Final Costing Quick Revision Marginal Costing

Our todays schedule shall be as follows : It is a technique used for managerial

First Session : 7 to 9 AM decision making.
Break 1 : 9 to 9:15 AM This technique recognises only two types
Second Session : 9:15 to 11:15 AM of costs i.e. (1) Variable cost and (2) Fixed
Break 2 : 11:15 to 11:30 AM cost.
Third Session : 11:30 AM to 1:30 PM If there is a semi-variable cost, then it
Important Note : As it is a quick revision session, needs to be sub-divided into variable and
please do not waste your time in writing, but fixed cost separately.
focus your attention only on revising.

CA. Rakesh Agrawal 1 CA. Rakesh Agrawal 2

Division of Cost Behaviour of Cost

Total Cost Production Variable Cost Fixed Cost
Per unit Total Per unit Total

Prime Cost Overheads Increase constant increases decreases constant

constant decreases increases constant

Decrease
Variable OH Fixed OH
Variable cost
Fixed cost

CA. Rakesh Agrawal 3 CA. Rakesh Agrawal 4

Golden Formula Profit Volume Ratio

Sales Variable Cost = Contribution Contribution
P/V Ratio = X 100
Sales
Contribution Fixed Cost = Profit/Loss
Sales

We can say that excess contribution over Variable Cost Contribution

fixed cost is profit and excess of fixed cost
over contribution is loss. Variable Cost Ratio P/V Ratio

CA. Rakesh Agrawal 5 CA. Rakesh Agrawal 6

1
 Break Even Point (BEP)
BEP All in one formula
It is the point at which there is no profit or no
loss.
It means, at BEP, Total Contribution = Total
Fixed Cost Total Fixed Cost
Management is interested in knowing BEP,
because the first objective of management is to =
cross BEP. cont. p.u./PV ratio/cont. at 1% cap.
A firm starts earning profit only after crossing
BEP.
BEP can be expressed in 3 ways (a) No. of
units, (b) Sale Value Or (c) % capacity.

CA. Rakesh Agrawal 7 CA. Rakesh Agrawal 8

Margin of Safety (MOS)

Margin of Safety Ratio
It is the sales in excess of BEP sales.
MOS = Total Sales BEP Sales
BEP Sales BEP Ratio

MOS Ratio = MOS Sales x 100

Total Sales
Total Sales

MOS Sales MOS Ratio

CA. Rakesh Agrawal 9 CA. Rakesh Agrawal 10

Short Cut Formulae

Net Profit = MOS Sales x P/V Ratio

BEP Sales Contribution

X P/V Ratio = Fixed Cost

Total Sales
X P/V Ratio

MOS Sales Contribution

X P/V Ratio = Net Profit

CA. Rakesh Agrawal 11 CA. Rakesh Agrawal 12

2
 Sales Sales @ Variable Contribut Fixed Profit Total Sales Sales @ Variable Contribut Fixed Profit Total
Qty. Rs. 10 Cost @ ion @ Cost Cost Qty. Rs. 10 Cost @ ion @ Cost Cost
Rs. 6 Rs. 4 Rs. 6 Rs. 4
10,000 1,00,000 60,000 40,000 25,000 15,000 85,000 10,000 1,00,000 60,000 40,000 25,000 15,000 85,000

15,000 1,50,000 90,000 60,000 25,000 35,000 1,15,000 15,000 1,50,000 90,000 60,000 25,000 35,000 1,15,000

Diff. 50,000 30,000 20,000 NIL 20,000 30,000 Diff. 50,000 30,000 20,000 NIL 20,000 30,000
5,000 5,000

Change in Total Cost Change in Profit

Variable Cost p.u. = --------------------------- Contribution p. u. = ---------------------------
Change in Output Change in Output

CA. Rakesh Agrawal 13 CA. Rakesh Agrawal 14

Sales Sales @ Variable Contribut Fixed Profit Total Sales Sales @ Variable Contribut Fixed Profit Total
Qty. Rs. 10 Cost @ ion @ Cost Cost Qty. Rs. 10 Cost @ ion @ Cost Cost
Rs. 6 Rs. 4 Rs. 6 Rs. 4
10,000 1,00,000 60,000 40,000 25,000 15,000 85,000 10,000 1,00,000 60,000 40,000 25,000 15,000 85,000

15,000 1,50,000 90,000 60,000 25,000 35,000 1,15,000 15,000 1,50,000 90,000 60,000 25,000 35,000 1,15,000

Diff. 50,000 30,000 20,000 NIL 20,000 30,000 Diff. 50,000 30,000 20,000 NIL 20,000 30,000
5,000 5,000

Change in Profit Change in Cost

P / V Ratio = --------------------------- x 100 Variable Cost = --------------------------- x 100
Change in Sales Ratio Change in Sales

CA. Rakesh Agrawal 15 CA. Rakesh Agrawal 16

Family of BEPs
There are 4 members in the family
Cash BEP
1. Normal BEP : It is the point at which, there is
no profit or no loss.
2. Cash BEP : It is the point at which, cash profit Total Cash Fixed Cost
or cash loss is zero.
=
3. Composite or Overall BEP : It is the point at
which, overall profit or loss of multiple products Contribution p. u. or P/V ratio
is zero.
4. Cost BEP : It is the point at which, total cost
under the two alternatives is same.

CA. Rakesh Agrawal 17 CA. Rakesh Agrawal 18

3
 Composite or Overall Break-even Point :
Comparison of Normal & Cash BEP
In case a concern is dealing in several products, a composite
break-even point can be computed using the following formula:

Composite Break-even Point Composite P/V Ratio

0 Cash BEP Normal BEP Total Fixed Cost Total Contribution
= -------------------------- = --------------------------- X 100
Composite P/V Ratio Total Sales

Cash Cash profit but Book

losses Profit
Book losses

CA. Rakesh Agrawal 19 CA. Rakesh Agrawal 20

Cost BEP An Example

It is the point at which the total cost of 2 Suppose we have to decide between
alternatives is exactly the same. purchase of 2 vehicles, say a Scooter
Cost BEP is used in decision making and a Motorcycle.
between 2 alternatives. Annual Fixed Cost for a Scooter is `
Below Cost BEP, the alternatives with 5,000 and variable cost is ` 1.2 per km.
lower fixed cost is better and above Cost Annual Fixed Cost for a Motorcycle is `
BEP, the alternative with lower variable 8,000 and variable cost is ` 0.8 per km.
cost per unit is better.

CA. Rakesh Agrawal 21 CA. Rakesh Agrawal 22

Lets calculate Cost BEP Short cut for Cost BEP

Lets assume that annual distance = Differential Fixed Cost
travelled is N kms. at which total cost Differential Variable Cost per km.
p.a. is same for both the vehicles.
= (8,000 5,000) / (1.2 0.8)
Scooter [(N x 1.2) + 5,000] = Motorcycle
= 3,000 / 0.4
[(N x 0.8) + 8,000]
= 7,500 kms. p.a.
1.2N 0.8N = 8,000 5,000
0.4N = 3,000
Hence, N = 7,500 kms. p. a.

CA. Rakesh Agrawal 23 CA. Rakesh Agrawal 24

4
 Interpretation of Cost BEP
Pricing Decision
Scooter is better Motorcycle is better
Decision regarding fixation of sales price
can be taken using marginal costing
0 Cost BEP
theory.
7,500 kms. p.a.
Sales price can be calculated as Variable
Alternative with Alternative with cost + Desired contribution.
Lower Fixed Cost Lower Variable Cost We should try to quote a competitive sales
price to our prospective customer, in order
to earn some incremental profit.

CA. Rakesh Agrawal 25 CA. Rakesh Agrawal 26

Pricing Decision
Make or Buy Decision
It is the decision regarding manufacture of
Many a times a question says that you should a particular component or buying from
calculate the sales price in order to maintain the
outside.
same profit as before. But, same profit could
mean any of the following : The decision depends on the relevant cost
(a) same overall profit as before or of buying and relevant cost of
(b) same profit per unit as before or manufacturing.
(c) same % profit as before Unavoidable fixed costs are irrelevant for
One should read the data carefully to avoid the decision making.
mistake in calculation.

CA. Rakesh Agrawal 27 CA. Rakesh Agrawal 28

Relevant & Irrelevant Fixed OH Non financial aspects

Relevant Fixed OH Irrelevant Fixed OH
Quality of supplies by outsider
Specific OH incurred is General OH or Absorbed OH
relevant is irrelevant Regularity of outside supplier
It is avoidable fixed cost It is unavoidable fixed cost Integrity and reliability of supplier
It is an incremental fixed cost It is not an incremental cost Behaviour of supplier during shortages
e.g. depreciation on M/C e.g. proportionate factory Dependence on outside agency etc.
purchased specially for rent charged to the product
manufacture

CA. Rakesh Agrawal 29 CA. Rakesh Agrawal 30

5
 Exploring New Markets Key Factor Questions
When the present market is saturated, then one It is a manufacturing resource, which is in short
has to explore new markets. supply. It could be limited availability of raw
If the firm is left with balance capacity, then the material or machine hours or skilled labour
incremental cost shall be variable cost, which hours etc.
should be compared with incremental revenue, These limited resources are also known as
to take the decision regarding entering in to new limiting factors or governing factors etc. because
market. they limit your production and sales activity and
Any special cost or benefit should also be thus profitability.
considered in decision making but existing fixed Our objective shall be to maximise the profit
cost should be ignored. within available limited resources.

CA. Rakesh Agrawal 31 CA. Rakesh Agrawal 32

Steps for solving Key Factor Questions Lets see the presentation of an answer
Identify the key factor of a key factor question
Calculate contribution per unit
Calculate contribution per key factor
Assign ranking to each product
Allocate key resources based on ranking
The resultant answer is optimum product mix.

CA. Rakesh Agrawal 33 CA. Rakesh Agrawal 34

ii) Statement showing allocation of Key Resources

i) Statement of contribution : ( i.e. Calculation of Optimum Product Mix)
Particulars No. of Material Total Balance
Particulars A B C
units per unit Material Material
a. Selling Price (Rs./unit) 120 80 200 (Kgs.) (Kgs.) (Kgs.)
b. Variable Cost (Rs./unit) 100 70 150 Total available Raw 50,000
material
c. Contribution per unit ( a b) 20 10 50
Less : To be used for 15,000 1 15,000 35,000
d. Material required (kgs. / unit) 1 2 5 maximum demand of A
e. Contribution per kg. of raw 20 5 10 Less : To be used for 5,000 5 25,000 10,000
Maximum demand of C
materials (c / d)
Less : Balance material 5,000 2 10,000 --
f. Priority for manufacture I III II to be used for B

CA. Rakesh Agrawal 35 CA. Rakesh Agrawal 36

6
 iii) Statement of Optimum Profit :
Absorption Costing & Marginal Costing
Particulars Rs.
Contribution :
A : (15,000 units x Rs. 20 per unit) 3,00,000
B : (5,000 units x Rs. 10 per unit) 50,000
C : (5,000 units x Rs. 50 per unit) 2,50,000
Total Contribution 6,00,000
Less : Fixed Cost 2,00,000
Maximum Profit 4,00,000

CA. Rakesh Agrawal 37 CA. Rakesh Agrawal 38

Difference Between Absorption Costing & Marginal Costing

Step Ladder Cost
S.N. Absorption Costing S.N. Marginal Costing
1. Fixed cost is treated as 1. Fixed cost is treated as Period It is a type of semi variable cost, which is
Product Cost. Cost.
2. Inventory is valued at total 2. Inventory is valued only at
partly fixed and partly variable. But the
cost. (i.e. variable cost + fixed variable cost. problem is that the fixed and variable parts
cost)
are not separable from each other.
3. Value of stock is higher under 3. Value of stock is lower under
absorption costing. marginal costing. This cost remains constant in a particular
4. Absorption Costing shows 4. Marginal Costing shows range and then changes. Then again it
higher profits if Production is higher profits if Sales is
more than Sales. i.e. more than Production. i.e. remains constant in another range and
absorption costing rewards marginal costing rewards
production. sales.
again changes and so on
5. It is primarily used for 5. It is primarily used for decision
accounting. making.

CA. Rakesh Agrawal 39 CA. Rakesh Agrawal 40

Concept of Step Ladder Cost Rental Step Ladder Cost

Cost
Lets assume that a mini bus can 1,50,000
accommodate 30 passengers.
Your company hires this bus to bring the
1,00,000
workers in the factory.
Rent of the bus is ` 50,000 per month.
Then the rent cost shall be a step ladder 50,000

cost and can be graphically presented as:

No. of Workers
0 30 60 90

CA. Rakesh Agrawal 41 CA. Rakesh Agrawal 42

7
 Approach Relevant & Irrelevant Costing
Whenever there is a step ladder cost given in In these questions, majority of the data is
the question, it cannot be solved using our irrelevant for decision making.
normal technique. Because, we cannot divide
Your skill lies in separating relevant data from
the cost in two parts namely, (a) variable cost
irrelevant data, to be used for the purpose of
and (b) fixed cost.
decision making.
Hence, the approach used in solving such
question is Trial & Error. You may either treat
the step ladder cost as variable cost and try the
answer or treat it as fixed cost and then try the
answer.

CA. Rakesh Agrawal 43 CA. Rakesh Agrawal 44

Relevant & Irrelevant Cost for Decision Making

Relevant & Irrelevant Cost for material lying in stock
Relevant Cost Irrelevant Cost
Future cost or cost to be Sunk cost or past cost
1. Historical Cost or Book Value It is a
incurred sunk cost, hence irrelevant.
Avoidable cost i.e. Unavoidable cost i.e. non- 2. Realisable Value (i.e. sale value) It is
discretionary cost discretionary cost relevant only if the material has no
Cost which changes due to Cost which remains same alternative use.
decision irrespective of decision
3. Replacement Cost (i.e. latest purchase
Incremental cost i.e. Non-incremental cost i.e. not
additional cost an additional cost
price) It is relevant only if the material
is of regular use and its consumption will
Specific overheads incurred Common or general
for the decision overheads absorbed necessitate additional purchase.

CA. Rakesh Agrawal 45 CA. Rakesh Agrawal 46

Standard Costing & Variance Analysis Types of Variances

It is a technique, which is popularly used Variances are
for cost control. of 3 types

Sales Variances Cost Variances Profit Variances

Material Cost Labour Cost Variable OH Fixed OH

CA. Rakesh Agrawal 47 CA. Rakesh Agrawal 48

8
 Summary of Material Cost Variances
Circular Tally
Total Cost Variance
= (SQ x SP) (AQ x AP)
Cost Variance
Price Variance Usage Variance SQ x SP
= AQ x (SP AP) = SP x (SQ AQ)
AQ x AP

Mix Variance Sub-Usage

= SP x (SM AM) = SP x (SQ SM) Usage Variance Price Variance

AM = Actual Qty. Consumed and

SM = Actual Total Qty. consumed revised in standard proportion. AQ x SP

CA. Rakesh Agrawal 49 CA. Rakesh Agrawal 50

Circular Tally Labour Cost Variances

Usage Variance
SQ AQ i.e. AM

SP
Sub-usage Variance Mix Variance

AQ revised
i.e. SM

CA. Rakesh Agrawal 51 CA. Rakesh Agrawal 52

Summary of Labour Cost Variances Circular Tally

Total Cost Variance
= (SH x SR) (AH x AR)
Cost Variance
Rate Variance Efficiency Variance SH x SR
= AH x (SR AR) = SR x (SH AH)
AH x AR

Mix Variance Sub-Efficiency

= SR x (SM AM) = SR x (SH SM) Efficiency Variance Rate Variance

AH x SR

CA. Rakesh Agrawal 53 CA. Rakesh Agrawal 54

9
 Circular Tally Labour Cost Variance with Idle Time
Total Cost Variance
Efficiency Variance = (SH x SR) (AH paid x AR)
SH AH i.e. AM
Rate Variance Efficiency Variance
= AH paid x (SR AR) = SR x (SH AH paid)
SR
Sub-efficiency Variance Mix Variance
Idle time Variance Mix Variance Sub-Efficiency
= SR x ( AH paid = SR x (SM AM) = SR x (SH SM)
AH revised AH worked)

i.e. SM
Note : Actual Mix is actual hours worked.

CA. Rakesh Agrawal 55 CA. Rakesh Agrawal 56

Circular Tally Circular Tally

Efficiency Variance
Cost Variance Std. Hrs. AH paid
SH x SR AH paid x AR
Sub-efficiency Idle Time
Variance
SR Variance

Efficiency Variance Rate Variance

AH worked AH worked
revised i.e. SM i.e. AM
Mix Variance
AH paid x SR

CA. Rakesh Agrawal 57 CA. Rakesh Agrawal 58

Labour Cost Variance with Idle Time but without Circular Tally
mix & sub-efficiency
Cost Variance
In the given problem, if there is labour idle time AH paid
SH x SR
but no labour mix. In such case, the labour x AR
cost variance is analysed in 3 parts:
Efficiency Rate
Variance Variance
Labour Cost
Variance
AH worked AH paid
x SR x SR
Idle Time Efficiency Idle Time
Rate Variance Variance
Variance Variance

CA. Rakesh Agrawal 59 CA. Rakesh Agrawal 60

10
 Variable OH Cost Variances Calculation of Standard Recovery Rates :

SRR/Unit = Budgeted Overheads

Budgeted Output

SRR/Hour = Budgeted Overheads

Budgeted Hours

CA. Rakesh Agrawal 61 CA. Rakesh Agrawal 62

Fixed OH Cost Variances

Analysis of V. OH Cost Variance
OH Cost Variance

Cost Variance
(SRR/unit x actual output) Actual OH
OH Volume Variance
OH Expenditure Variance ( Output based )

Expenditure Variance Efficiency Variance

= (SRR/hr. x actual hrs.) Actual OH = SRR/hr. (Std. hrs. Actual hrs.)

OH Capacity Variance OH Efficiency Variance

( Hours based )

CA. Rakesh Agrawal 63 CA. Rakesh Agrawal 64

Fixed OH Cost Variances

Trick to remember formulae
OH Cost Variance
= (SRR/unit x Actual Output) Actual Overheads
First and last variance is same as Variable OH
variance i.e. Cost variance and Efficiency OH Volume (output) Variance =
OH Expenditure Variance
variance. = Budgeted OH Actual OH
SRR/unit x (Budgeted Output
Actual Output)
Rest all the variances are Budget minus Actual.

OH Capacity (hours) Variance = OH Efficiency Variance =

SRR/hour x ( Budgeted Hours SRR/hour x ( Standard Hours
Actual Hours ) Actual Hours )

CA. Rakesh Agrawal 65 CA. Rakesh Agrawal 66

11
 OH Calendar Variance OH Capacity Variance Revised
It is based on no. of working days However, there is a small change in Capacity
= SRR/day x (Bud. Working days Actual working days) Variance due to Calendar Variance.
If actual no. of working days are more, the variance is = SRR/hour x (Bud. hours in actual working
favourable and if actual working days are less, then it
days Actual hours in actual working days)
is adverse.
SRR/day = Bud. OH / Bud. Working days

CA. Rakesh Agrawal 67 CA. Rakesh Agrawal 68

Sales Variances Summary

Sales Value Variance
(Bud. Qty. x SSP) (Actual Qty. x ASP)

Sales Price Variance Sales Volume Variance

Actual Qty. x (SSP ASP) SSP x (Bud. Qty. Actual Qty.)

Sales Mix Variance Sales Qty. Variance

SSP x (Std. Mix Actual Mix) SSP x (Bud. Qty. Std. Mix)

Note : Actual Mix is actual quantity sold and Std. Mix is the total of actual
Quantity sold, revised in Std. proportion.

CA. Rakesh Agrawal 69 CA. Rakesh Agrawal 70

Circular Tally Circular Tally

Sales Value Volume Variance
Variance BQ AQ i.e. AM
BQ x SSP AQ x ASP
SSP
Qty. Variance Mix Variance
Sales Volume Sales Price
Variance Variance AQ revised
i.e. SM
AQ x SSP

CA. Rakesh Agrawal 71 CA. Rakesh Agrawal 72

12
 Profit Variances Profit Variances
Total Profit Variance
Total Profit Variance Budgeted Profit Actual Profit
Budgeted Profit Actual Profit (Bud. Qty. x SPPU) (Actual Qty. x APPU)
(Bud. Qty. x SPPU) (Actual Qty. x APPU)

Profit Price Variance Profit Volume Variance

Actual Qty. x (SPPU APPU) SPPU x ( BQ AQ )

CA. Rakesh Agrawal 73 CA. Rakesh Agrawal 74

Total Profit Variance Analysis of Profit Price Variance

Budgeted Profit Actual Profit
(Bud. Qty. x SPPU) (Actual Qty. x APPU)
Profit Price Var. = AQ x ( SPPU APPU )
Profit Price Variance Profit Volume Variance
Actual Qty. x (SPPU APPU) SPPU x ( BQ AQ )
Sales Price Var. = AQ x ( SSP ASP )
Cost Price Var. = AQ x ( SCP ACP )
Profit Mix Variance Profit Qty. Variance
SPPU x ( SM AM ) SPPU x ( BQ SM )

CA. Rakesh Agrawal 75 CA. Rakesh Agrawal 76

Total Profit Variance Profit Price Var. = AQ x ( SPPU APPU )

(Bud. Qty. x SPPU) (Actual Qty. x APPU)

Profit Price Variance Profit Volume Variance

Sales Price Var. = AQ x ( SSP ASP )
Actual Qty. x (SPPU APPU) SPPU x ( BQ AQ ) Cost Price Var. = AQ x ( SCP ACP )
Sales Price Var. Profit Mix Var. Profit Qty. Var.
AQ x (SSP ASP) SPPU x (SM AM) SPPU x (BQ SM)
Material Cost Var. = AQ x ( SMC AMC )
Cost Price Var. Labour Cost Var. = AQ x ( SLC ALC )
AQ x (SCP ACP)
[Link] Cost Var. = AQ x ([Link] [Link])
[Link] Cost Var. = AQ x ([Link] [Link])

CA. Rakesh Agrawal 77 CA. Rakesh Agrawal 78

13
 Total Profit Variance Total Profit Variance
(Bud. Qty. x SPPU) (Actual Qty. x APPU) (Bud. Qty. x SPPU) (Actual Qty. x APPU)

Profit Price Variance Profit Volume Variance Profit Price Variance Profit Volume Variance
Actual Qty. x (SPPU APPU) SPPU x ( BQ AQ ) Actual Qty. x (SPPU APPU) SPPU x ( BQ AQ )

Sales Price Var. Cost Price Var. Profit Mix Var. Profit Qty. Var. Sales Price Var. Cost Price Var. Profit Mix Var. Profit Qty. Var.
AQ x (SSP ASP) AQ x (SCP ACP) SPPU x (SM AM) SPPU x (BQ SM) AQ x (SSP ASP) AQ x (SCP ACP) SPPU x (SM AM) SPPU x (BQ SM)

Material Cost Labour Cost Variable OH Fixed OH Material Cost Labour Cost Variable OH Fixed OH

Price Usage Rate Efficiency Exp. Efficiency Exp. Volume

Mix Sub-usage Idle Mix Sub-efficiency Calendar Capacity Efficiency

CA. Rakesh Agrawal 79 CA. Rakesh Agrawal 80

Difference between Budgeted Profit, Reconciliation of Budgeted Profit with

Standard Profit & Actual Profit Actual Profit
Bud. Profit = Std. Profit = Actual Profit =
BQ x SPPU AQ x SPPU AQ x APPU

Profit Price Variance

Profit Volume
Variance Sales Price Cost Price
Variance Variance

CA. Rakesh Agrawal 81 CA. Rakesh Agrawal 82

An Example of Reconciliation Statement of Profit :

Total Profit Variance
(Bud. Qty. x SPPU) (Actual Qty. x APPU) Particulars W.N. Rs. Rs.
Profit Price Variance Profit Volume Variance Budgeted Profit [ 10,000 units x 14.23 ] 1,42,300
Actual Qty. x (SPPU APPU) SPPU x ( BQ AQ )
Less : Profit Volume Variance 3 (14,230)
Sales Price Var. Cost Price Var. Profit Mix Var. Profit Qty. Var. Standard Profit [ 9,000 units x 14.23 ] 1,28,070
AQ x (SSP ASP) AQ x (SCP ACP) SPPU x (SM AM) SPPU x (BQ SM) Add : Favourable Variances :
Sales price variance 2 11,250
Material Cost Labour Cost Variable OH Fixed OH Labour efficiency variance 7 6,750
Variable OH efficiency variance 9 1,008
Fixed OH expenditure variance 10 1,340
Price Usage Rate Efficiency Exp. Efficiency Exp. Volume
Fixed OH efficiency variance 12 1,935 22,283

Mix Sub-usage Idle Mix Sub-efficiency Calendar Capacity Efficiency

CA. Rakesh Agrawal 83 CA. Rakesh Agrawal 84

14
Statement continued . . .
Particulars W.N. Rs. Rs. Budgets and Budgetary Control
Less : Adverse Variances :
Material price variance 4 23,400 Budget is a quantitative plan of action for
Material usage variance 5 9,000
Labour rate variance 6 10,125
future period.
Variable OH expenditure 8 1,258 Budgetary control is a technique of
Fixed OH capacity variance 11 4,085 (47,868)
exercising overall managerial control with
Actual Profit 1,02,485
the help of budgets.

CA. Rakesh Agrawal 85 CA. Rakesh Agrawal 86

Types of Budgets
Difference between
From examination point of view, you are
Standard Costing Budgetary Control generally asked to prepare :
Stress is on cost control Stress is on overall 1. Functional Budgets : i.e. Sales budget,
managerial control Production budget, Purchase budget,
Micro level control Macro level control Manpower budget, Cash budget etc. and
Doesnt help in Helps in coordinating 2. Flexible Cost Budgets : i.e. Calculation of
coordinating activities various activities cost at various levels of activities. These
are based on marginal costing principles.

CA. Rakesh Agrawal 87 CA. Rakesh Agrawal 88

Functional Budgets Common Link used in Budget

These are very popular questions. Sales Budget Master Budget

To solve these questions, first you have
to identify the key factor or budget factor.
In majority cases, it is sales. Production Budget Manpower Budget
Then you have form a linkage between
key factor and other dependent budgets
like production, material consumption, Consumption Budget Purchase Budget
material purchase, manpower etc.

CA. Rakesh Agrawal 89 CA. Rakesh Agrawal 90

15
 Pricing Decisions & Pareto Analysis Methods of Pricing
It is one of the most crucial and difficult There are 4 methods of fixation of sales price :
decision, which management has to make. 1. Cost plus Pricing
Growth and profitability of an organisation 2. Rate of Return Pricing
largely depends upon its pricing decision. 3. Variable Cost Pricing
Pricing decisions are of two types : 4. Competitive Pricing
1. Pricing for External Customers and
2. Pricing for Internal Transfers

CA RAKESH AGRAWAL 91 CA RAKESH AGRAWAL 92

Market Entry Strategies Price Differentials

1. Skimming Pricing 2. Penetration Pricing (a) Clock Time Differential

It is the pricing method, It is the pricing method,
where very high price is where very low prices are (b) Calendar Time Differential
charged initially and then it is charged initially and then it is
reduced gradually over a increased gradually over a (c) Geographical Price Differential
period of time. period to time.
It is generally used for a new This pricing policy is
(d) Consumer Category Price Differential
invention and technologically generally used in a
new product being launched. competitive market.

CA RAKESH AGRAWAL 93 CA RAKESH AGRAWAL 94

Pareto Analysis Pareto Analysis

He observed a similar pattern in other states
It was developed by an Italian Economist also.
called Vilfredo Pareto.
Then Mr. Pareto applied this observation to
He was studying the pattern of wealth owned other business situations to prove its validity.
by the people of state of Milan.
He noticed that with some approximation say
He noticed that 80% of the wealth of Milan was 70 : 30 or 75 : 25, it applied to all situations.
owned by 20% of its citizens.
In nutshell, few things are responsible for big
He called it as 80 : 20 Rule. results or few reasons are responsible for big
problems and so on.

CA RAKESH AGRAWAL 95 CA. Rakesh Agrawal 96

16
 Pareto Analysis Application of Pareto Analysis
Very often, 80% of consequences flow from Here are some business applications
20% of causes, 80% of results come from 20% of this theory :
of effort, the opinion of 20% defines the
society, 20% of customers contribute to 80% of 1. Pricing of product
our profitability and 80% of the question paper 2. Customer Profitability
comes from 20% of the syllabus. 3. Stock Control
Joseph Juran referred to this 20% as the vital
few and the 80% as the trivial many. Focus
4. Application in Activity Based Costing
on the 20% vital few and ignore 80% trivial 5. Quality Control
many to improve the productivity.

CA. Rakesh Agrawal 97 CA. Rakesh Agrawal 98

Transfer Pricing Types of

Responsibility
Transfer price is the price which one unit of an Centres
organisation charges to another fellow unit of the
same organisation for the goods or services
supplied. Revenue Cost Profit Investment
Centre Centre Centre Centre
This decision assumes more significance
specially when the various units of the
organisation are treated as responsibility
centres.

CA. Rakesh Agrawal 99 CA. Rakesh Agrawal 100

Objectives of Transfer Pricing Methods of Transfer Pricing

Primarily there are 3 methods of transfer pricing :
To foster commercial attitude in the executives who
1. Pricing at Cost : It includes
are responsible for the performance.
(a) Actual manufacturing cost
To ensure optimum utilisation of resources, so that
overall profit of the organisation can be maximised. (b) Standard cost
To promote healthy competition amongst the sister (c) Full cost
units of the same concern. (d) Full cost plus
2. Market Price method
3. Negotiated Price method

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 Important Points for Problem Solving Activity Based Costing (ABC)
The objective should always be to maximise It is an alternative method of charging Factory
Overheads.
the total profits of the organisation and not of
There are 3 methods of charging factory
the individual profit center.
overheads:
Method of transfer pricing does not affect the 1. Single Rate or Blanket Rate Method
overall profit of the organisation, but it only 2. Departmental Rate Method and
affects the profitability of individual 3. Activity Based Costing Method
responsibility centers.
When we buy goods from outside or sale the
goods outside, then only the overall profit of
the organisation gets affected.

CA. Rakesh Agrawal 103 CA. Rakesh Agrawal 104

Activity Based Costing Method Steps Involved in ABC

It is similar to departmental rate method with the 1. Make a list of all activities, which are carried out in
only difference that the rates are calculated activity the organisation.
wise instead of department wise. 2. Bifurcate the activities in to Primary and
Generally, the no. of activities carried out in an Secondary activities.
organisation are more than the no. of 3. Group the cost data activity wise. It is similar to
departments. allocation of OH.
Hence, this method leads to more detailed 4. Charge common cost of various activities to each
analysis of overheads activity wise. activity, on suitable basis. It is similar to
This method is considered to be superior to all apportionment of OH.
other methods. 5. Charge secondary activity costs to primary
Overheads are charged more accurately and thus activities, on the basis of services rendered. It is
the cost data is reliable for decision making. similar to re-apportionment of OH.

CA. Rakesh Agrawal 105 CA. Rakesh Agrawal 106

Costing in Service Sector

Steps Involved in ABC
(Operating Costing)
6. Take the total of overheads cost of each
Primary Activity. It is known as Activity This method of costing is used for
Cost Pool. calculating cost and profitability in
7. Divide the total cost by a suitable basis the Service industry. E.g. Goods
(known as activity cost driver), to calculate
overhead recovery rate for that activity transport, Passenger transport,
(known as activity cost driver rate). Hotels, Hospitals, Educational
8. Use this rate to charge the overheads cost Institutes etc.
to cost object.

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Important points to note : Cost Sheet Format
1. Identification of Unit of Service Particulars Total Per unit
A. Variable Cost :
2. Quantification of effective services
B. Semi Variable Cost :
rendered
C. Fixed Cost
3. Uniformity of data D. Total Cost (A+B+C)
E. Revenue
4. Cost Sheet format
F. Profit

CA. Rakesh Agrawal 109 CA. Rakesh Agrawal 110

Target Costing Target Costing

It is defined as a structured approach to From the definition, we can say that it is the
determining the cost at which a proposed reverse approach of calculating cost from its
product with specified functionality and quality selling price.
must be produced, to generate a desired level of Under conventional method, we calculate cost,
profitability at its anticipated selling price. and then add profit to it, to get selling price.
Under Target Costing, we first anticipate the
sales price, then deduct our desired profit
margin, to arrive at the target cost.

CA. Rakesh Agrawal 111 CA. Rakesh Agrawal 112

Life Cycle Costing Total Quality Management (TQM)

This technique of costing believes that like a human life The TQM theory is based on a belief that There
cycle, a product also passes through various cycles in its is always a scope for improvement, whatever
life. Which is known as Product Life Cycle. small.
A product generally passes through the following 5 This belief, makes you to adjust to the changes
phases in its life : in economy, change in technology and so on. In
simple words, it causes frequent changes for
(a) Introduction making further improvement.
(b) Growth The objective is not to stop at the best
(c) Maturity performance, but to better the previous bests.
(d) Decline This theory believes that, we not only have to
(e) Deletion satisfy the customers expectation but we should
exceed his expectation.

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 Six Cs of TQM
Certain Concepts in TQM
Quality Control (QC) : The stress is only on the For successful implementation of TQM in an
quality of finished goods produced. organisation, following are considered to be
the essential requirements :
Quality Assurance (QA) : The stress is on
assuring good quality of finished product, that is 1. Commitment : specially form top management
zero defect policy. 2. Culture : TQM is a culture or attitude
Quality Management (QM) : The stress is on the 3. Continuous Improvement :
entire managerial process, by which the goods 4. Co Operation : total employee involvement
are produced and sold. 5. Customer focus : external & internal both
6. Control : i.e. monitoring and supervision

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Cost of Quality Cost of Quality

The "cost of quality" isn't the price of The quality costs are of 4 types i.e.
creating a quality product or service. It's (a) Prevention cost
the cost of NOT creating a quality product
or service. (b) Appraisal cost
Every time work is redone, the cost of (c) Internal failure cost and
quality increases. (d) External failure cost.
In short, any cost that would not have
been incurred if quality were perfect
contributes to the cost of quality.

CA. Rakesh Agrawal 117 CA. Rakesh Agrawal 118

Value Chain Analysis Procedure of Value Chain Analysis

This technique views an organisation as a chain 1. Treat all customers i.e. internal as well as external
of activities which are inter-related to each other. customers as your customers.
2. Arrange for a feedback process, to know how much
Which means, an organisation is divided in to a
value your customer receives from an activity.
number of activities. Then each activity is
analysed for cost incurred on it and value added 3. Compare the cost incurred on each activity versus
value received by your customer.
by it.
4. Identify Value Added (VA) activities and Non Value
Activities (NVA). Stop the NVA activities.
5. Some activities which are NVA, but are required to be
carried out for the sake of legal compliance, should be
continued.

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 Objectives of Value Chain Analysis Just in Time Approach (JIT)
1. Reduce cost without affecting value This approach aims at removal of all possible
received by the customer waste from the system.
The broad approach is to remove the wastage
2. Increase Value without increasing the
of resources like men, machine, material etc.
cost
However, it places more stress on inventory
3. Reduce cost and simultaneously management i.e. Raw Material, WIP and
increase the value received by customer. Finished Goods.

CA. Rakesh Agrawal 121 CA. Rakesh Agrawal 122

Raw Material Management under JIT WIP & FG under JIT

The company will identify such suppliers of Lack of co-ordination between different machine
material, who can deliver quality material, just operators, usually result in building up huge
inventories of WIP.
before the start of production.
To reduce this inventory, a Kanban Card system may
The purpose is to have no stock of material be introduced.
and thereby save material management cost. Kanban Card, is a written instruction passed on by
Production schedules are shared with the downstream machine operator to upstream machine
supplier, so that he can supply right quantity of operator. It specifies the type of input, quantity of input
material at right time. and timing of material needed to upstream machine
operator. Thus it helps in better co-ordination between
them.

CA. Rakesh Agrawal 123 CA. Rakesh Agrawal 124

WIP & FG under JIT WIP & FG under JIT

Another idea is to produce the goods in small batch size, to avoid One more method is to have Small Working Cells. That is 4 to 5
overstocking. different machines of small capacity can be put in one cell and
However, small batch size will lead to more number of batches only one operator is appointed for that cell.
and thus higher set-up cost. The operator is trained to handle all the machines in the cell. He
To reduce the set-up cost of machine, a Video Tape approach can do machine set up, necessary repairs etc.
may be introduced. Thus the capital investment in machinery is reduced and
Under this approach, a video shooting is done while the machine manpower cost is reduced.
is under set-up. The machine operator is held fully responsible for his work and he
This video tape is shown to skilled engineers and technicians to cannot pass on the blame to other.
suggest the improvements in the methods of machine set-up. If demand picks up later on, then more such working cells can be
After 4 to 5 trials, it is observed that the set-up time and set-up established, over a period of time. The idea is to avoid huge
cost can be considerably reduced. investment in the initial stage and avoid manpower cost.

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 Material Requirement Planning MRP I Material Requirement Planning MRP I
It is an automated approach to plan for the material The concerned clerk or manager will view his schedule
requirement of an organisation. In this approach, on daily basis and will execute the same.
Computer and Software is used to do the entire For smooth functioning of this system, one has to
material requirement planning. ensure that the pre-requisite information fed in to the
Sales people will feed the data of customer orders system is accurate. Like, Bill of Material, Lead Time,
booked by them. Like, the quantity to be delivered, Processing Time, Delivery Time etc.
place of delivery and time of delivery. Another important thing is to ensure the strict
The software will automatically update, the delivery adherence to the schedules.
schedules, packing schedules, production schedules,
purchase orders etc., depending upon the time
required for each activity.

CA. Rakesh Agrawal 127 CA. Rakesh Agrawal 128

MRP-II ERP - Enterprise Resource Planning

This is the recent development in MRP. ERP is an integrated software, which covers all the
It says that in addition to planning for material, we managerial functions of an organisation.
need to plan for other resources also like manpower, It is the best gift of Software Industry to this
machinery etc. commercial world.
Hence, MRP-II stands for Manufacturing Resource In todays era of globalisation and competition, it is
Planning. Just an extension of MRP-I. becoming very difficult to effectively manage the
business. Specially, in case of Multinational
Companies, whose business operations are spread all
over the world, control has become very difficult.
In such a situation, ERP is the only effective solution,
to manage the business.

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Advantage of ERP Software Balanced Score Card

Duplication of work is avoided It is a method of comparison of performance of 2 or
Uniformity in approach, all over the world more business entities.
Very quick in consolidation of data This method suggests that the comparison should not
All business functions are bundled into one software be based on Quantitative data only, but Qualitative
aspects should also be considered, to make the
Competitive Edge over others comparison meaningful.
This tool for comparison was devised by Kaplan &
Norton in the year 1992.

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 Business Perspective of Balanced Score Card Benchmarking
Generally, balanced score card has the following It is a technique for continuous improvement.
four perspectives from business evaluation point
of view. It involves comparing a firms product, service
or activity against other best performing
1. Customer perspective : i.e. how do customers see
us. organisation.
2. Internal perspective : i.e. what must we excel at. The objective is to find the difference between
3. Innovation and Learning perspective : i.e. can we
our organisation and the best organisation, to
continue to improve and create value. know the areas of improvement.
4. Financial perspective : i.e. how do we look to our
shareholders.

CA. Rakesh Agrawal 133 CA. Rakesh Agrawal 134

Process of Benchmarking Computer Aided Manufacturing (CAM)

1. Planning : It includes defining the goals, When manufacturing process is carried out using
machinery and integrated software, it is called as
identification of best performance, forming a computer aided manufacturing.
benchmarking team etc. It is a process of automation to avoid the chances of
error due to human element.
2. Collection of data and information Production people call it is as CNC machines i.e.
3. Analysing the findings Computer Numerical Control machines.
CNC machines are able to repeat the same operation
4. Recommendations continuously in identical manner, with high accuracy
level.
5. Monitoring and Reviewing
The machine operators job has changed from doing
the work to getting the work done from machines with
the help of computers.

CA. Rakesh Agrawal 135 CA. Rakesh Agrawal 136

Throughput Accounting Theory of Constraints (TOC)

This concept is similar to key factor concept of This theory was advocated by Goldratt and Cox of
marginal costing. USA in 1989.
The only difference here is that, all costs other than The same theory in UK was known as Throughput
material cost is treated as fixed cost. Accounting.
Throughput Contribution = Sales Material cost This theory distinguishes between a bottleneck and a
The objective is to maximize throughput contribution, constraint.
within available limited resources. Bottleneck is a key factor i.e. something in short
supply, which is internal to the organisation and
Constraint is a limitation which is external to the
organisation.

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 Procedure of TOC Uniform Costing & Inter Firm Comparison
Step 1 : Calculate total resources required for each department Uniform Costing is not a separate method of costing.
separately. i.e. [ no. of units x resources required per unit ] In fact, when several undertakings start using the
Step 2 : Calculate throughput accounting (TA) ratio for each same costing principles and practices, they are said to
department as
be following uniform costing.
Capacity Required x 100
Capacity Available Uniform Costing is a pre-requisite for inter firm
Step 3 : The highest TA ratio will be considered as the bottleneck comparison.
factor. Inter firm comparison is a technique of evaluation of
Now, we have to follow the same procedure of marginal costing performance, efficiency, costs and profits of firms
question, treating this bottleneck factor as a key factor, to belonging to same industry.
maximise throughput contribution.

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Uniform Costing & Inter Firm Comparison Some areas of differences

The purpose of inter firm comparison is to exchange Method of stock valuation.
the cost and profit data with each other, to improve the Method of charging depreciation.
efficiency of each organisation. Labour remuneration system.
However, in order to make the data comparable, one Method of allocation and absorption of overheads.
has to follow Uniform Costing approach.
Method of apportionment of joint cost etc.
There are various areas in cost accounting, where the
calculation of cost is different for different
organisations. One needs to bring uniformity in the Note : Unless the differences in these areas are
approach of cost calculation to make the data reconciled and uniform approach to cost calculation is
comparable with each other. followed, the data is not fit for inter firm comparison.

CA. Rakesh Agrawal 141 CA. Rakesh Agrawal 142

Thank you !
Wish you Best luck for your exam !

CA. Rakesh Agrawal 143

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