Demand for final product.
receipt of goods, authorising issue • Production starts to process the
of the materials etc. demand for product.
• Storage: of all materials and • Material Requirement is sent to
Purchase department.
supplies in a well designated • Order for raw materials sent to
location with proper safeguards. supplier.

2.1 CA Harshad JAJU

 Weighted Average Method
ABC Analysis Last in First Out Method
This system exercises discriminating This method is based on the assumption This method gives due weightage
control over different items of inventory that the items of the last batch (lot) to quantities. Issue price is
on the basis of the investment involved. purchased are the first to be issued. calculated dividing sum of products
Advantages of ABC Advantages of price and quantity by total
• It ensures that, minimum investment • The cost of materials issued will be number quantities.
will be made in inventories of stocks to either nearer to and or will reflect the Advantages
be carried. current market price. • It smoothens the price
• The cost of placing orders, receiving • The use of LIFO helps to iron out the fluctuations if at all it is there
goods and maintaining stocks is fluctuations in profits. due to material purchases.
minimised. • In the period of inflation LIFO will • Issue prices need not be
• Attention Required tend to show the correct profit. calculated for each issue unless
• Time is saved since attention need be Disadvantages new lot of materials is received.
paid only to some of the items rather • Costs of different similar batches of Disadvantages
than all. production carried on at the same time • Material cost does not
may differ a great deal. represent actual cost price and
• This method of valuation of material is therefore, a profit or loss will
First in First Out Method arise out of such a pricing
not acceptable to the income tax
The materials are issued in the order in authorities. method
which they arrive in the store or the
items longest in stock are issued first. Simple Average Method
Advantages
• Simple to understand and easy to Materials issued are valued at
operate. average price, which is calculated
• Cost charged to production represents by dividing the total of rates at
actual cost. which different lot of materials are
• Closing stock of material will be purchased by total number of lots.
represented very closely at current In this method quantity purchased
market price. in each lot is ignored.

2.2 CA Harshad JAJU

 CHAPTER 3-EMPLOYEE COST AND DIRECT EXPENSES
Direct Employee Cost Indirect Employee Cost Collection of Employee Cost
• Payment of employees • Payment of employee It is the duty to analyse the total payment of
who are directly who are not directly wages of each department into:
engaged in the engaged in the The amount treated as-
production process. production process. • direct cost = goods produced
• Easily identified and • Apportioned on some • indirect employee = overheads
allocated to cost unit. appropriate basis • cost of idle time = loss.
• Varies with the volume • May not vary with the • abnormal loss/ gain t/f profit and loss
of production. volume of production. account.

EMPLOYEE
COST
Important Factor to control
CONTROL Employee Cost
• Assessment of manpower requirements.
Engineering and
Personnel Time-Keeping • Control over time-keeping and time-
Work Study
Department Department booking.
Department
It searches for Supervises Concerned with • Time & Motion Study.
the required skills production the maintenance • Control over idle time and overtime.
and qualification. activities. of attendance • Control over employee turnover.
• Wage and Incentive systems.

3.1
 Normal Idle Time
IDLE TIME
The time during which no production is Treatment
• Causes
carried-out because the worker remains The time lost b/w factory gate It is treated as a part of cost
idle but are paid. and the place of work. of production.
• Idle time can be normal or abnormal. The interval between one job In case of indirect workers,
and another. normal idle time is considered
• Eg-paid leaves, allowable rest or off
The setting up time for the for the computation of
time etc.
machine. overhead rate.
Normal rest time, break for
Overtime lunch etc.
Work done beyond normal working hours is
known as ‘overtime work’. Abnormal Idle Time
Overtime Payment = Wages paid for overtime Treatment
Causes
at normal rates + Premium (extra) payment It is shown as a separate
Idle time may also arise due
item in the Costing P&L.
to abnormal factors. It should be further
Overtime Premium Power failure, Breakdown of categorised into
The rate for overtime work is higher than machines controllable &
the normal time rate; usually it is at double Non-availability of raw uncontrollable.
For each category, the
the normal rates. The extra amount so paid materials, strikes, lockouts, break-up of cost due to
over the normal rate is called overtime poor supervision etc. various factors should be

Controllable & Uncontrollable idle time

It refers to that time It refers to time lost due to
which could have been put abnormal causes, over which
to productive use had the management does not have
management been more any control e.g., breakdown
alert and efficient. of machines etc.

3.2
 Causes & Treatment of overtime premium
Advantages of Rowan
Causes Treatment • It is claimed to be a fool-proof
The customer may agree to bear the If overtime is resorted to at the system in as much as a worker can
entire charge of overtime because desire of the customer, then never double his earnings even if
urgency of work. overtime premium may be charged to there is bad rate setting.
Overtime may be called for to make up the job directly. • It is admirably suitable for
any shortfall in production due to some It should be treated as overhead encouraging moderately efficient
unexpected development. cost of the particular department or workers as it provides a better
Overtime work may be necessary to cost centre which works overtime. return for moderate efficiency
make up a shortfall in production due If overtime is worked due to the than under the Halsey Plan.
fault of another department. It • The sharing principle appeals to the
to some fault of management.
should be charged to the latter employer as being equitable.
Overtime work may be resorted to,
secure an out-turn in excess ofe department.
normal output to take advantage of an It should not be charged to cost, but Disadvantages of Rowan
expanding market or of rising demand. to Costing Profit and Loss Account.
• The system is a bit complicated.
• The incentive is weak at a high
production level where the time
Advantages of Halsey Disadvantages of Halsey
saved is more than 50% of the time
• Time rate is guaranteed while there • Incentive is not so strong as allowed.
is opportunity for increasing with piece rate system. In fact • The sharing principle is not generally
earnings by increasing production. welcomed by employees.
the harder the worker works,
• The system is equitable in as much the lesser he gets per piece.
as the employer gets a direct return • The sharing principle may not be
for his efforts in improving prodn liked by employees.
methods and providing better
equipment.

3.3
 CHAPTER – 4 OVERHEADS – ABSORPTION COSTING METHOD

CLASSIFICATION By Element
OF OVERHEADS

Indirect Materials which do not normally

form part of the finished product
Materials
are known as indirect materials.

By Function By Element By Nature Indirect which cannot be allocated but can

Employee Cost be apportioned to or absorbed by
cost units.

Which cannot be directly,

By Function Indirect conveniently and wholly allocated
Expenses to cost centres.
Factory or all expenditures incurred from the
Manufacturing or
Production OH
procurement of materials to the
By Nature
completion of finished product.

which is not related directly to They do not tend to increase or

Office and Fixed
Administrative production, selling, distribution, decrease with the changes in
research or development activity. Overhead output.
Overheads

Selling and It includes all indirect expenses in

Distribution Variable These costs tend to vary
sales management for the organization
Overheads & making product available for sale. Overhead with the volume of activity.

These costs contain both

components & are partly
Semi-Variable affected by fluctuations in the
Overheads level of activity.

4.1 CA Harshad Jaju

 ACCOUNTING AND CONTROL OF MANUFACTURING OH The process of assigning service
Re- department OH to production
departments is called re-
Apportionment
factory overhead rates are estimated and apportionment. Here all the factory
overheads are collected under
overheads absorbed at last show how actual are production departments.
compared with the absorbed amount. Each unit of production automatically
absorbs a certain amount of factory
Absorption overheads through pre-determined
rates.During the year a certain amount
Distinction Between Various Terms Used: will be absorbed over the various
products.

Estimation and The first stage is to estimate the amount of The overheads are generally either
Treatment of
Collection of overheads, keeping in view the past figures and under-absorbed or over-absorbed. The
adjusting them for known future changes. Over and Under
OH difference has to be adjusted keeping in
Absorption view of such differences and the reasons
therefore.
Assignment of It is the traceability of the overheads to a
OH cost object in an economically feasible
manner.
Basis of
It refers to the direct assignment of cost apportioning OH
Cost Allocation
to a cost object which can be traced
directly.

Cost OH which cannot be directly allocated to the

various departments & cost centres. Such un-
Analysis or survey of Efficiency
Apportionment Ability to pay.
allocable expenses are to be spread over the existing conditions or incentive.
various departments.

4.2 CA Harshad Jaju

 Difference Between Allocation and Apportionment Reciprocal Service Method

Allocation Apportionment
Simultaneous equation method: The costs of
Allocation deals with the Apportionment deals with the service departments are ascertained. then re-
whole items of cost, which proportions of an item of cost, distributed on the basis of given percentages.
are identifiable with any Apportionment is an indirect
Trial and Error Method: The cost of one
one department. process because there is a need
service cost centre is apportioned to another
Allocation is a direct process for the identification of the service cost centre. The cost of another
of charging expenses to appropriate portion of an expense service centre plus the share received from
different cost centers. to be borne by the different the first cost centre is again apportioned to
Allocation is a much wider departments benefited. the first cost centre. This process is repeated
term than apportionment. This is narrower than Allocation. till the amount to be apportioned becomes
negligible.

Repeated Distribution Method: Service

Direct Re- Service department costs under this method are apportioned departments’ costs are distributed to other
over the production departments only, ignoring the services service and production departments on
distribution
rendered by one service department to the other. agreed percentages and this process
Method
continues to be repeated, till the figures of
service departments are either exhausted or
Non – It gives cognizance to the services rendered by service
reduced to too small a figure.
department to another service department. this method is
Reciprocal
more complicated bcz a sequence of apportionments has to be
Method selected here.

Method of Absorbing Overhead to various products or job

Percentage of Percentage of Prime Percentage of Labour/Machine Rate per Unit of

Direct Material Cost Labour Cost Hour Rate Output

4.3 CA Harshad Jaju

 CHAPTER-5 COST SHEET
Prime Cost Cost of Production Cost of Goods Sold
Prime cost represents the total of direct In a conventional cost sheet, this item It is the cost of production for goods
materials costs, direct employee costs and of cost can be seen. It is the total of sold. It is calculated after adjusting
direct expenses. The total of cost for each prime cost and factory related costs the values of opening and closing
element has to be calculated separately. stocks of finished goods.
and overheads.

Cost of Sales Packing Cost Administrative OH

Primary-Packing material which is essential to Production- It includes the cost of
It is the total cost of a product incurred
to make the product available to the hold and preserve the product for its use. production administration only.
customer or consumer. It includes Cost Sales- It is the cost related with
Secondary-Packing material that enables to
of goods sold, administration and
store, transport make the product marketable. General & administration of the entity.
marketing. expenses.

Advantages of Cost Sheet

(i) It provides the total cost figure.
(ii) It helps in cost comparison.
(iii) Facilitates preparation of cost estimates.
(iv) Help in arriving at the figure of selling price.
(v) Facilitates cost control.

5.1 CA Harshad Jaju

 CHAPTER – 6 Cost Accounting System
NON-INTERGRATED ACCOUNTING SYSTEM INTERGRATED ACCOUNTING SYSTEM

It is a system of accounting under which separate It is system of accounting where cost and financial
ledgers are maintained for cost and financial accounts. accounts are kept in the same set of books.
No separate sets of books for Costing and Financial
Cost • This is the principle ledger of the cost records.
Ledger department in which impersonal
accounts are recorded. Advantages
Stores • It contains an account for each item of No Need for The question of reconciling
Ledger stores. Reconciliation costing profit and financial profit
• The entries in each account maintained does not arise, as there is only
in this ledger are made from the one figure of profit.
invoice, GRN, MRN etc.
Less Efforts Due to use of one set of books,
Work – in • This ledger is also known as job ledger,
there is a significant saving in
– Process it contains accounts of unfinished jobs
Ledger and processes. efforts made.
• All material costs, wages and overheads Less time No delay is caused in obtaining
for each job in process are posted to consuming information as it is provided from
the respective job account in this books of original entry.
ledger.
Economical It is economical also as it is based
Finished • It contains an account for each item of on the concept of “Centralisation
process
Goods finished product manufactured or the
of Accounting function”.
Ledger completed job.

6.1 CA Harshad Jaju

 RECONCILIATION OF ACCOUNTS Features of integrated
When the cost and financial accounts are kept • Complete analysis of cost and sales are
separately, it is imperative that those should be kept.
reconciled; otherwise the cost accounts would not
• Complete details of all payments in cash
be reliable.
are kept.
Reconciliation of the balances generally, is possible • Complete details of all assets and
preparing a Memorandum Reconciliation Account. In this
account, the items charged in one set of accounts but not
liabilities are kept and this system does
in the other or those charged in excess as compared to not use a notional account to represent
that in the other are collected and by adding or all impersonal accounts.
subtracting them from the balance of the amount of
profit shown by one of the accounts, shown by the other
Procedure for Reconciliation
can be reached.
• Ascertainment of profit as per financial accounts.
The procedure is similar to the one followed for • Ascertainment of profit as per cost accounts.
reconciling the balance with a bank that shown by the cash • Reconciliation of both the profits (similar to the bank
book or the ledger. reconciliation statement).

6.2 CA Harshad Jaju

 CHAPTER – 7 ACTIVITY BASED COSTING
Meaning of Important Terms Advantages of ABC
Activity Based Costing is an accounting methodology that • It enables better pricing policies by supplying accurate cost information.
assigns costs to activities rather than products or • Help to identify non-value added activities which facilitates cost
services. reduction.
• It highlights problem areas which require attention of the management.
Activity refers to an event that incurs cost.
• More accurate costing of products/services.
Cost Object is an item for which cost measurement is • Overhead allocation is done on logical basis.
required e.g. a product or a customer.
Disadvantages of ABC
Cost Driver is a factor that causes a change in the cost of
• It is not helpful to small Organization.
an activity.
• Selection of most suitable cost driver may not be useful.
Cost Pool represents a group of various individual cost • It may not be applied to organization with very limited products.
items. It consists of costs that have same cause effect • It is more expensive particularly in comparison with Traditional costing
relationship. system.

ABC Method ABC Method Activity Based Budgeting

Overheads are related to Overheads are related to It provides a framework for estimating the amount of resources
activities and grouped into activities and grouped into required in accordance with the budgeted level of activity.
activity cost pools. activity cost pools.
Benefits of ABB
Costs are related to activities Costs are related to activities It can enhance accuracy of financial forecasts and
and hence are more realistic. and hence are more realistic.
increasing management understanding.
Activity–wise cost drivers are Activity–wise cost drivers are ABB eliminates much of the needless rework created by
determined. determined. traditional budgeting techniques.

7.1 CA Harshad Jaju

 CHAPTER-8 UNIT & BATCH COSTING

Batch Costing
2. When customer’s annual requirement
Unit Costing is to be supplied in uniform quantities
over the year.
Concept- Single/ output / unit Batch- Where the output of the
3. When certain features like size, colour,
costing is applied in situation job consists of homogeneous taste, quantity etc. are required
where standardized product(s) is (similar) units, a lot (or) collection uniformly over a collection of units.
/ are produced from a single of similar units may used as a cost
process. In other words, Output is unit for ascertaining cost. Such EOQ
identical, and each unit of output lot or collection of units is called Meaning- Economic Batch
requires identical cost. as a batch. Quantity (EBQ) represents
the optimum size for batch
Examples- Unit Costing Method is Batch Costing- It is a form of Job
production, at which the
applied in industries which produces costing, wherein cost is ascertained
total of set – up costs per
single output or a few variants of a for a collection/ lot of units called a
annum, and Inventory
single output. Ex. Quarries, batch. Separate cost sheet are
Carrying Costs per annum,
Brickworks, colliery, paint maintained for each batch of are minimum.
manufacturing, etc. products by assigning a batch
If batch size increases,
number.
Focus Area- The primary focus there is an increase in the
area is on the preparation of cost Batch costing may be used in the carrying cost but the set up
sheet for the product. following circumstances- cost per unit of product is
1. When the output of a job consists reduced, this situation is
Costing- The principles of
of a number of dependent units. reversed when the batch
cost ascertainment are the
size decreases.
same as applicable for job
costing.
8.1 CA Harshad JAJU
 CHAPTER-9 JOB & CONTRACT COSTING

Job Costing Contract Costing

A Job refers to any specific assignment, Contract costing is a form of specific order costing where job
contract or work order wherein work is undertaken is relatively large and normally takes period longer than
executed as per customer’s specific a year to complete.
requirements. The output of the job generally Cost Plus Contact- where the value of the contract is determined
consists of one unit or a manageable number by adding an agreed percentage of profit to the total cost.
of units. Ascertainment of cost of each Job is Advantages
called Job Costing. • The Contractor is assured of a fixed percentage of profit.
Advantages
• It is useful when the work to be done is not definitely fixed at
• Helps in Cost Ascertainment & ensure the time of making the estimate.
Profit.
• Contractee can ensure himself about ‘the cost of the contract’.
• Aids Production Planning and Control.
• Easy to implement Budgetary Control and Escalation Clause
Standard Costing. It empowers a contractor to revise the price of the contract in
case of increase in the prices of inputs. Inclusion of such a clause
Disadvantages
in a contract deed is called an “Escalation Clause”.
• Time consuming, costly and laborious
clerical process.
• Higher possibilities of errors in job Cost
Estimates.
• Not suitable for long term work, or in
inflationary situations.

9.1 CA Harshad Jaju

 CHAPTER – 10 PROCESS & OPERATION COSTING
Inter-Process Profit Opreation Costing
Process Costing
It is defined as “a method of Cost • It is used when an entity produces
more than one variant of final
Accounting whereby costs are charged to The difference between cost and
product using different materials but
processes or operations and averaged over the transfer price is known as
with similar conversion activities.
units produced”. inter-process profits.
• It is also known as Hybrid product
costing system.
Features
• Moreover, under operation costing,
• The output of one process becomes the conversion costs are applied to
Advantages
input of another process. products using a predetermined
• Comparison between the cost application rate.
• The end product is not distinguishable
of output and its market price • This predetermined rate is based on
from one another. budgeted conversion costs.
at the stage of completion is
• It is not possible to trace the identity facilitated. • The cost of raw material is
of any particular lot of output. • Each process is made to stand accumulated on the basis of job or
• Production of a product may give rise to by itself as to the batches or units of two variants of
Joint and/or By-Products. profitability. products. But the costs for the
conversion activities need not to be
Disadvantages identified with the product variants
as both the Products require similar
• The use of inter - process
activities for conversion.
profits involves complication.
• Conversion activity costs are
• The system shows profits
accumulated on the basis of
which are not realised because
departments or processes only.
of stock not sold out.

10.1 CA Harshad Jaju

 CHAPTER – 11 Joint Product

Joint Product: Two or more product(s), Method of Joint Cost Apportionment

Produced from the same process or operation,
considered to be of relatively equal importance. Physical Quantities Method: Joint Costs are
apportioned on the basis of physical quantities, such as
Co-Product: Two or more product, belonging weight or measure expressed in gallons, tonnes,
to the same line of activity, but arising from kilograms, litres etc. Any loss arising in processing is also
different processes or operations, considered apportioned over the products on the same basis.
to be of relatively equal importance.
Disadvantages: It gives equal importance and value to all
By- Product: “products recovered from the joint products, if the quantities were the same.
material discarded in a main process, or from This method cannot be applied if the physical quantities
the production of some major products, where of the Joint Products are measured differently, e.g. one
the material value is to be considered at the product in kilograms and the other product in liters.
time of severance from the main product.”
Average Cost Method: Under this method, Total Joint
Costs up to the split off point are divided by total units
Spilt off Point: refers to the stage or point of joint products produced. Costs are apportioned in the
of production, wherein common raw material ratio of quantities produced.
gets spilt or identified into two or more
Disadvantages: Here, all Joint Products will have uniform
Finished Products.
cost per unit. Relative importance is not considered.

11.1 CA Harshad JAJU

 CH-12 Operating Cost
Meaning: Operating Costing is the Standard Load • On the same principle,
method of ascertaining the costs of the Cost of Electricity
providing/ operating/ rendering a • Where the goods to be Generation is correlated
with units generated and
service.The principal of Operating transported are of varying bulk
also with units sold, and
Costing is to accumulate costs under and weight, the calculation of
similarly in Hospitals the
suitable heading and to express then actual number of Tonne – cost of their
in terms of number of units of kilometers may not be easy. maintenance is co –
service rendered. • In such a case, the ‘Standard related to units of
The factors that have a bearing on Load’ is selected as the unit, i.e. ‘Available Bed – Days’.
cost are identified based on study of the load which a Lorry would • This principle also can
technical and operating data. carry. This would have reference be extended for
associating cost with
both to bulk and weight and would
convenient units of
Absolute (Weighted Average) give an efficient method for
service rendered by an
Tonne – kilometres- This is the sum distributing the cost of transport Entity, so that
total of Tonne – kilometers, arrived over different departments. Management is able to
at by multiplying various distances by • Thus, if the Turnover of various judge whether the
respective load quantities carried. departments is reduced to the Entity is running
‘Standard Load’ by first efficiency and in the
Commercial (Simple Average)
calculating their weight and then manner in which the
Tonne – kilometres-It is derived by service requires to be
the bulk of article produced, the
multiplying total distance (i.e. improved or be made
costs of distributing the product
kilometers), by average load quantity more economical.
can be easily ascertained.
(Tons).
12.1 CA Harshad JAJU
 CHAPTER – 13 Standard Costing
STANDARD COSTING
Standard Cost is the pre – determined • Financial Standard: These are standards, which relate to
operating cost calculated from monetary factors of cost, i.e. Material Prices, Wage Rates, These
Management’s standards of efficient are also called Monetary Standards.
operation and the relevant necessary • Physical Standards: which relate to Material Consumption Quantity,
expenditure. Labour Processing Time, etc. may also be called Non – Monetary
• Uses of Standard Costs Standards.
1. Planning & Control: It provide a Problems faced while setting Physical Standards
benchmark, which serve two purpose
• When new products are manufactured for sale, material quality
– showing direction to the activities
requirements and labour skill requirement may not be accurately
of the Firm (planning) and analysing determined.
whether actual activities are in • Installation of new machines, for which estimation of output and
proper direction (control). standard of achievable efficiency is not possible.
2. Pricing Decisions: It facilitate • There may be various ways in which the materials can be processed.
pricing decisions as also for Each of these methods of work has different requirements.

decisions involving submission of Favourable Variance: Variances which lead to an increase in Profit
quotations, responding to tenders, are called Favourable Variances. Favourable Variances are credited
etc. to the P& L Account.
3. Inventory Valuation: It is used to Adverse Variance: Variances which lead to a decrease in Profit are
value Inventory, where actual called Adverse variance. Adverse Variances are debited to the P&L
figures are not available. Account.

13.1 CA Harshad JAJU

 Controllable vs Non-Controllable Variances Advantages of Standard Costing
• Measuring Performance: Standards provide a basis for
Controllable Variances: These can be
controlled / managed by the concerned measurement of actual performance.
Department Heads/ Responsibility • Cost Control: Adverse variances can be controlled and their
Centres. they may also be called as the recurrence avoided.
Operational Component of the Variance. • Price Fixing: where demand for a product is elastic, standard
Department Managers are appreciated cost can be used as a basis for fixing the selling price.
for Favourable Variances and answerable
• Quotations and Estimates: Standard Costing facilitates the
for Adverse Variances.
estimation of the cost of new products with greater accuracy.
Non – Controlled Variance: These are • Stock Valuation: Standard Costs represent normal cost and are
beyond the control of Department Heads ideal for Stock Valuation, when compared to actual costs.
/ Responsibility Centres. they may also
be called as the Planning Component of
Advantages of Standard Costing
the Variances. Department Managers
cannot be held responsible for • Variation in Price: The prices cannot be accurately estimated.
Favourable or Adverse Variances. Hence, the System cannot operate effectively in such
situations.
Budgetary Control • Varying level of output: Capacity utilisation cannot be precisely
estimated for absorption of overhead.
Budgets are financial and / or
• Changing technology: In light of frequent technological changes
quantitative statements, prepared and
affecting the conditions of production, standard costing may
approved prior to a defined period of
not be suitable.
time, of the policy to be pursued during • People’s Attitude: Technical people are accustomed to think of
that period for achieving that objective. standards as physical standards. so, they will be misled.

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 CHAPTER – 14 MARGINAL COSTING
PV Ratio is the relationship Limitation of BEC
Meaning
•
between Contribution and
• The Variable Cost line need not
Sales Value. It is also termed
• The effect on profit, of changes in volume or type necessarily be a straight line because
as Contribution to Sales Ratio.
of output, by differentiating between Fixed Costs of the possibility of operation of law of
• BEP is the level of Sales at increasing returns or law of decreasing
and Variable Costs is called marginal costing.
which Total Contribution returns.
• Direct Costing is the practice of charging all equals Fixed Costs. Hence, at • The Selling Price may be a constant
Direct Costs to operations, processes or products, that level, there is neither a factor. Any increase or decreases in
leaving all Indirect Costs to be written off against Profit nor a Loss to the Firm. output is likely to have an influence on
profits in the period in which they arise. • MOS represents the the Selling Price per unit.
• Differential Cost is “the increases or decrease in difference between the • The Break Even Chart assumes that
total cost or the change in specific elements of Actual Sales and Break – Even business condition will not change. This
cost that result from any variation in operations. Point Sales. It can be assumption is not realistic.
• Variable Cost is that portion of cost, which expressed as a percentage of
changes or varies proportionately based on output/ Total Sales, or in terms of Improvement in MOS
volume / quantity. quantity.
• Fixed Costs are costs which are assumed to • Indifference Point is the • Increases in Selling Price, provided the
remain constant, for a given period of time, demand is inelastic so as to absorb the
level of Sales at which Total
irrespective of level of output during that period. increased prices.
Costs of two options are equal.
• Reduction in Fixed Expenses.
• Cost Variance is the difference between • Shut Down Point indicates • Reduction in Variable Expenses
Standard Cost and comparable Actual Cost the level of operations (Sales), • Increasing the Sales Volume
incurred during a period. below which it is not • Substitution or introduction of a
• Expenses that exhibit features of Fixed and justifiable to pursue product mix such that more profitable
Variable Costs are Semi-variable cost. operations. lines are introduced.

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 Advantages of Marginal Costing Limitation of Marginal Costing
• Pricing Decision: Since Marginal Cost per unit is constant
from period to period within a short span of time, firm • Difficult to classify: It is difficult to exactly segregate
decisions on pricing policy can be taken. the expenses into Fixed and Variable category.
• Overheads Variances: Marginal Costing avoids under • Single Cost Driver: It assumes that the Output
recovery or over recovery of Fixed Overheads since these Quantity is the only Cost and Revenue Driver, which causes
costs are recognised as Period Costs. changes in the levels of Revenue and Costs.
• Break–Even Analysis: It shows the effect of increasing or • Contribution is not final: Contribution of a product
decreasing production activity on the profitability of the itself is not a guide for optimum profitability unless it is
Company. linked with the Key Factor.
• Control over Expenditure: Management can compare the • Naïve assumptions: Some assumptions regarding the
actual Variable Expenses with the budgeted Variable behaviour of Revenue and Costs are not necessarily true in
Expenses and take corrective action through Variance a realistic situation.
Analysis.

Areas Where Marginal Costing Technique is Used

• Determination of Selling Price: under normal circumstances, for special market or for a special customer, during recession,
at Marginal Cost or below Marginal Cost.
• Product Mix Decision: Selection of optimal product mix, Substitution of one product with another, Discounting or dropping of
a product line, etc.
• Shut – down or Continue Decision, or determination of output level in period of recession or depression.
• Marketing Decision Selling in the Domestic Market or in the Export Market, acceptance of Export Offers, etc.
• Change vs. Status Quo Retaining or replacing a Machine/ Process, etc.

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 CHAPTER-15 BUDGETARY CONTROL
Budget is a quantitative expression of a Features of Budget
plan for a defined period of time.
1. Scope: A Budget is a detailed Budgetary Control
1. It may included planned Sales Volume
plan of all the economic
and Revenue, Resource Quantities, a. Objectives: Determining the
activities of a Business.
Costs and Expenses, and Assets, objectives to be achieved, over
2. Futuristic: A Budget is
Liabilities and Cash Flows. the budget period, and the
concerned for a definite future
Budgeting means of – policy that might be adopted
period.
Co- ordinating the combined intelligence for the achievement of these
3. Written: A Budget is a written ends.
of an entire organisation, into a plan of
document. b. Activities: Determining the
action, Based on past performance, and
4. Co-operation: All the variety of activities that should
Governed by rational judgement of
Department of a Business Unit be undertaken for achievement
factors, that will influence the course of
co – operate for the of the objectives.
business in the future. c. Plans: Drawing up a plan or a
preparation of a Business
Essentials of Budget Budget. scheme of operation in respect
of each class of activity, in
5. Focus: Budget is a written
Clearly defined organizational structure. physical as well as monetary
document.
terms for the full budget period
Responsibility assigned to identifiable 6. Past and Present: Budget is and its parts.
units within the Entity. usually prepared in the light of d. Performance Evaluation: Laying
past experience, adjusted for out a system of comparison of
Commitment of entire organisation to
current trends. actual performance by each
budgeting. Setting of clear objectives person, section or department
7. Continuous and Flexible:
and reasonable targets. Budget should be updated, with the relevant budget and
corrected and controlled determination of causes for the
Objectives to be in tune with the Entity’s
discrepancies, if any.
Strategies and long term plans. whenever circumstances
1 change.

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 Advantages of Budgetary Disadvantages of Budgetary Control Fixed Budget
1. Control
Efficiency: It enables the 1. Estimates: Budgets may or may not Meaning: It is a Budget
Management to conduct its business be true, as they are based on designed to remain unchanged
activities in an efficient manner. estimates. The assumptions about irrespective of the level of
2. Resource Utilisation: Effective future events may or may not activity actually attained.
utilization of scarce resources, i.e. actually happen.
men, material, machinery, methods Merits
2. Rigidity: Budgets are considered as • Simple to understand.
and money – is made possible
rigid document. Too much emphasis • Can be quickly prepared.
through Budgets.
3. Cost Control: It is a powerful on budgets may affect day – to – • Variables and Sensitivity
instrument used by Firms to control day operations and ignores the Analysis not required.
their expenditure. dynamic state of organisational • Single Absorption Rate
4. Cost Consciousness: It inculcates functioning. avoids confusion.
the felling of cost consciousness 3. False Sense of Security: Mere Demerits
among workers and Managers. budgeting cannot lead to • Misleading since poor
5. Performance Evaluation: It profitability. Budgets cannot be performance may remain
provides a yardstick for measuring
executed automatically. It may undetected and a good
and evaluating the performance of
create a false sense of security performance may go
individuals and their departments.
6. Standard Costing: It creates that everything has been taken unrealized.
suitable conditions for the care of in the budgets. • Not suitable for long term
implementation of Standard Costing 4. Lack of co – ordination: Staff co – evaluation
System in the Firm. ordination is usually not available • Not suitable when
7. Variance Analysis: It reveals during Budgetary Control exercise. evironment conditions
deviations from the budgeted 5. Time and Cost: The introduction change constantly
figures after making a comparison and implementation of the system
with actual figures.
may be expensive.
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15.2 CA Harshad JAJU
 Flexible Budget
ZERO BASE BUDGETING
1. Meaning: It is Budget, which
Physical Budgets: Budgets that Meaning: It is an Expenditure Control
by recognising the difference
contain information in terms of Device where each Divisional Head has to
between fixed, semi – variable
physical units about sales, justify the requirement of funds for each
and variable costs, is designed
head of expenditure and prepare the
to change in relation to level production, etc. for example,
budget accordingly, without reference to
of activity. Quantity of sales, Quantity of
the past budget or achievements.
Merits Production, Inventories,
• Sales, Costs and profit can Advantages
Manpower Budgets.
calculate easily for various Priority Allocation: It provides a
Cost Budgets: Budgets which
levels of production capacity. systematic approach for the evaluation of
provide Cost Information in different activities and rank them in
• Change in business condition
respect of Manufacturing, order of preference for the allocation of
are considered and adjusted
suitably. Selling, Administration, etc. for scarce resources
Demerits example, Manufacturing Costs, Management by Objectives: The
• Useful only when a Standard Selling Costs, Administration technique can be used for the introduction
System is in use. Cost, R&D Cost Budgets. and implementation of the system of
• Time consuming, expensive Financial Budgets: A Budget, ‘Management by Objectives’
and labour oriented which facilitates to ascertain Disadvantages
preparation process the Financial Position of a Time Consuming: It is time consuming &
costly. It needs properly trained Personal
Profit Budget: Budgets that concern, for example, Cash
to do the required job.
enable the ascertainment of Budgets, Capital Expenditure
Lack of Adequate Data: ZBB requires
Profit, for example, Sales Budget, Budgeted Balance data for justifying the allocation of
Budget, Profit & Loss Budget, Sheet, etc. resources to various alternatives in every
etc. period. Sometimes, this data may not be
available for analysis.
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15.3 CA Harshad JAJU