‭Chapter 4‬

‭Budgets‬
‭4.1 Meaning of Budget, Budgeting‬

‭ .‬ B
1 ‭ udget is a quantitative expression of a plan for a defined period of time.‬
‭Budget‬ ‭2.‬ ‭It‬‭may‬‭include‬‭planned‬‭–‬‭(a)‬‭Sales‬‭Volumes‬‭and‬‭Revenues,‬‭(b)‬‭Resource‬‭Quantities,‬‭Costs‬‭and‬‭Expenses,‬
‭and (c) Assets, Liabilities and Cash Flows.‬
I‭ t is a means of –‬
‭●‬ c‭ o–ordinating the combined intelligence of an entire organisation,‬
‭ udgetin‬
B ‭●‬ ‭into a plan of action,‬
‭g‬ ‭●‬ ‭based on past performance, and‬
‭●‬ ‭governed by rational judgment of factors,‬
‭●‬ ‭that will influence the course of business in the future.‬

‭4.2 Different Types of Budgets‬

‭Particulars‬ ‭Fixed Budget‬ ‭Flexible Budget‬

I‭ t‬ ‭is‬ ‭a‬ ‭Budget,‬ ‭which‬ ‭by‬ ‭recognising‬ ‭the‬
I‭ t‬‭is‬‭a‬‭Budget‬‭designed‬‭to‬‭remain‬‭unchanged‬‭irrespective‬ ‭difference‬ ‭between‬ ‭fixed,‬ ‭semi–variable‬
‭(a)‬ ‭Definition‬
‭of the level of activity actually attained.‬ ‭and‬‭variable‬‭costs‬‭is‬‭designed‬‭to‬‭change‬‭in‬
‭relation to level of activity attained.‬
I‭ t‬ ‭does‬ ‭not‬ ‭change‬ ‭with‬ a
‭ ctual‬ v‭ olume‬ ‭of‬ ‭activity‬ ‭It‬‭can‬‭be‬‭re–casted‬‭on‬‭the‬‭basis‬‭of‬‭activity‬
‭(b)‬ ‭Rigidity‬
‭achieved. Thus it is known as a Rigid or Inflexible budget.‬ l‭evel to be achieved. Thus it is not rigid.‬
I‭ t‬‭operates‬‭on‬‭one‬‭level‬‭of‬‭activity‬‭and‬‭under‬‭one‬‭set‬‭of‬
‭(c)‬ ‭Level of‬ ‭It‬‭consists‬‭of‬‭various‬‭budgets‬‭for‬‭different‬
‭conditions.‬‭It‬‭assumes‬‭that‬‭there‬‭will‬‭be‬‭no‬‭change‬‭in‬‭the‬
‭Activity‬ l‭evels of activity.‬
‭prevailing conditions, which is unrealistic.‬
‭(d)‬ ‭Effect of‬ ‭ ariance‬ ‭Analysis‬ ‭does‬‭not‬‭give‬‭useful‬‭information‬‭as‬‭all‬
V ‭ ariance‬ ‭Analysis‬ ‭provides‬ ‭useful‬
V
‭variance‬ ‭Costs‬ ‭(fixed,‬ ‭variable‬ ‭and‬ ‭semi–variable)‬ ‭are‬ ‭related‬ ‭to‬ ‭information‬ ‭as‬ ‭each‬ ‭cost‬ ‭is‬ ‭analysed‬
‭analysis‬ ‭only one level of activity.‬ ‭according to its behaviour.‬
‭(e)‬ ‭Use for‬ I‭ f‬ ‭the‬ ‭budgeted‬ ‭and‬ ‭actual‬ ‭activity‬ ‭levels‬ ‭differ‬ I‭ t‬ ‭facilitates‬ ‭the‬ ‭ascertainment‬ ‭of‬ ‭cost,‬
‭Decision‬ ‭significantly,‬ ‭then‬ ‭aspects‬ ‭like‬ ‭cost‬ ‭ascertainment‬ ‭and‬ ‭fixation‬ ‭of‬ ‭selling‬ ‭price‬‭and‬‭submission‬‭of‬
‭making‬ ‭price fixation do not give a correct picture.‬ ‭quotations.‬
‭(f)‬ P
‭ erforman‬ ‭ omparison‬‭of‬‭actual‬‭performance‬‭with‬‭budgeted‬‭targets‬
C I‭ t‬ ‭provides‬ ‭a‬ ‭meaningful‬ ‭basis‬ ‭of‬
‭ce‬ ‭will‬‭be‬‭meaningless,‬‭especially‬‭when‬‭there‬‭is‬‭a‬‭difference‬ ‭comparison‬‭of‬‭the‬‭actual‬‭performance‬‭with‬
‭Evaluation‬ ‭between two activity levels.‬ ‭the budgeted targets.‬

‭4.4 Types of Functional Budgets‬

‭Functional Budgets are broadly grouped under the following heads –‬

‭1.‬ P‭ hysical‬ ‭Budgets:‬ ‭Budgets‬ ‭that‬ ‭contain‬ ‭information‬ ‭in‬ ‭terms‬ ‭of‬ ‭physical‬ ‭units‬ ‭about‬ ‭sales,‬ ‭production,‬ ‭etc.‬ ‭for‬
‭example, Quantity of Sales, Quantity of Production, Inventories, Manpower Budgets.‬
‭2.‬ C‭ ost‬ ‭Budgets:‬ ‭Budgets‬ ‭which‬ ‭provide‬ ‭Cost‬‭Information‬‭in‬‭respect‬‭of‬‭Manufacturing,‬‭Selling,‬‭Administration,‬‭etc.‬‭for‬
‭example, Manufacturing Costs, Selling Costs, Administration Cost, R & D Cost Budgets.‬
‭3.‬ ‭Profit Budgets:‬‭Budgets that enable the ascertainment‬‭of Profit, for example, Sales Budget, Profit & Loss Budget, etc.‬
‭4.‬ F‭ inancial‬ ‭Budgets:‬ ‭A‬ ‭Budget,‬ ‭which‬ ‭facilitates‬ ‭to‬ ‭ascertain‬ ‭the‬ ‭Financial‬ ‭Position‬ ‭of‬ ‭a‬ ‭concern,‬ ‭for‬‭example,‬‭Cash‬
‭Budgets, Capital Expenditure Budget, Budgeted Balance Sheet, etc.‬

‭4.5 Commonly Used Functional Budgets‬

‭ .‬ C
1 ‭ ash Budget‬
‭2.‬ ‭Sales Budget.‬
‭3.‬ ‭Production Budget.‬
‭4.‬ ‭Plant Capacity Utilisation Budget.‬
‭5.‬ ‭Direct Materials – Usage & Purchase Budgets.‬
‭6.‬ ‭Direct Labour – Requirement & Recruitment Budgets.‬
‭7.‬ ‭Overhead Cost Budgets – Factory OH, Administration OH, and S&D OH Budgets.‬
‭8.‬ C‭ ost‬‭Summary‬‭Budgets‬‭–‬‭Prime‬‭Cost‬‭Budget,‬‭Cost‬‭of‬‭Production‬‭Budget,‬‭Ending–inventory‬‭Budget,‬‭Cost–of–Goods–Sold‬
‭Budget.‬
‭9.‬ ‭Specific Budgets – R&D Cost Budget, Capital Expenditure Budget, Cash Budget.‬
‭10.‬ ‭Budget Summaries / Master Budget – Budgeted Income Statement and Budgeted Balance Sheet.‬

‭4.5 Cash Budget‬

‭ .‬ C
1 ‭ ash Budget is the plan of Receipts and Payments of Cash for the budget period.‬
‭Meaning‬
‭2.‬ ‭It analyses the monthly flow of cash such that the balance can be forecasted at regular intervals.‬
‭1.‬ I‭ nformation‬‭from‬‭various‬‭Operating‬‭/‬‭Functional‬‭Budgets,‬‭(viz.‬‭Sales,‬‭Materials‬‭Purchases,‬‭Wage‬‭Cost,‬‭OH,‬
‭etc.) affects the preparation of Cash Budget.‬
‭Factors‬
‭2.‬ ‭Cash‬ ‭Budget‬ ‭is‬‭also‬‭influenced‬‭by‬‭inputs‬‭from‬‭Capital‬‭Expenditure‬‭Budget,‬‭the‬‭Entity’s‬‭Dividend‬‭Policies,‬
‭and plans for Equity or long–term Debt Financing.‬
‭1.‬ C ‭ ash‬‭Budget‬‭helps‬‭in‬‭identifying‬‭the‬‭surplus‬‭or‬‭shortfall‬‭in‬‭funds‬‭as‬‭to‬‭take‬‭appropriate‬‭managerial‬‭action‬
‭ urpose‬
P ‭in respect thereof.‬
‭s‬ ‭2.‬ ‭Cash‬‭Budget‬‭helps‬‭in‬‭the‬‭finalization‬‭of‬‭the‬‭Budgeted‬‭Balance‬‭Sheet,‬‭in‬‭terms‬‭of‬‭figures‬‭relating‬‭to‬‭Cash‬
‭and Bank Balances, forecast Short–Term Investments, and other Balance Sheet Items.‬

‭4.6 ZBB – Meaning and its features‬

‭1.‬ I‭ t‬‭is‬‭an‬‭Expenditure‬‭Control‬‭Device‬‭where‬‭each‬‭Divisional‬‭Head‬‭has‬‭to‬‭justify‬‭the‬‭requirement‬‭of‬‭funds‬‭for‬‭each‬‭head‬‭of‬
‭expenditure and prepare the budget accordingly, without reference to the past budget or achievements.‬
‭2.‬ ‭It‬‭is‬‭an‬‭operating‬‭planning‬‭and‬‭budgeting‬‭process,‬‭which‬‭requires‬‭each‬‭Manager‬‭to‬‭justify‬‭his‬‭entire‬‭budget‬‭requests‬‭in‬
‭detail from “scratch” (hence zero–base).‬
‭3.‬ ‭It is a decision–oriented approach to budgeting, whereby all activities are re–evaluated, each time a Budget is set.‬

‭4.7 Steps in ZBB‬

‭ BB involves the following steps –‬
Z
‭1.‬ ‭Objectives:‬‭Determine a set of objectives.‬
‭2.‬ ‭Coverage:‬ ‭Decide‬ ‭about‬ ‭the‬ ‭extent‬ ‭to‬ ‭which‬ ‭the‬ ‭technique‬ ‭of‬ ‭ZBB‬ ‭is‬ ‭to‬ ‭be‬ ‭applied,‬ ‭whether‬ ‭in‬ ‭all‬ ‭areas‬‭of‬‭Firm’s‬
‭activities or only in a few selected areas on trial basis.‬
‭3.‬ ‭Decision Areas:‬‭Identify areas where decisions are‬‭required to be taken.‬
‭4.‬ ‭Ranking:‬‭Develop Decision Packages and rank them in‬‭order or preference.‬
‭5.‬ ‭Budgeting:‬‭Prepare‬‭the‬‭Budget,‬‭i.e.‬‭translating‬‭decision‬‭packages‬‭into‬‭practicable‬‭units/items‬‭and‬‭allocating‬‭financial‬
‭resources.‬

‭4.8 Advantages of ZBB‬

‭The advantages of Zero–Base Budgeting are –‬

‭1.‬ P‭ riority‬‭Allocation:‬ ‭It‬‭provides‬‭a‬‭systematic‬‭approach‬‭for‬‭the‬‭evaluation‬‭of‬‭different‬‭activities‬‭and‬‭rank‬‭them‬‭in‬‭order‬
‭of preference for the allocation of scarce resources.‬
‭2.‬ M‭ aximum‬‭Efficiency:‬‭It‬‭ensures‬‭that‬‭the‬‭various‬‭functions‬‭undertaken‬‭by‬‭the‬‭Firm‬‭are‬‭critical‬‭for‬‭the‬‭achievement‬‭of‬
‭its‬ ‭objectives‬ ‭and‬ ‭are‬ ‭being‬ ‭performed‬ ‭in‬ ‭the‬ ‭best‬ ‭possible‬ ‭way.‬ ‭The‬ ‭areas‬ ‭of‬ ‭wasteful‬ ‭expenditure‬ ‭can‬ ‭be‬ ‭easily‬
‭identified and eliminated.‬
‭3.‬ C‭ ost‬‭Benefit‬‭Analysis:‬‭It‬‭provides‬‭an‬‭opportunity‬‭to‬‭the‬‭Management‬‭to‬‭allocate‬‭resources‬‭for‬‭various‬‭activities‬‭only‬
‭after having a thorough Cost–Benefit Analysis. The chances of arbitrary cuts and enhancement are thus avoided.‬
‭4.‬ ‭Goal Congruence:‬‭Departmental Budgets (i.e. Decision‬‭Packages) are linked with overall Corporate Objectives.‬
‭5.‬ M‭ anagement‬ ‭by‬ ‭Objectives:‬ ‭The‬‭technique‬‭can‬‭be‬‭used‬‭for‬‭the‬‭introduction‬‭and‬‭implementation‬‭of‬‭the‬‭system‬‭of‬
‭‘Management by Objectives’ (MBO).‬

‭4.9 Traditional Budgeting vs Zero–Based Budgeting‬

‭Traditional Budgeting‬ ‭Zero–Based Budgeting‬

‭‬
1 I‭ t‬ ‭is‬ ‭accounting–oriented‬‭,‬ ‭with‬ ‭stress‬ ‭laid‬ ‭on‬ ‭the‬ ‭It‬‭is‬‭decision–oriented‬‭,‬‭in‬‭a‬‭rational‬‭manner,‬‭for‬‭allocation‬
‭.‬ ‭previous years’ level of expenditure.‬ ‭ f resources for both old and new programmes & activities.‬
o
‭‬
2 ‭ ere,‬ ‭reference‬ ‭is‬ ‭made‬‭to‬‭the‬‭past‬‭period‬‭levels‬ ‭of‬
H ‭ ere,‬‭a‬‭decision‬‭unit‬‭is‬‭broken‬‭into‬‭understandable‬‭Decision‬
H
‭.‬ ‭Revenues‬‭and‬‭Costs,‬‭and‬‭then‬‭adjustments‬‭are‬‭made‬‭to‬ ‭Packages,‬ ‭which‬ ‭are‬ ‭ranked‬ ‭according‬ ‭to‬ ‭importance,‬
‭recognize‬ ‭factors‬ ‭like‬ ‭inflation‬ ‭trends,‬ ‭market‬ ‭demand‬ ‭enabling‬ ‭Top‬ ‭Management‬ ‭to‬ ‭focus‬ ‭their‬ ‭attention‬ ‭on‬ ‭top‬
‭situations, etc.‬ ‭priority Decision Packages‬‭.‬
‭‬
3 I‭ t‬ ‭is‬ ‭a‬ ‭routine‬ ‭and‬ ‭direct‬ ‭approach,‬ ‭treating‬ ‭each‬ ‭It‬‭is‬‭an‬‭analytical‬‭approach,‬‭and‬‭immediately‬‭highlights‬‭the‬
‭.‬ ‭Division / Decision Unit equally.‬ ‭ ecision Packages enjoying priority over others.‬
D
‭‬
4 I‭ t‬ ‭is‬‭for‬‭Top‬‭Management‬ ‭to‬‭decide‬‭why‬‭a‬‭particular‬ ‭Here,‬ ‭Manager‬ ‭of‬ ‭each‬ ‭Division‬ ‭should‬ ‭completely‬ ‭justify‬
‭.‬ ‭amount should be spent on a particular decision unit.‬ ‭ hy there should be a budget allocation for his Division.‬
w
‭‬
5 I‭ t‬ ‭is‬ ‭comparatively‬ ‭rigid‬‭,‬ ‭and‬‭not‬‭clearly‬‭responsive‬ ‭This‬ ‭is‬ ‭very‬ ‭flexible‬ ‭and‬ ‭responsive‬ ‭to‬ ‭environmental‬
‭.‬ ‭to environmental changes.‬ c‭ hanges.‬
‭‬
6 ‭ anagers‬ ‭may‬‭deliberately‬‭inflate‬ ‭their‬‭Budget‬‭Cost‬
M ‭ anagers‬‭cannot‬‭have‬‭an‬‭adhoc‬‭approach‬‭for‬‭Cost‬‭Budgets.‬
M
‭.‬ ‭Request,‬‭so‬‭that‬‭they‬‭may‬‭still‬‭get‬‭the‬‭required‬‭amount,‬ ‭Top‬ ‭Management‬ ‭accords‬ ‭its‬ ‭approval‬ ‭only‬ ‭to‬ ‭a‬ ‭carefully‬
‭after cost “cuts” from Top Management.‬ ‭devised,‬‭result–oriented Decision Package‬‭.‬

‭Chapter 5‬
‭Costing‬
‭5.1 Cost Classification based on Behaviour / Nature / Variability‬
‭On the basis of Behaviour / Nature / Variability, Costs are classified as under –‬
‭Type and Description‬ ‭Examples‬
‭Fixed‬ ‭Cost‬ ‭is‬ ‭the‬ ‭cost‬ ‭which‬ ‭does‬ ‭not‬ ‭vary‬‭with‬‭the‬‭change‬‭in‬‭the‬‭volume‬‭of‬
‭1‬ ‭Salaries,‬ ‭Rent,‬ ‭Insurance,‬ ‭Audit‬
‭activity‬‭in‬‭the‬‭short–run.‬ ‭These‬‭costs‬‭are‬‭not‬‭affected‬‭by‬‭temporary‬‭fluctuation‬
‭.‬ ‭ ees, Depreciation, etc.‬
F
‭in activity of an enterprise. These are also known as‬‭Period Costs‬‭.‬
‭Variable‬ ‭Cost‬ ‭is‬ ‭the‬ ‭cost‬ ‭of‬ ‭elements‬ ‭which‬ ‭tends‬ ‭to‬ ‭directly‬ ‭vary‬ ‭with‬ ‭the‬ ‭ aterials‬
M ‭Consumed,‬ ‭Direct‬
‭2‬
‭volume‬‭of‬‭activity.‬‭Variable‬‭Cost‬‭has‬‭two‬‭parts‬‭–‬‭(a)‬‭Variable‬‭Direct‬‭Cost,‬‭and‬‭(b)‬ ‭Labour,‬ ‭Sales‬ ‭Commission,‬
‭.‬
‭Variable Indirect Costs. Variable Indirect Costs are termed as Variable Overhead.‬ ‭Royalties, Freight, Packing, etc.‬
‭3‬ ‭Semi‬‭Variable‬‭Costs‬ ‭contain‬‭both‬‭fixed‬‭and‬‭variable‬‭elements.‬‭They‬‭are‬‭partly‬ ‭Repairs‬ ‭and‬ ‭Maintenance,‬ ‭Power,‬
‭.‬ ‭affected by fluctuation in the level of activity.‬ ‭Water, Telephone, Lighting, etc.‬

‭5.2 Cost Sheet and its Uses‬

‭1.‬ M‭ eaning:‬ ‭A‬ ‭Cost‬ ‭Sheet‬ ‭is‬ ‭a‬ ‭statement‬ ‭which‬ ‭shows‬ ‭the‬ ‭break–up‬ ‭and‬ ‭build–up‬ ‭of‬ ‭costs.‬ ‭It‬ ‭is‬ ‭a‬ ‭document‬ ‭which‬
‭provides the consolidation of the detailed cost of a Cost Centre or a Cost Unit.‬
‭2.‬ ‭Uses:‬‭The following are the uses of the Cost Sheet‬‭–‬
‭(a)‬ ‭Presentation of Cost information.‬ ‭(e)‬ ‭Inter–Firm and Intra–Firm Cost Comparison.‬
‭(b)‬ ‭Determination of Selling Price.‬ ‭(f)‬ ‭Preparing Cost Estimates for submitting tenders / quotations.‬
‭(c)‬ ‭Ascertainment of profitability.‬ ‭(g)‬ ‭Product–wise and Location–wise Cost Analysis.‬
‭(d)‬ ‭Preparation of Budgets.‬ ‭(h)‬ ‭Disclosure of operational efficiency for Cost Control.‬

‭Particulars‬ ‭̀‬
‭Opening Stock of Raw Materials‬
‭ dd:‬
A ‭ urchases‬
P
‭Less:‬ ‭Closing Stock of Raw Materials‬ ‭.‬
‭Direct Materials Consumed / Raw Materials Consumed‬
‭ dd:‬
A ‭Direct Labour‬
‭Add:‬ ‭Direct Expenses‬
‭PRIME COST‬
‭Add:‬ ‭Factory Overheads (also called Works OH / Manufacturing OH / Production OH)‬
‭GROSS FACTORY COST / GROSS WORKS COST‬
‭ dd:‬
A ‭Opening Stock of Work–in–Progress‬
‭Less:‬ ‭Closing Stock of Work–in–Progress‬
‭FACTORY COST / WORKS COST‬
‭Add:‬ ‭Administrative Overheads relating to Production Activity (if any)‬
‭COST OF PRODUCTION‬
‭Add:‬ ‭Opening Stock of Finished Goods‬
‭Sub–Total‬ ‭(‭N
‬ ote:‬‭This may be‬‭considered‬‭as‬‭COST OF‬‭GOODS AVAILABLE FOR SALE.‬‭)‬
‭Less:‬ ‭Closing Stock of Finished Goods‬
‭COST OF GOODS SOLD‬
‭Add:‬ ‭General Administration Overheads (also called Office OH / General OH / Management OH)‬
‭Selling and Distribution Overheads (also called Marketing OH)‬
‭COST OF SALES‬
‭Add:‬ ‭Profit / Loss (Balancing Figure)‬
‭SALES‬

‭5.3 Marginal Costing‬

‭1.‬ ‭Marginal Costing is a technique of decision–making, which involves –‬
‭(a)‬ ‭Ascertainment of Total Costs,‬
‭(b)‬ ‭Classification of Costs into – (i) Fixed and (ii) Variable, and,‬
‭(c)‬ ‭Use of such information for analysis and decision–making.‬
‭2.‬ M‭ arginal‬ ‭Costing‬ ‭is‬ ‭the‬ ‭ascertainment‬ ‭of‬ ‭Marginal‬ ‭Cost,‬ ‭and‬ ‭of‬ ‭the‬ ‭effect‬ ‭on‬ ‭Profit‬ ‭of‬‭changes‬‭in‬‭volume‬‭or‬‭type‬‭of‬
‭output, by differentiating between Fixed Costs and Variable Costs.‬

‭5.4 Variable Cost and Fixed Cost‬

‭Particulars‬ ‭Variable Cost‬ ‭Fixed Cost‬

‭ ixed‬‭Costs‬‭are‬‭costs‬‭which‬‭are‬‭assumed‬‭to‬
F
‭ ariable‬ ‭Cost‬ ‭is‬ ‭that‬ ‭portion‬ ‭of‬ ‭cost,‬ ‭which‬ ‭changes‬‭or‬
V
‭remain‬ ‭constant‬‭,‬ ‭for‬ ‭a‬ ‭given‬ ‭period‬ ‭of‬
‭1.‬ ‭Meaning‬ ‭varies‬ ‭proportionately‬ ‭based‬ ‭on‬ ‭output‬ ‭/‬ ‭volume‬ ‭/‬
‭time,‬ ‭irrespective‬ ‭of‬ ‭level‬ ‭of‬ ‭output‬ ‭during‬
‭quantity.‬
‭that period.‬
‭ ariable‬‭Cost‬‭=‬‭Direct‬‭Materials‬‭+‬‭Direct‬‭Labour‬‭+‬‭Direct‬
V ‭Fixed‬ ‭Cost‬ ‭=‬ ‭Fixed‬ ‭Production‬ ‭OH‬ ‭+‬
‭2.‬ ‭Items‬
‭Expenses + Variable Production OH + Variable S&D OH.‬ ‭ dministrative OH‬‭+‬‭Fixed S&D OH.‬
A
‭ aw‬ ‭Materials,‬ ‭Labour‬ ‭(based‬ ‭on‬ ‭number‬ ‭of‬ ‭units‬
R
‭3.‬ ‭Examples‬ ‭Rent, Salary, Insurance, etc.‬
‭produced), Power, Royalty (based on production), etc.‬
‭ ixed‬ ‭Cost‬ ‭per‬ ‭unit‬ ‭of‬ ‭output‬ ‭will‬ ‭vary‬
F
‭4.‬ C
‭ ost per‬ ‭ ariable‬ ‭Cost‬ ‭per‬‭unit‬‭is‬‭assumed‬‭to‬‭remain‬‭constant‬
V ‭inversely‬ ‭with‬ ‭changes‬ ‭in‬ ‭the‬ ‭level‬ ‭of‬
‭unit‬ ‭at all levels of output.‬ ‭output‬‭.‬‭As‬‭output‬‭increases,‬‭Fixed‬‭Cost‬‭per‬
‭unit decreases, and vice–versa.‬
‭ ariable‬ ‭Costs‬ ‭are‬ ‭incurred‬ ‭only‬ ‭when‬ ‭production‬
V ‭ ixed‬ ‭Costs‬ ‭are‬ ‭incurred‬ ‭even‬ ‭at‬ ‭zero‬
F
‭5.‬ P
‭ oint of‬
‭takes‬ ‭place‬‭.‬ ‭Hence,‬ ‭no‬ ‭production‬ ‭means‬‭no‬‭Variable‬ ‭level‬‭of‬‭output‬‭.‬‭Hence,‬‭even‬‭at‬‭Nil‬‭Activity‬
‭incurrence‬
‭Costs.‬ ‭Level, Fixed Costs will be incurred.‬
‭ nce‬ ‭incurred,‬ ‭Variable‬ ‭Costs‬ ‭will‬ i‭ncrease‬
O
‭6.‬ C
‭ ost‬ ‭Fixed‬ ‭Costs,‬ ‭once‬ ‭incurred,‬ ‭will‬ ‭be‬
‭proportionately‬ b‭ ased‬ ‭on‬ ‭the‬ ‭level‬ ‭of‬ ‭output‬ ‭/‬
‭Behaviour‬ ‭ onstant at all output levels‬‭.‬
c
‭quantity.‬
 ‭Particulars‬ ‭Variable Cost‬ ‭Fixed Cost‬
‭ ariable‬ ‭Costs‬ ‭are‬ ‭considered‬ ‭as‬ ‭product–related‬
V ‭ ixed‬‭Costs‬‭are‬‭treated‬‭as‬‭period–related‬
F
‭7.‬ ‭Nature‬
‭costs.‬ ‭costs.‬
‭ ariable‬ ‭Costs‬ ‭are‬ ‭Product‬ ‭Costs,‬ ‭and‬ ‭hence‬ ‭included‬
V ‭ ixed‬ ‭Costs‬ ‭are‬ ‭not‬ ‭included‬ ‭in‬
F
‭8.‬ I‭ nclusion‬
‭in‬‭inventory‬‭valuation‬‭.‬‭So,‬‭Inventory‬‭Value‬‭comprises‬ ‭Inventory‬ ‭Valuation‬‭.‬ ‭They‬ ‭are‬ ‭charged‬
‭in‬
‭Direct‬ ‭Materials‬ ‭+‬ ‭Direct‬ ‭Labour‬ ‭+‬ ‭Direct‬ ‭Expenses‬ ‭+‬ ‭off‬ ‭fully‬ ‭to‬ ‭the‬ ‭Profit‬ ‭and‬ ‭Loss‬ ‭Account‬ ‭in‬
‭Inventory‬
‭Variable Production OH.‬ ‭the period in which it is incurred.‬

‭5.5 Format of Marginal Cost Sheet‬

‭ nder‬‭the‬‭theory‬‭of‬‭Marginal‬‭Costing,‬‭it‬‭is‬‭presumed‬‭that‬‭Variable‬‭Costs‬‭are‬‭related‬‭to‬‭output‬‭and‬‭Fixed‬‭Costs‬‭are‬‭related‬‭to‬
U
‭the‬ ‭period.‬ ‭Hence,‬ ‭the‬ ‭Fixed‬ ‭Costs‬ ‭are‬ ‭charged‬ ‭off‬ ‭to‬ ‭the‬ ‭Profit‬ ‭and‬ ‭Loss‬ ‭Account.‬‭The‬‭cost‬‭and‬‭revenue‬‭information‬‭is‬
‭presented in the following format –‬
‭Particulars‬ ‭Amount‬
‭Sales Value‬ ‭XXX‬
‭Less:‬ ‭Variable Cost‬ ‭(Direct Materials + Direct Labour‬‭+ Variable POH + Variable S&D OH)‬ ‭XXX‬
‭Contribution‬‭= Sales Less Variable Costs‬ ‭XXX‬
‭Less:‬ ‭Fixed Cost‬ ‭(Fixed Production OH + All AOH +‬‭Fixed S&D OH)‬ ‭XXX‬
‭Profit / (Loss)‬‭= Contribution Less Fixed Costs‬ ‭XXX‬

‭When there are a number of products, the Marginal Cost Statement will be as under:‬
‭Particulars‬ ‭Product A‬ ‭ roduct B‬
P ‭Product C‬ ‭ otal‬
T
‭Sales Revenue‬ ‭XXX‬ ‭XXX‬ ‭XXX‬ ‭XXXX‬
‭Less:‬ ‭Variable Costs‬ ‭XX‬ ‭XX‬ ‭XXX‬ ‭XXX‬
‭Contribution‬ ‭XX‬ ‭XX‬ ‭XXX‬ ‭XXX‬
‭Less:‬ ‭Fixed Costs‬ ‭XXX‬
‭Profit‬ ‭XXX‬

‭5.6 Format of Marginal Cost Sheet‬

‭The Marginal Cost Statement, when written in an equation form, constitutes the Marginal Cost Equation.‬
‭Sales‬‭Less‬‭Variable Cost = Contribution = Fixed Cost‬‭+ Profit‬
‭5.7 Marginal Cost Problems‬

1‭ .‬ ‭Computation of Basic Data‬ ‭M 01‬

‭Fill in the blanks for each of the following independent situations:‬
‭Situations‬ ‭AYE‬ ‭BYE‬ ‭ EE‬
C ‭DEE‬ ‭ YE‬
W
‭Selling Price per unit‬ ‭? (a)‬ ‭̀‬‭50‬ ‭̀‬‭20‬ ‭ (g)‬
? ‭̀‬‭30‬
‭Variable Cost as % of Selling Price‬ ‭60‬ ‭? (c)‬ ‭75‬ ‭75‬ ‭? (i)‬
‭No. of units sold‬ ‭10,000‬ ‭4,000‬ ‭? (e)‬ ‭6,000‬ ‭5,000‬
‭Marginal Contribution‬ ‭̀‬‭20,000‬ ‭̀‬‭80,000‬ ‭? (f)‬ ‭̀‬‭25,000‬ ‭̀‬‭50,000‬
‭Fixed Costs‬ ‭̀‬‭12,000‬ ‭? (d)‬ ‭̀‬‭1,20,000‬ ‭̀‬‭10,000‬ ‭? (j)‬
‭Profit / Loss‬ ‭? (b)‬ ‭̀‬‭20,000‬ ‭̀‬‭30,000‬ ‭? (h)‬ ‭̀‬‭15,000‬
‭Solution:‬
‭Situations‬ ‭AYE‬ ‭BYE‬ ‭CEE‬ ‭DEE‬ ‭WYE‬

‭(Given)‬ ‭(Given)‬ ‭(Given)‬

‭1. Selling Price per unit‬ ‭ ‬
= ‭ ‬
=
‭̀‬‭50 pu‬ ‭̀‬‭20 pu‬ ‭̀‬‭30 pu‬
‭̀‬‭5 pu‬ ‭̀‬‭16.67 pu‬

‭2. Variable Cost as % of SP‬ ‭(Given) 60%‬ ‭(Given) 75%‬ ‭(Given) 75%‬
‭ 60%‬
= ‭=66.67%‬
‭ P – Cn‬
S ‭SP – Cn =‬ ‭20 × 75% =‬ ‭SP – Cn =‬ ‭ P – Cn‬
S
‭3. Variable Cost per unit (1 × 2)‬
‭=‬‭̀‬‭3 pu‬ ‭̀‬‭30 pu‬ ‭̀‬‭15 pu‬ ‭̀‬‭12.00 pu‬ ‭=‬‭̀‬‭20 pu‬
‭SP pu – VC pu‬
‭4. Contribution per unit (1 – 3)‬ ‭=‬ ‭= 20 – 15 =‬ ‭=‬
‭=‬‭̀‬‭2 pu‬ ‭̀‬‭20 pu‬ ‭̀‬‭5 pu‬ ‭=‬‭̀ ‬‭4.17 pu‬ ‭̀‬‭10 pu‬
‭(Given)‬ ‭(Given)‬ ‭(Given)‬ ‭(Given)‬
‭5. No. of units sold‬
‭10,000 units‬ ‭4,000 units‬ ‭6,000 units‬ ‭5,000 units‬
‭= 30,000 units‬
‭(Given)‬ ‭(Given)‬ ‭FC + Profit =‬ ‭(Given)‬
‭6. Marginal Contribution (4 × 5)‬ ‭(Given)‬‭̀‬‭50,000‬
‭̀‬‭20,000‬ ‭̀‬‭80,000‬ ‭̀‬‭1,50,000‬ ‭̀‬‭25,000‬
 ‭(Given)‬‭̀‬ ‭Contrib. – Pft‬ ‭(Given)‬ ‭(Given)‬ ‭Contrib. – Pft =‬
‭7. Fixed Costs‬
‭12,000‬ ‭=‬‭̀‬‭60,000‬ ‭̀‬‭1,20,000‬ ‭̀‬‭10,000‬ ‭̀‬‭35,000‬
‭Contrib. – FC =‬ ‭(Given)‬ ‭(Given)‬ ‭Contrib. – FC‬
‭8. Profit / (Loss) (6 – 7)‬ ‭(Given)‬‭̀‬‭15,000‬
‭̀‬‭8,000‬ ‭̀‬‭20,000‬ ‭̀‬‭30,000‬ ‭=‬‭̀‬‭15,000‬
‭Answer:‬ ‭(a)‬‭̀‬‭5,‬ ‭(b)‬‭̀‬‭8,000,‬ ‭(c) 60%,‬ ‭(d)‬‭̀‬‭60,000,‬ ‭(e) 30,000 units,‬
‭(f)‬‭̀‬‭1,50,000,‬ ‭(g)‬‭̀‬‭16.66,‬ ‭(h)‬‭̀‬‭15,000,‬ ‭(i)‬‭66.67%,‬ ‭(j)‬‭̀‬‭35,000.‬

2‭ .‬ ‭Marginal Costing – Computation of PVR, BEP, etc.‬ ‭M 09, M 15‬

‭ABC‬‭Limited‬‭started‬‭its‬‭operations‬‭in‬‭a‬‭year‬‭with‬‭a‬‭Total‬‭Production‬‭Capacity‬‭of‬‭2,00,000‬‭units.‬‭The‬‭following‬‭information,‬‭for‬
‭two years, are made available to you:‬
‭Year 1‬ ‭Year 2‬
‭Sales (units)‬ ‭80,000‬ ‭1,20,000‬
‭Total Cost (‬‭̀ ‬‭)‬ ‭34,40,000‬ ‭45,60,000‬
‭There‬‭has‬‭been‬‭to‬‭change‬‭in‬‭the‬‭Cost‬‭Structure‬‭and‬‭Selling‬‭Price‬‭and‬‭it‬‭is‬‭anticipated‬‭that‬‭it‬‭will‬‭remain‬‭unchanged‬‭in‬‭Year‬‭3‬
‭also. Selling Price is‬‭̀‬‭40 per unit.‬
‭Calculate:(1)‬ ‭Variable‬ ‭Cost‬ ‭p.u.‬ ‭(2)‬ ‭PV‬ ‭Ratio,‬ ‭(3)‬ ‭Break–Even‬ ‭Point‬ ‭(in‬ ‭units),‬ ‭(4)‬ ‭Profit‬ ‭if‬ ‭the‬ ‭Firm‬ ‭operates‬ ‭at‬ ‭75%‬ ‭of‬ ‭the‬
c‭ apacity.‬
‭ olution:‬
S
‭1.‬‭Variable Cost‬‭per unit‬‭=‬ ‭Difference in Costs‬ ‭̀‬‭45,60,000 –‬‭̀‬‭34,40,000‬
‭(using Level of Activity‬ ‭Difference in Prodn‬ ‭=‬ ‭=‬‭̀‬‭28 per unit.‬
‭Method)‬ ‭(1,20,000 – 80,000) units‬
‭Quantity‬

‭2.‬ ‭Fixed Cost‬ ‭= Total Costs‬‭less‬‭Variable Costs‬‭(estimated using 80,000 units output level data)‬
‭=‬‭̀‬‭34,40,000 – (80,000 units×‬‭̀ ‬‭28)‬‭=‬‭̀‬‭12,00,000‬‭[Note:‬‭1,20,000 units level can also be taken here.]‬

‭3.‬ ‭PV Ratio =‬ ‭×‬‭100 =‬ ‭×‬‭100 =‬‭30%‬

‭4.‬ ‭Break Even Quantity =‬ ‭=‬ ‭= 1,00,000 units.‬

‭5. Profit at 75% Sales Capacity‬ ‭= Total Contribution – Fixed Cost‬
‭= (2,00,000 units × 75%‬‭̀‬‭12 p.u.) –‬‭̀‬‭12,00,000‬‭=‬‭̀‬‭6,00,000‬

3‭ .‬ ‭OH Analysis and Computation of BEP‬ ‭N 08‬

‭PQ Limited reports the following cost structure at two capacity levels:‬
‭POH‬ ‭2,000 units (100% capacity)‬ ‭1,500 units‬
‭Production Overhead I‬ ‭̀‬‭3 per unit‬ ‭̀‬‭4 per unit‬
‭Production Overhead II‬ ‭̀‬‭2 per unit‬ ‭̀‬‭2 per unit‬
‭If the Selling Price, reduced by Direct Material and Labour is‬‭̀‬‭8 per unit, what would be its Break–Even‬‭Point?‬
‭Solution:‬
‭OH‬ ‭At 2,000 units‬ ‭At 1,500 units‬ ‭Remarks / Inference‬
‭ ince‬‭total‬‭amount‬‭is‬‭constant‬‭at‬‭both‬‭levels,‬‭POH‬‭I‬‭is‬
S
‭POH I‬ ‭2,000‬‭🞨‬ ‭̀‬‭3 =‬‭̀‬‭6,000‬ ‭1,500‬‭🞨‬ ‭̀‬‭4 =‬‭̀‬‭6,000‬
‭a‬‭Fixed Cost‬‭in nature.‬
‭Since‬‭Total‬‭POH‬‭II‬‭varies‬‭proportionately‬‭at‬‭two‬‭levels,‬
‭POH II‬ ‭2,000‬‭🞨‬ ‭̀‬‭2 =‬‭̀‬‭4,000‬ ‭1,500‬‭🞨‬ ‭̀‬‭2 =‬‭̀‬‭3,000‬ ‭and‬‭POH‬‭II‬‭per‬‭unit‬‭remains‬‭constant‬‭at‬‭both‬‭levels,‬‭it‬
‭is a‬‭Variable Cost‬‭in nature.‬
‭1.‬ ‭Contribution = Selling Price‬‭Less‬‭All Variable‬‭Costs =‬‭̀‬‭8 –‬‭̀‬‭2 =‬‭̀‬‭6‬‭per unit.‬

‭2.‬ ‭Break Even Quantity =‬ ‭=‬ ‭= 1,000 units.‬

‭Note:‬‭Information is not sufficient for computing‬‭PVR and BES.‬

‭4.‬ ‭Computation of Basic Data‬ ‭N 19‬

 ‭Following details are related to M/s XYZ Limited:‬
‭ otal Cost‬
T ‭̀‬‭56,78,000‬
‭Margin of Safety‬ ‭̀‬‭48,18,450‬
‭Margin of Safety (in units)‬ ‭6,500 units‬
‭Break Even Sales‬ ‭3,500 units‬
‭You are required to calculate – (1) Profit, (2) Profit Volume Ratio, (3) Break Even Sales (in‬‭̀‬‭), and (4)‬‭Fixed Costs.‬

‭ olution:‬
S ‭Sale Price p.u. =‬ ‭=‬ ‭=‬‭̀‬‭741.30 pu‬
‭1.‬ ‭Profit‬ ‭= Total Sales (–) Total Cost‬ ‭[‬‭Note:‬‭Total‬‭Sales = BES + MOS = 6,500+3,500 = 10,000 units)‬
‭= (6,500 + 3,500) units ×‬‭̀‬‭741.30 – 56,78,000 =‬‭̀‬‭17,35,000‬
‭2.‬ ‭Also,‬ ‭Profit‬ ‭= MOS Quantity‬ ‭× Contribution p.u.‬

‭On substitution,‬ ‭17,35,000 = 6,500 units‬ ‭× Contribution p.u. So, Contribution p.u. =‬ ‭=‬‭̀‬‭266.92‬

‭Hence PVR =‬ ‭=‬ ‭=‬‭36.01%‬

‭3.‬ ‭BES in‬‭̀‬‭= BES Quantity × Sale Price p.u. = 3,500‬‭units ×‬‭̀‬‭741.30 =‬‭̀‬‭25,94,550‬
‭4.‬ ‭At BEP, Total Contribution = Fixed Cost .‬
‭Total Contribution at BEP = 3,500 units ×‬‭̀‬‭266.92‬‭p.u. So,‬‭Fixed Cost =‬‭̀‬‭9,34,230‬